Coordinating contracts under default risk control-based trade credit

Abstract

This study considers a supplier–wholesaler channel in which providing trade credit to buyers incurs default risk. The motivation for this research stems from the apparel industry, where a supplier sells clothes to a wholesaler and multiple retail traders buy clothes from the wholesaler. The wholesaler provides a (down-stream) credit period to retail traders and makes optimal credit period and order quantity decisions under random and credit period dependent demand. The wholesaler assumes the risk in case they do not receive the payment for goods from a retail trader on time. In this situation, neither the wholesaler nor the supplier can receive the account owed for the same batch of clothes. Thus, the supplier provides the wholesaler a (up-stream) credit period, called default risk control-based trade credit, which decreases as the down-stream credit period increases. Based on the newsvendor model, we design coordinating contracts under default risk control-based trade credit. Our results show that trade credit policy cannot coordinate the channel, even if a buyback policy is provided simultaneously or the supplier's selling price is endogenously determined. To achieve channel coordination and Pareto optimality, two composite contracts based on partial trade credit (with buyback or quantity flexibility) are designed. Additionally, the wholesaler orders fewer product and provides a shorter credit period to retailers when the supplier considers default risk control in providing trade credit to the wholesaler. Overall, we show that the partial trade credit scheme plays an important role in channel coordination when considering default risk control-based trade credit.