On the effect of overtime and subcontracting on supply chain safety stocks

Abstract

In supply chain safety stock placement models, production lead times are typically considered exogenous; however, in many supply networks, lead times are controllable and should be considered as endogenous variables. This work integrates strategic safety stock placement with subcontracting and overtime planning that can be used to optimize lead times. We formulate the problem of jointly optimizing safety stocks and lead times to minimize production and inventory holding costs, while guaranteeing a customer service level.Using a two-stage supply chain, we analyze the impact of subcontracting and overtime on optimal safety stock placement both analytically and numerically. Our analysis suggests that high usage of subcontracting and overtime tend to decouple safety stocks such that both raw materials and finished goods safety stocks are held. For multistage networks, we derive bounds on decision variables, which are used in a dynamic programming algorithm to solve the integrated problem. Experiments on selected supply chains from publicly available data sets show the value resulting from joint optimization of lead times and safety stocks. The results indicate that the integrated problem leads to greater usage of operational flexibility and shorter lead times as compared to the sequential problem, where lead times are optimized locally. In addition, the value of integration depends on the subcontracting and overtime costs along with the value added at a stage.