Financing inventories with an investment efficiency objective: ROI-maximising newsvendor, bank loans and trade credit contracts

Abstract

Our work offers an understanding of how capital efficiency metrics, such as Return-on-Investment (ROI), affect orders at a stand-alone single stocking stage under demand uncertainty or within bilateral supply chains of a supplier and buyer interacting with the use of a trade-credit-contract. In both environments, the buyer is looking for financing its inventories either through a bank or through the supplier via extended payment terms. In the single stocking stage case, our buyer – the newsvendor – exhibits conservative behaviour and orders less than the traditional quantity. The analysis of the bilateral supply chain of our newsvendor buyer and a supplier, who is willing to finance the buyer's inventories via trade-credit contract, continues to support the low interest rate of such contracts. Interestingly now the buyer orders more than under profit optimisation. The ROI-driven buyer enjoys higher margins due to unusually low supplier financing rates even at slightly increased wholesale. The overall supply chain efficiency improves, and the supplier increases her percentage of the chain profit by offering higher wholesale prices but accepting some inventory financing risk. Using ROI to make ordering decisions better aligns these decisions with sound working capital management metrics while accounting in a balanced way for profit margins.