Supply chain coordination under trade credit and retailer effort

Abstract

In this paper, we study the role of trade credit in coordinating a Capital Constrained Supply Chain in the presence of retailer Effort (CCSCE), essentially because of the impact of its related default risks on the relationship between the chain’s members. We consider a CCSCE consisting of a supplier and a retailer where the retailer may exert costly promotional efforts to increase the market demand but has limited capital and no access to bank financing due to low credit rating. Conversely, the supplier has adequate funds to offer trade credit to the retailer without borrowing from external channels. We then examine whether the existing coordination contracts can still coordinate the CCSCE under trade credit. Our result shows that these contracts can achieve coordination of the supply chain when the interest rate of trade credit is competitively priced. Nevertheless, this position cannot always be reached. That’s why we propose a generalised contract based on risk compensation to coordinate the CCSCE. Using our proposed coordinating contract, the supplier perfectly coordinates the retailer’s decisions for the largest joint profit, and arbitrarily allocates the maximised joint profit among supply chain members. Finally, the numerical study allows to verify this finding. From managerial insights, our results provide the supply chain managers with novel insights on how to combine trade credit with the existing coordination contracts in order to improve the profitability of the entire supply chain as well as the individual member.