COORDINATING BUYBACK CONTRACTS WITH LIMITED FUNDING
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STATEMENT ABOUT THE INDEPENDENT CHARACTER
OF THE MASTER THESIS 3
АННОТАЦИЯ 4
ABSTRACT 6
INTRODUCTION 8
CHAPTER 1. BUYBACK CONTRACT WITH LIMITED FUNDING 11
1.1. Contracts as a Mechanism of Supply Chain Coordination 11
1.2. Supply Chain Coordination with Buyback Contract 16
1.3. Limited Funding of Supply Chain Parties and Its Impact on Supply Chain Coordination 19
Summary of Chapter 1 26
CHAPTER 2. THE MODEL OF CONDITIONALLY COORDINATING BUYBACK
CONTRACT WITH LIMITED FUNDING 27
2.1. Model Description 27
2.2. Coordinating Buyback Contract with the Bank Loan 30
2.3. Coordinating Buyback Contract with Trade Credit 34
2.4. Conditionally Coordinating Buyback Contract with Limited Funding 37
Summary of Chapter 2 43
CHAPTER 3. SELECTING PARAMETERS OF CONDITIONALLY COORDINATING
BUYBACK CONTRACT WITH LIMITED FUNDING 44
3.1. Conditionally Coordinating Buyback Contract with Demand Distributed as Uniformly ..44
3.2. Comparing the Contracts with the Trade Credit and Bank Loan 47
3.3. Selecting Conditionally Coordinating Buyback Contract with Limited Funding 49
3.4. The Case of the Supply Chain for a Perishable Product 54
Summary of Chapter 3 63
CONCLUSION 65
REFERENCES 69
APPENDICES 73
OF THE MASTER THESIS 3
АННОТАЦИЯ 4
ABSTRACT 6
INTRODUCTION 8
CHAPTER 1. BUYBACK CONTRACT WITH LIMITED FUNDING 11
1.1. Contracts as a Mechanism of Supply Chain Coordination 11
1.2. Supply Chain Coordination with Buyback Contract 16
1.3. Limited Funding of Supply Chain Parties and Its Impact on Supply Chain Coordination 19
Summary of Chapter 1 26
CHAPTER 2. THE MODEL OF CONDITIONALLY COORDINATING BUYBACK
CONTRACT WITH LIMITED FUNDING 27
2.1. Model Description 27
2.2. Coordinating Buyback Contract with the Bank Loan 30
2.3. Coordinating Buyback Contract with Trade Credit 34
2.4. Conditionally Coordinating Buyback Contract with Limited Funding 37
Summary of Chapter 2 43
CHAPTER 3. SELECTING PARAMETERS OF CONDITIONALLY COORDINATING
BUYBACK CONTRACT WITH LIMITED FUNDING 44
3.1. Conditionally Coordinating Buyback Contract with Demand Distributed as Uniformly ..44
3.2. Comparing the Contracts with the Trade Credit and Bank Loan 47
3.3. Selecting Conditionally Coordinating Buyback Contract with Limited Funding 49
3.4. The Case of the Supply Chain for a Perishable Product 54
Summary of Chapter 3 63
CONCLUSION 65
REFERENCES 69
APPENDICES 73
Optimal performance of supply chains is a hot topic these days. It commonly implies an optimal set of actions taken by the supply chain members so as to maximize supply chain’s total profit while maximizing their own profits. To ensure that the supply chain members act in accordance with the optimal set of actions, their relationships and interdependencies should be managed through cooperation, with coordination being its main component and the subject of this study.
To coordinate the actions of supply chain parties several mechanisms can be applied, including contracts. The ubiquity of the contracts’ application makes the problem of setting optimal contract parameters that ensure the maximum of supply chain’s profit highly relevant today.
Nonetheless, practice shows that the process of managing contractual relationships often fails to provide the contracting parties with the best possible results. Despite the fact that companies can save up to 80% on transaction costs with generally accepted and clearly regulated rules and procedures related to contracting, only 48% of business entities actually run an organized process of contract management (Berezinets, Meshkova & Nikolchenko, 2019).
