Financing Suppliers in the Presence of Demand Risk

Abstract

Capital constraints are prevalent in supply chains. Since traditional bank financing is often inaccessible, especially for small and medium enterprises, two new alternatives, purchase order financing (POF) and buyer direct financing (BDF), are receiving increasing attention for financing capital-constrained suppliers. We study these two financing schemes under demand risk. We find that, first, surprisingly, POF can always coordinate the supply chain with effectively a wholesale price contract, eliminating the adverse effect of the supplier's financial constraint. BDF can also coordinate the supply chain under certain conditions, but not always. Second, the benefit of supply chain coordination is not distributed evenly. Compared with traditional bank financing, both POF and BDF benefit the buyer but hurt the supplier. Finally, when the buyer has superior information regarding the market demand, the benefit of POF is more pronounced, since POF can perfectly address the information asymmetry while BDF can not. Our research findings thus provide new perspectives on the mechanisms of POF and PDF and also explanations for the increasing popularity of POF.

Keywords: bank financing; buyer direct financing; purchase order financing; demand risk; information asymmetry