Analysis of a Downward Substitution Strategy in a Manufacturing/Remanufacturing System

A hybrid production system is considered where both manufacture of new product and remanufacture of returned items is performed. Due to consumer perception, new and remanufactured products are treated as different products with different costs and selling prices as well as separate demand streams. Remanufactured products have a higher stock out risk because the remanufacturing capacity is limited by the amount of returns available for remanufacture. One way to cope with this risk is to use a downward substitution strategy, i.e. a higher valued manufactured product is substituted for an out of stock lower valued remanufactured product. We formulate this control problem as an infinite-horizon hybrid manufacturing/remanufacturing system with product substitution under stochastic demand and returns. We model it as a Markov Decision Process in order to determine the optimal manufacturing and remanufacturing decisions under product substitution. The effects of stochastic demand/return distributions on the profitability of the substitution strategy are investigated through numerical experimentation.