As the field of research, supply chain contracting is focused on the profit maximization by the companies involved in the supply chain, so it is straightforward to confirm that the problem studied in this body of research is essential not only for management in general, but also for financial management.
Besides addressing general management issues, the study touches upon such particular aspect of financial resources management as credit used by the retailer to pay the supplier in exchange for the goods retailer wants to purchase for further retailing. This issue is indicated by the term “limited funding”, which refers to a situation where the retailer’s holdings of cash are constrained and might be insufficient to pay the supplier. The paper considers two types of credit - bank loan and trade credit.
The issue of limited funding has grown since the start of the COVID pandemic. Recent research on the state of US supply chains carried out by SAP (2022), one of the world’s largest enterprise software companies, found that more than half of businesses (that took part in the survey) suffered a decrease in revenue and faced the need for taking new financing measures, such as business loans.
Consequently, researchers have been showing interest in the supply chain coordination with contracts with limited funding considered. However, the majority of those studies focus on the contract types other than the buyback contract (Kouvelis, Zhao, 2012; Chen, 2015; Zhan, Chen, Hu, 2018). Besides, the papers dedicated to the buyback contract do not exhaustively consider the problem of limited funding - they analyze coordinating properties of the contract with only one form of borrowing applied and focus on different aspects of limited funding, such as bankruptcy risk tolerance or working capital management (Xiao, Sethi, Liu, Ma, 2017; Fu, Liu, 2019).
Therefore, the goal of this study is to build a model of the buyback contract with limited funding that allows for two forms of borrowing - bank loan and trade credit - and develop an algorithm for selecting parameters of the buyback contract with limited funding that provide conditional coordination of a supplier-retailer supply chain.
Although there exist various approaches to defining it, in this paper the term ‘supply chain coordination’ refers to the situation where the contract parameters agreed by supply chain members allow both supplier and retailer to maximize their profits, thus achieving the maximum of supply chain profit. Unfortunately, supply chain coordination by this definition fails virtually for all contract types studied in the field of supply chain contracting, which is why the term ‘conditional coordination’ is used.
Conditional coordination of a supplier-retailer supply chain indicates the situation where the set of the contract parameters ensures maximal retailer’s profit, improves supplier’s profit relative to the benchmark contract instead of maximizing it, and thus maximizes supply chain’s profit. The benchmark contract is usually the wholesale-price contract as this is the simplest and most popular contract type that is generally considered to be non-coordinating. The definition of conditional coordination and, hence, the framework for modeling the buyback contract have been proposed by Berezinets et al. (2020).
To achieve the research goal, the following tasks were formulated:
• To analyze existing approaches to supply chain coordination with contracts, and with buyback contract in particular, and approaches to limited funding in order to justify the scope and approach to modeling the buyback contract with limited funding and studying its coordinating properties;
• To construct the model of the buyback contract with limited funding and analyze coordinating properties of this contract;
• To develop an algorithm for selecting the parameters of conditionally coordinating buyback contract with limited funding; and
• To apply the constructed model and developed algorithm to a company case.
The object of the study is the buyback contract with limited funding, and also the wholesale-price contract with limited funding as required by the definition of conditional coordination. The subject of the study is conditional coordination, and also the procedure for selecting the parameters of the conditionally coordinating buyback contract with limited funding fixed in the algorithm that can support the decision-making process when negotiating the contract parameters.
...
To coordinate the actions of supply chain parties several mechanisms can be applied, including contracts. The ubiquity of the contracts’ application makes the problem of setting optimal contract parameters that ensure the maximum of supply chain’s profit highly relevant today.
Nonetheless, practice shows that the process of managing contractual relationships often fails to provide the contracting parties with the best possible results. Despite the fact that companies can save up to 80% on transaction costs with generally accepted and clearly regulated rules and procedures related to contracting, only 48% of business entities actually run an organized process of contract management (Berezinets, Meshkova & Nikolchenko, 2019).
