The supply chain effects of trade credit under uncertain demands

Abstract

Trade credit is an important form of short-term financing for capital-constrained small firms. In this paper, we build a supply chain model consisting of one supplier and two competing retailers to investigate the impacts of trade credit on both vertical and horizontal supply chain interactions. The supplier is a large-scale manufacturer with a strong financial status that can offer trade credit to the two downstream retailers who may be financially constrained. The two retailers are engaged in Cournot competition with uncertain market demands. The demand risks may expose a financially distressed retailer to bankruptcy risk, which may be transmitted vertically through trade credit to the upstream supplier. Horizontally, the trade credit and the ensuing bankruptcy risk of one retailer will also affect the other retailer’s competition behavior and profit. We find that trade credit has two opposite effects on downstream retailers’ selling quantity decisions: it may either aggravate or soften two retailers’ competition. Interestingly, when two retailers have unbalanced financial statuses, the supplier may bail-out the financially distressed retailer, and the predation between two retailers exhibits a bidirectional pattern. Moreover, we show that a retailer always benefits from a better financial status. Improvement of the competitor’s financial status, however, may be either beneficial or harmful to the retailer, depending on the demand uncertainty and competition intensity. The supplier’s preference for the retailers’ financial statuses may also be influenced by the demand uncertainty and competition intensity.