Horizontal subcontracting agreements between rival firms, each of which is capable of producing and marketing its products independently, are common. This article explains this practice and evaluates its welfare implications. The analysis shows that firms with asymmetric convex costs can use horizontal subcontracting to allocate production more efficiently between them and consequently generate a mutually beneficial surplus. For a wide range of parameters, this increase in production efficiency leads to an increase in industry output. The counterintuitive result is that welfare is thereby enhanced. In fact, even when industry output falls, welfare can still increase if production costs are sufficiently lowered.