Financing Strategies for a Capital-Constrained Supplier under Yield Uncertainty

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We consider a supply chain with a supplier who has a capital constraint and faces the productivity yield uncertainty. We propose an advance payment with risk compensation (APRC) mechanism, under which the distributor finances the supplier with an advance payment, and the supplier pays interest on the advance payment to compensate the distributor for the supplier's bankruptcy risk. The optimal solutions are derived under the APRC mechanism and are compared with those under the bank loan financing. The results indicate that under the APRC, the profits and the strategies of the supply chain are the same with those under the case that the supplier has enough capital. In other words, the whole supply chain will perform at least as well as if there is no capital constraint. Therefore, the APRC is a perfect solution for the supplier's capital constraint issue. Especially, when the deficit is big and the supplier can not get financed from a bank due to the high risk, the APRC provides an alternative financing arrangement and it can bring higher profits for both parties. Another very interesting thing we find is that, when the capital deficit is small, the supplier can do better with the bank loan financing, despite that a higher interest rate needs to be paid in this case.