As the field of research, supply chain contracting is focused on the profit maximization by the companies involved in the supply chain, so it is straightforward to confirm that the problem studied in this body of research is essential not only for management in general, but also for financial management.
Besides addressing general management issues, the study touches upon such particular aspect of financial resources management as credit used by the retailer to pay the supplier in exchange for the goods retailer wants to purchase for further retailing. This issue is indicated by the term “limited funding”, which refers to a situation where the retailer’s holdings of cash are constrained and might be insufficient to pay the supplier. The paper considers two types of credit - bank loan and trade credit.
The issue of limited funding has grown since the start of the COVID pandemic. Recent research on the state of US supply chains carried out by SAP (2022), one of the world’s largest enterprise software companies, found that more than half of businesses (that took part in the survey) suffered a decrease in revenue and faced the need for taking new financing measures, such as business loans.
Consequently, researchers have been showing interest in the supply chain coordination with contracts with limited funding considered. However, the majority of those studies focus on the contract types other than the buyback contract (Kouvelis, Zhao, 2012; Chen, 2015; Zhan, Chen, Hu, 2018). Besides, the papers dedicated to the buyback contract do not exhaustively consider the problem of limited funding - they analyze coordinating properties of the contract with only one form of borrowing applied and focus on different aspects of limited funding, such as bankruptcy risk tolerance or working capital management (Xiao, Sethi, Liu, Ma, 2017; Fu, Liu, 2019).
Therefore, the goal of this study is to build a model of the buyback contract with limited funding that allows for two forms of borrowing - bank loan and trade credit - and develop an algorithm for selecting parameters of the buyback contract with limited funding that provide conditional coordination of a supplier-retailer supply chain.
Although there exist various approaches to defining it, in this paper the term ‘supply chain coordination’ refers to the situation where the contract parameters agreed by supply chain members allow both supplier and retailer to maximize their profits, thus achieving the maximum of supply chain profit. Unfortunately, supply chain coordination by this definition fails virtually for all contract types studied in the field of supply chain contracting, which is why the term ‘conditional coordination’ is used.
Conditional coordination of a supplier-retailer supply chain indicates the situation where the set of the contract parameters ensures maximal retailer’s profit, improves supplier’s profit relative to the benchmark contract instead of maximizing it, and thus maximizes supply chain’s profit. The benchmark contract is usually the wholesale-price contract as this is the simplest and most popular contract type that is generally considered to be non-coordinating. The definition of conditional coordination and, hence, the framework for modeling the buyback contract have been proposed by Berezinets et al. (2020).
To achieve the research goal, the following tasks were formulated:
• To analyze existing approaches to supply chain coordination with contracts, and with buyback contract in particular, and approaches to limited funding in order to justify the scope and approach to modeling the buyback contract with limited funding and studying its coordinating properties;
• To construct the model of the buyback contract with limited funding and analyze coordinating properties of this contract;
• To develop an algorithm for selecting the parameters of conditionally coordinating buyback contract with limited funding; and
• To apply the constructed model and developed algorithm to a company case.
The object of the study is the buyback contract with limited funding, and also the wholesale-price contract with limited funding as required by the definition of conditional coordination. The subject of the study is conditional coordination, and also the procedure for selecting the parameters of the conditionally coordinating buyback contract with limited funding fixed in the algorithm that can support the decision-making process when negotiating the contract parameters.
...
The paper considers the buyback contract with limited funding. It investigates coordinating properties of this contract and aspects of its practical implementation in the case where the retailer’s funds are limited and he is faced with the credit necessity.
As the study aims to build a model of the buyback contract with limited funding that allows for two forms of borrowing - bank loan and trade credit - and develop the algorithm for selecting parameters of the buyback contract with limited funding that provide conditional coordination of a supplier-retailer supply chain, the model for the supply chain with the retailer faced with limited funding is established. It suggests two types of credit to deal with the retailer’s limited funds - bank loan and trade credit. Then two contract types - buyback and wholesale-price - are applied to it.
The model analysis shows that the buyback contract does not coordinate the two-echelon supply chain neither with the bank loan raised by the retailer, nor with the trade credit provided by the supplier. Coordination fails as the profits earned by the supply chain members do not achieve their maximum and, hence, the supply chain’s profit as their sum is not maximized either.
