Financing Disruptive Suppliers: Payment Advance, Timeline, and Discount Rate

Abstract

This study considers a dyadic supply chain in which a large and creditworthy buyer procures a product from a capital‐constrained supplier subject to disruption risk. In facilitating the production, the buyer may offer direct financing to the supplier by way of advance payment (AP). Concurrently, the buyer may also set a tailored discount rate (TR) that applies to the AP and an extended payment timeline (PE) for the balance due. We analyze the value and interplay of these elements by comparing optimal contractual terms with different AP, PE, and TR potentials. In general, AP applies to more reliable suppliers, and the coverage could be broadened by the inclusion of PE and TR. Specifically, when the advance discount rate is regulated within a certain limit, the buyer should offer TR without PE to the most reliable suppliers, vs. the floor discount rate with PE to those posing higher risk. Although the buyer normally benefits from practicing PE, the supplier benefits from it only when the risk level is relatively high and suffers from it when the risk level is relatively low; these effects persist although they are weakened in the presence of TR. Overall, PE and TR focus on different risk spectrums and are strategic substitutes for each other. The buyer can thereby retain its maximum payoff by properly configuring PE or TR when the other is under strict regulation. These insights offer strategic guidance for buyers to engineer business cash flows with respect to the risk level of their suppliers and the external regulation environment.