An inventory model with capacity flexibility in the existence of advance capacity information

In this paper we study the inventory/production problem of a firm that uses operational level outsourcing to hedge against uncertainty. We consider an environment in which the maximum amount that can be produced in a period, the regular capacity of the system, is uncertain, but information on its realization (which we call the advance capacity information (ACI)) is available. We model the uncertainty in regular capacity, and present an ACI process that tracks and updates the information on the availability of the regular capacity. For this system we propose an ACI-dependent order-up-to level policy. We characterize the optimal solution under the order-up-to level policy, and through a numerical study we derive managerial insights with respect to the benefits of using outsourcing option and ACI. (C) 2012 Elsevier B.V. All rights reserved.