As it has been mathematically justified that the buyback contract with limited funding does not have coordinating properties, the concept of conditional coordination proposed by Berezinets et al. (2020) has been applied to the model. Under conditionally coordinating buyback contract with limited funding retailer’s and supply chain profits are to be maximized whereas supplier’s profit must exceed her profit with the wholesale-price contract. So the model analysis included the step dedicated to building the model of the wholesale-price contract with limited funding for the cases with bank loan and trade credit.
Then the buyback contracts with bank loan and trade credit were examined to answer the question whether they can be conditionally coordinating in the presence of retailer’s limited funds and credit necessity. Analysis of the model with the bank loan showed that there exists a set of conditionally coordinating buyback contracts that provides the retailer with maximal profit and improves the supplier’s profit, and the conditions that are to be satisfied in order to achieve conditional coordination were identified. The model with the trade credit was analyzed with the same purpose, and the same conclusion was made - there exists a set of conditionally coordinating buyback contracts with trade credit that allow to achieve supply chain profit maximization if certain conditions are met; those conditions were identified as well. The solution also showed that with trade credit the supply chain profit achieves its maximum that coincides with maximal supply chain profit in the case where the retailer’s funds are sufficient and the issue of limited funding does not occur.
Further, comparative analysis of the contract with trade credit and that with the bank loan was carried out in order to justify supplier’s motivation to offer trade credit and retailer’s choi ce between trade credit and bank loan. The wholesale-price contract also has been examined in this section as it is essential part of negotiating a conditionally coordinating buyback contract with limited funding - supplier and retailer negotiate about the conditionally coordinating buyback contract when the parameter 1 that is responsible for the supply chain profit allocation between them is greater than 0.5, or about the wholesale-price contract when this parameter is lower than 0.5.
Comparative analysis has shown that under both contract types - wholesale-price and conditionally coordinating buyback contract - supplier’s profit with trade credit is higher than with the bank loan if the trade credit rate is lower than the rate charged by the bank. Retailer’s and supply chain’s profits in this case also improve relative to the bank loan. Thus, rational supplier and retailer should always prefer the trade credit to the bank loan both when they enter into a conditionally coordinating buyback contract and wholesale-price contract. Analysis allowed to derive specific conditions for the trade credit rate that make this type of credit more attractive than the bank loan; those conditions were derived for both contract types.
Based on the mathematically justified solutions presented in the paper, the algorithm for selecting parameters of the buyback contract with limited funding was proposed. This algorithm allows to select the contract parameters based on a wholesale price they have agreed prior to the start of the selection process. The parameters of the buyback contract with limited funding that are determined with the use of the proposed algorithm provide conditional coordination of a supplierretailer supply chain. The algorithm also helps to determine the parameters of the wholesale-price contract that improve the profits of supply chain members. Selection of the wholesale-price contract with limited funding concerns the case when the negotiation does not arrive at the conditionally coordinating contract (when Я < 0.5).
Consequently, the proposed model and algorithm were applied to the case of the supply chain that is engaged in manufacturing and retailing a perishable product with short shelf life. Application of the model and algorithm to a practical case aimed to verify their applicability.
The case study considered the models of the buyback contract built for the cases with the bank loan and trade credit, and demonstrated that conditional coordination with the buyback contract with limited funding could be achieved. It also showed that profits earned by the supplier and the retailer in the case where the retailer accepts the offer of the trade credit exceed those earned by them in the case where the retailer takes the bank loan. Thus, it was confirmed that trade credit is preferable to the bank loan as it allows the supply chain members to obtain higher total profit relative to the supply chain profit with the bank loan.
...
As the study aims to build a model of the buyback contract with limited funding that allows for two forms of borrowing - bank loan and trade credit - and develop the algorithm for selecting parameters of the buyback contract with limited funding that provide conditional coordination of a supplier-retailer supply chain, the model for the supply chain with the retailer faced with limited funding is established. It suggests two types of credit to deal with the retailer’s limited funds - bank loan and trade credit. Then two contract types - buyback and wholesale-price - are applied to it.
