Trade credit for supply chain coordination

Trade‐credit is a seller’s short‐term loan to the buyer, allowing the buyer to delay payment of an invoice. It has been the largest source of working capital for a majority of business‐to‐business firms in the United States. Numerous theories have been proposed to explain trade‐credit, mainly from finance perspectives. It has also been an important issue in supply chain management. Surprisingly, most literature in supply chain management has examined the retailer’s stocking policies given a supplier’s trade‐credit. This paper attempts to shed light on trade‐credit from a supplier’s perspective, and presents it as a tool for supply chain coordination. Specifically, we explicitly assume firms’ financial needs for inventory. Following a Newsvendor framework, we assume that the supplier grants trade‐credit and markdown allowance. Given the supplier’s offer, the retailer determines order quantity and the financing option for the inventory, either trade‐credit or direct financing from a financial institution. Our result shows that the supplier’s markdown allowance alone cannot fully coordinate the supply chain if the retailer employs direct financing. Positive financing costs call for trade‐credit in order to subsidize the retailer’s costs of inventory financing. Using trade‐credit in addition to markdown allowance, the supplier fully coordinates the retailer’s decisions for the largest joint profit, and extracts a greater portion of the maximized joint profit.