A supportive pricing model for suppliers with purchase order financing

Abstract

Traditionally, lowering the purchase price is welcomed by a business buyer since people believe it can reduce the costs. However, it can be another story if her supplier is short of money and applies for purchase order financing to fund the production. This paper identifies the conditions under which a buyer has the motivation of allowing higher purchase price to facilitate the supplier’s loan application and consequently improve the supply availability. We use a Stackelberg model to describe the interaction between the supplier’s plan (deciding the loan amount and production input simultaneously) and the buyer’s order design (deciding the purchase price and order size jointly). We show the buyer’s optimal order design has four kinds of closed-form solutions as the supplier’s operational state follows a two-point distribution. The design choice should depend on the item value and the supplier’s reliability. In short, this research shows when to increase the purchase price and how to coordinate the order size with it. Generally speaking, if the item value is high and the supplier’s reliability is medium, a buyer allowing a premium price can ensure the supply and actually maximise her expected profit.

Keywords:

• purchasing
• financial management
• production management
• purchase order financing
• Stackelberg model

Notes

1. For instance, if the supplier and the buyer reach a deal thus the supplier can receive the order with unit purchasing price after Δ unit times, then is the present value of the unit price where r_f denotes the risk-free rate.