Investment Framing Under Trade Credit for a Manufacturer in Supply Chain

Abstract

Although trade credit is a crucial component of supply chain finance, the investment decisions of upstream firms under trade credit in different supply chain structures have not been well studied. In this paper, we consider two basic supply chain structures: a single supply chain comprising a manufacturer and a retailer and a competing supply chain consisting of a manufacturer and two retailers. Based on whether initial capital and trade credit are available, we analyze the following three scenarios: each retailer has no initial capital but is offered trade credit (NY), each retailer has initial capital but is not offered trade credit (YN) and each retailer has initial capital and is offered trade credit (YY). We first derive the equilibrium results for different supply chain structures under the above three scenarios, based on which the optimal decisions of supply chain participants are characterized. Then, the equilibrium outcomes for the three scenarios are compared to illustrate how initial capital impacts the manufacturer's investment decisions in the structural dimension and pricing dimension under trade credit. The results indicate that when trade credit is exclusively considered, the manufacturer always chooses the investment decision with the same wholesale price. However, when both trade credit and initial capital are taken into account, the optimal investment decision for the pricing dimension depends on demand uncertainty and the level of initial capital. Notably, when demand uncertainty is high and initial capital is at a medium level, the manufacturer adopts the investment decision with unequal wholesale prices, resulting in an asymmetric equilibrium outcome even with ex ante identical retailers. In addition, when either trade credit or initial capital is examined, the manufacturer always chooses the competing rather than single supply chain structure, which is consistent with conventional thoughts. However, surprisingly, we identify certain conditions under which the manufacturer prefers the single supply chain while the retailer favors the competing one when both initial capital and trade credit are on the table.

Keywords: trade credit, initial capital, supply chain structure, investment decision