Implications of credit default and yield uncertainty on supply chain's equilibrium financial strategy.

Abstract

Two financial schemes, i.e., purchase order financing (POF) and buyer direct financing (BDF), have been proposed for small and medium-sized manufacturers. This study considers a supply chain consisting of a capital-constrained manufacturer who faces the random yield and has a probability of credit default, a well-capitalized retailer, and a bank. We find that the manufacturer prefers POF scheme if the unit production cost is high and the default risk is low, and BDF scheme otherwise. Whereas the retailer benefits from POF when the unit production cost is small. Thus, the retailer, as the leader, has an incentive to distort the purchase price to induce the manufacturer’s financing strategy towards the retailer’s preference. Furthermore, only BDF can achieve a Pareto improvement since the retailer plays a dual role (i.e., buyer and lender) under BDF.