Coordination contracts in the presence of positive inventory financing costs

Numerous studies have offered diverse contractual forms of alliance, in which the supply chain partners coordinate their decisions for greater joint performance in an entirely self-interested way. Prior literature implicitly assumes free inventory financing. However, this assumption is questionable in the real marketplace. Firms frequently finance their working capital from a variety of credit sources, such as banks, and incur positive costs of the funds for inventory. Surprisingly, the impact of inventory financing costs on supply chain coordination has not been sufficiently investigated by supply chain academics. We address this issue by explicitly assuming capital-constrained agents and positive inventory financing costs. Specifically, we consider four extensively discussed coordination mechanisms for investigation: (i) all-unit quantity discount, (ii) buybacks, (iii) two-part tariff, and (iv) revenue-sharing. We show that, under the assumption of positive inventory financing costs, these contracts fail to achieve joint profit maximization if each agent relies on direct financing from a financial institution. Positive financing costs call for trade-credit in order to subsidize the retailer's costs of inventory financing. Using trade-credit in addition to the contracts, the supplier fully coordinates the supply chain for the largest joint profits. Moreover, positive inventory financing costs make revenue-sharing less profitable than the other three contracts. We present three different schemes for coordination in a decentralized supply chain, using buybacks, quantity discount, and two-part tariff, respectively. We also derive the optimal trade-credit rate not only for the supplier's profit, but also for joint supply chain profit.