Motivated by the remanufacturing systems at Daimler AG and other automobile, aerospace and heavy machinery parts dealers/manufacturers, we develop a hybrid manufacturing/remanufacturing system with controlled two-way substitution between new and remanufactured products. We develop Markov decision processes for management on product-level as well as on component-level. We show that the optimal policy on product-level has the switching-curve structure under the assumption that the lost sales costs for new and remanufactured products are identical. Based on this structural result, we develop an efficient, close-to-optimal heuristic for the general product-level model and for the component-level model. Our numerical experiments indicate that two-way substitution on component level significantly reduces total cost. We also extend our model to strategic cost that includes environmental aspects in the objective function. For this model, we find that substitution appears to be a phenomenon primarily beneficial for profit-oriented firms. Sustainability-oriented firms require significantly less frequent product substitution.
