Retailer-Initiated Inventory-Based Financing

Abstract

Problem definition: We examine retailer-initiated inventory-based financing (IBF), a novel mechanism in which a small retailer pledges on-hand inventory as collateral to secure loans from a large retailer outside its traditional supply network. By iterating pledge–procure cycles, the borrower can ``stockpile" inventory ahead of peak selling periods, then repay or default on remaining collateral, which the lender liquidates through its own channels. To better understand the efficiency drivers of inventory-based financing schemes, we also introduce and compare a Future Goods Financing (FGF) scheme, which uses future production or procurement commitments, instead of existing stock, as collateral. Methodology/Results: We analyze the contract design and the effectiveness of IBF through a game-theoretical model. We derive the optimal inventory ordering decision and pledging strategy for the borrower, and characterize the optimal loan interest rate for the lender. We also show that the lender's choice between IBF and FGF depends critically on the borrower's initial inventory and the effective cost per unit of collateral. Using datasets obtained from a leading online retailer, we empirically demonstrate that stockpiling behavior is prevalent in IBF and often occurs prior to shopping seasons and holidays. Furthermore, we employ double machine learning and estimate that small retailers shorten the planning horizon by 18% during the stockpiling phase or reduce the loan amount by 15% for single-period loans when facing a one-percentage-point increase in the interest rate. Managerial implications: To maximize the effectiveness of inventory-based financing, lenders should tailor the financing scheme to the borrower characteristics: IBF is best suited for those in volatile, high-risk supply chains with moderately high initial inventory, while FGF is more appropriate for borrowers operating in stable, reliable networks.

Keywords: Inventory-based financing, Operations-finance interface, Empirical operations management