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Subcontracting versus capacity expansion and the impact on pricing of services

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  • Cheryl Gaimon

Abstract

The strategic trade‐offs between acquiring new capacity and subcontracting (or leasing) capacity are explored for service environments characterized by rapid technological improvement or highly seasonal demand. Reflecting the focus on service‐sector organizations, it is assumed that demand cannot be met from inventory. Furthermore, the critical impact that subcontracting has on a firm's competitive pricing policy is examined. The analysis presented is of particular relevance for firms in price‐competitive industries such as telecommunications, information services, or health care, because subcontracting capacity represents an alternative to acquiring costly new capacity which may soon become obsolete or unnecessary. It is shown that the optimal price charged is based on the higher of the two operating costs incurred (internal unit cost or unit cost of subcontracting). It is also shown that as a consequence of subcontracting to maximize profit, the optimal price charged is never reduced and may increase. © 1994 John Wiley & Sons, Inc.

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  • Cheryl Gaimon, 1994. "Subcontracting versus capacity expansion and the impact on pricing of services," Naval Research Logistics (NRL), John Wiley & Sons, vol. 41(7), pages 875-892, December.
    • Handle: RePEc:wly:navres:v:41:y:1994:i:7:p:875-892
    DOI: 10.1002/1520-6750(199412)41:73.0.CO;2-Y
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    References listed on IDEAS

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    1. Gaimon, Cheryl, 1988. "Simultaneous and dynamic price, production, inventory and capacity decisions," European Journal of Operational Research, Elsevier, vol. 35(3), pages 426-441, June.
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    Cited by:

    1. Yasemin Merzifonluoğlu & Joseph Geunes & H.E. Romeijn, 2007. "Integrated capacity, demand, and production planning with subcontracting and overtime options," Naval Research Logistics (NRL), John Wiley & Sons, vol. 54(4), pages 433-447, June.
    2. James R. Bradley, 2004. "A Brownian Approximation of a Production-Inventory System with a Manufacturer That Subcontracts," Operations Research, INFORMS, vol. 52(5), pages 765-784, October.

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