Purchase Order Financing: Credit, Commitment, and Supply Chain Consequences

Abstract

We study a supply chain where a retailer buys from a supplier who cannot fully finance her production. Informational problems about the supplier’s demand prospects and production capabilities restrict her access to capital. By committing to a minimum purchase quantity, the retailer can mitigate these informational problems and expand the supplier’s feasible production set. We assume a newsvendor model of operations and analyze the strategic interaction of the two parties as a sequential game. Key parameters in our model are the supplier’s ex-ante credit limit; her informational transparency (which conditions the amount of additional capital released by the commitment); and the demand characteristics of the final market. We show that in equilibrium the supplier can benefit from a lower ex-ante credit limit or lower informational transparency. The retailer always benefits from an increase in these parameters. Moreover, the supplier’s ex-ante credit limit and informational transparency may be substitutes or complements with respect to her own profit, but are always substitutes with respect to the retailer’s profit. Our study provides a novel perspective on capital market frictions in supply chain contracting.