The model analysis shows that the buyback contract does not coordinate the two-echelon supply chain neither with the bank loan raised by the retailer, nor with the trade credit provided by the supplier. Coordination fails as the profits earned by the supply chain members do not achieve their maximum and, hence, the supply chain’s profit as their sum is not maximized either.
As it has been mathematically justified that the buyback contract with limited funding does not have coordinating properties, the concept of conditional coordination proposed by Berezinets et al. (2020) has been applied to the model. Under conditionally coordinating buyback contract with limited funding retailer’s and supply chain profits are to be maximized whereas supplier’s profit must exceed her profit with the wholesale-price contract. So the model analysis included the step dedicated to building the model of the wholesale-price contract with limited funding for the cases with bank loan and trade credit.
Then the buyback contracts with bank loan and trade credit were examined to answer the question whether they can be conditionally coordinating in the presence of retailer’s limited funds and credit necessity. Analysis of the model with the bank loan showed that there exists a set of conditionally coordinating buyback contracts that provides the retailer with maximal profit and improves the supplier’s profit, and the conditions that are to be satisfied in order to achieve conditional coordination were identified. The model with the trade credit was analyzed with the same purpose, and the same conclusion was made - there exists a set of conditionally coordinating buyback contracts with trade credit that allow to achieve supply chain profit maximization if certain conditions are met; those conditions were identified as well. The solution also showed that with trade credit the supply chain profit achieves its maximum that coincides with maximal supply chain profit in the case where the retailer’s funds are sufficient and the issue of limited funding does not occur.
Further, comparative analysis of the contract with trade credit and that with the bank loan was carried out in order to justify supplier’s motivation to offer trade credit and retailer’s choi ce between trade credit and bank loan. The wholesale-price contract also has been examined in this section as it is essential part of negotiating a conditionally coordinating buyback contract with limited funding - supplier and retailer negotiate about the conditionally coordinating buyback contract when the parameter 1 that is responsible for the supply chain profit allocation between them is greater than 0.5, or about the wholesale-price contract when this parameter is lower than 0.5.
Comparative analysis has shown that under both contract types - wholesale-price and conditionally coordinating buyback contract - supplier’s profit with trade credit is higher than with the bank loan if the trade credit rate is lower than the rate charged by the bank. Retailer’s and supply chain’s profits in this case also improve relative to the bank loan. Thus, rational supplier and retailer should always prefer the trade credit to the bank loan both when they enter into a conditionally coordinating buyback contract and wholesale-price contract. Analysis allowed to derive specific conditions for the trade credit rate that make this type of credit more attractive than the bank loan; those conditions were derived for both contract types.
Based on the mathematically justified solutions presented in the paper, the algorithm for selecting parameters of the buyback contract with limited funding was proposed. This algorithm allows to select the contract parameters based on a wholesale price they have agreed prior to the start of the selection process. The parameters of the buyback contract with limited funding that are determined with the use of the proposed algorithm provide conditional coordination of a supplierretailer supply chain. The algorithm also helps to determine the parameters of the wholesale-price contract that improve the profits of supply chain members. Selection of the wholesale-price contract with limited funding concerns the case when the negotiation does not arrive at the conditionally coordinating contract (when Я < 0.5).
Consequently, the proposed model and algorithm were applied to the case of the supply chain that is engaged in manufacturing and retailing a perishable product with short shelf life. Application of the model and algorithm to a practical case aimed to verify their applicability.
The case study considered the models of the buyback contract built for the cases with the bank loan and trade credit, and demonstrated that conditional coordination with the buyback contract with limited funding could be achieved. It also showed that profits earned by the supplier and the retailer in the case where the retailer accepts the offer of the trade credit exceed those earned by them in the case where the retailer takes the bank loan. Thus, it was confirmed that trade credit is preferable to the bank loan as it allows the supply chain members to obtain higher total profit relative to the supply chain profit with the bank loan.
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