The Role of Financial Services in Procurement Contracts

Abstract

In this paper we investigate the interplay between operational and financial decisions within the context of a two-echelon supply chain. A retailer purchases a single product from a supplier and afterwards sells it in the retail market to a random demand. The retailer, however, is budgetconstrained and is therefore limited in the number of units that he may purchase from the supplier. We study two alternative forms of financing that the retailer can use to overcome the limitations imposed by the budget constraint. First, we consider the case of internal financing in which the supplier offers financial services to the retailer in the form of a procurement contract. The type of contracts that we consider allows the retailer to pay in arrears a fraction of the procurement cost after demand is realized. Second, we consider the case of external financing in which a third party financial institution (e.g., a bank) offers a commercial loan to the retailer. Our results show that the performance of the entire supply chain can be severely affected by the lack of financing and that it is in the interest of both players to find ways to finance the retailer's operations. We also show that, for the most part, both the supplier and the retailer (and the entire supply chain) are better off by using internal financing rather than by relying on external financing. From the supplier's point of view, we show that the value of offering internal financing decreases with the size of the retailer's initial budget. This is despite of the fact that the risk of the retailer defaulting on his contractual obligations decreases with his initial budget. Interestingly, from the retailer's standpoint the value of internal financing is non-monotonic in his budget and there is an intermediate value at which his expected payoff is maximized.

Focusing the financial flow of supply chains: An empirical investigation of financial supply chain management

“…However, scholars only recently began to demonstrate in formal analytical models how planning, managing, and controlling financial flows along supply chains positively affect supply chain profitability (Caldentey and Chen, 2009;Liu and Cruz, 2012;Raghavan and Mishra, 2012). For instance, scholars have expounded how inventory control models should be adapted to financial considerations, such as trade credits, stochastic prices, or dynamic financial constraints (e.g.…”

Managing the Innovation Adoption of Supply Chain Finance—Empirical Evidence From Six European Case Studies

“…Even though we tackle an empirical research phenomenon there has been a rise in formal analytical modeling papers informing our research on the logistics and finance interface (e.g., Buzacott and Zhang ; Berling and Rosling ; Caldentey and Chen ). For instance, Protopappa‐Sieke and Seifert () analyze the interrelation of financial and logistics decisions within a supply chain indicating that improved upstream cash flows may reduce suppliers’ financial constraints and thus improve physical flows.…”

“…The theoretical contributions of our research to innovations in logistics are manifold. First, we add to the emerging research on the logistics and finance interface (e.g., Buzacott and Zhang 2004;Berling and Rosling 2005;Caldentey and Chen 2009;Hofmann and Kotzab 2010) by taking an organizational perspective. Whereas previous research in this new domain focused mainly on the outcomes of managing the financial and physical flows jointly, we explore the process of getting there.…”

A financing model with rebate contract in a capital-constrained supply chain

“…Babich et al [3] examined the comparisons between bank and trade credit in different settings, and showed that the firm should choose finance channel with a lower finance cost. Caldentey and Chen [7] explored the value of delayed payment model (internal trade credit) in the supply chain, and showed that the manufacturer preferred an internal trade credit over bank financing when there exists competition between external and internal financing channels to the retailer. Kouvelis and Zhao [25] documented that a risk-neutral supplier always finance the retailer at less than or equal to the risk-free rate, and the retailer will always choose trade credit rather than bank financing in an optimally structured trade credit contract.…”

“…Lemma 1 reflects that the retailer's ordering and supplier's pricing decisions are identical to those results under the newsvendor model with no budget constraint. Just as [7], because a competitive financial market leads to a zero profit of bank and allows the supply chain to operate in the same way that the retailer has no capital constraints, so the retailer makes an order quantity just as under the classic newsvendor model. Under this case, the optimal expected profits of retailer and supplier are…”