Trade credit insurance in a capital‐constrained supply chain

• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/itor.12766
• Author: Gongbing Bi,Dong Wang,Xiaoyong Yuan,Hongping Li
• Date: 01 September 2020

Intl. Trans. in Op. Res. 27 (2020) 2340–2369

DOI: 10.1111/itor.12766

INTERNATIONAL

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IN OPERATIONAL

RESEARCH

Trade credit insurance in a capital-constrained supply chain

Hongping Lia, Gongbing Bia,∗, Xiaoyong Yuanband Dong Wangc

aSchool of Management, University of Science and Technology of China, Hefei230026, China

bSchool of International Economics and Trade, Nanjing Universityof Finance and Economics, Nanjing 210023, China

cSchool of Business Administration, Guangzhou University, Guangzhou 510006, China

E-mail: hpli@mail.ustc.edu.cn [Li]; bigb@ustc.edu.cn [Bi]; yuanxy@mail.ustc.edu.cn[Yuan];

wangdong@gzhu.edu.cn [Wang]

Received 26 December 2018; receivedin revised form 14 November 2019; accepted 28 November 2019

Abstract

We examine the role of trade credit insurance in a capital-constrained supply chain with one (or two) loss-

neutral retailer(s) and one loss-averse manufacturer. We model the interplay between these supply chain

participants as a Stackelberg game and analyze their operating and financing decisions. In one capital-

constrained retailer case, we find that either the manufacturer’s high loss aversion level or the retailer’s low

initial capital motivatesthe manufacturer to adopt insurance.Insurance drives more credit financing with more

attractivefinancing ter ms (a lowerwholesale price), which promotes the manufacturer to collect better product

sales and performance. Although the retailer enjoysimproved profit from insurance,its default risk increases.

In contrast, in one capital-constrained retailer and one well-funded retailer scenario, numerically, when the

manufacturer’s loss aversion level is high or the weak retailer’s initial capitalis low, insurance is also adopted

but is not always preferredby the capital-constrained retailer due to competition. In addition, as the demand

substitution rate increases, the manufacturer is more likely to prefer insurance due to better performance.

Keywords:trade credit insurance; loss aversion; Stackelberg game; asymmetric competing newsvendor

1. Introduction

Tradecredit refers to a short-term delay in payments that a seller (manufacturer)offers to a customer

(retailer) to procure products (Teng et al., 2006; Yang and Birge, 2018). Studies have found that

trade credit is beneficial for its provider (manufacturer), such as boosting product sales (Chen and

Wang, 2012; Jing et al., 2012) and improving profit (Kouvelis and Zhao, 2012; Yang and Birge,

2018). However, due to the volatility and uncertainty in a commodity market, the manufacturer

may also face a challenge that its retailer(s) may experience capital loss, resulting in breaking the

trade credit contract with the manufacturer. As a consequence, the manufacturer may be put on

heavy pressure to survive from the disruption in cash flow (Shi and Zhang, 2010; Kouvelis and

∗Corresponding author.

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H. Li et al. / Intl. Trans. in Op. Res. 27 (2020) 2340–2369 2341

Zhao, 2011). Take a case in China, for example. On March 3, 2017, an export firm (manufacturer)

in China failed to receive the full delayed payment due to the unexpected bankruptcy of its client’s

firm in Korea. However, thanks to the purchase of trade credit insurance, this manufacturer was

still able to minimize its financial loss through collecting the defaulted claim from the insurance

company.1

Research has suggested that trade credit insurance acts as a credit guarantee between a manufac-

turer and its retailer(s) for the delayed or installment payment (Li et al., 2016). As an effective risk

management tool, trade credit insurance can help a firm obtain more financing (Soumar´

e et al.,

2010), increase sales and profitability, and reduce the potential damage caused bycredit risk (Jones,

2010; Li et al., 2016). Therefore, it is widely used in commercial trade. For example, a report from

the International Credit Insurance and Surety Association showed that the amount of its members’

premiums exceeded 6.3 billion euros with a payout ratio of approximately 50% in 2015.

The extensive application of trade credit insurance in practice gives rise to several research

questions: (a) what are the operating and financing factors that drive the adoption of insurance in

a supply chain with one capital-constrained retailer and one manufacturer? (b) how does insurance

influence each participant in a supply chain? and (c) what are the adoption condition and role of

insurance in a supply chain when it is consisted of one manufacturer and two retailers, one weak

(capital-constrained) and one dominant (well-funded), in a competing retailing market?

Toanswer these questions, first, we study a supply chain with one loss-neutral retailerwith capital

constraints and one loss-averse manufacturer. Under this condition, the retailer is allowed to delay

payment and determines the order quantity procured from the manufacturer at the beginning of the

sales season. To tackle the potential default risk, the manufacturer buys insurance and determines

the wholesale price as well as insurance coverage. Then, we expand the condition to a supply chain

with two competing retailers (one capital-constrained and one well-funded) and one manufacturer,

and further analyze operating and financial decisions.

Our study shows that in the one-retailer case, either the manufacturer’s high loss aversion level or

the retailer’s low initial capital motivates the adoption of insurance. Insurance allows the retailer to

obtain a larger trade credit line with better financing terms (e.g., alower wholesale price). Therefore,

it enhances product sales and the performance of the manufacturer. In addition, insurance is always

favorable for the retailerdue to an increased profit. However,with the boost in order level stemming

from the introduction of insurance, the bankruptcy risk of the retailer also increases. In the case

of two competing retailers, by numerical studies, we find that if the level of loss aversion of the

manufacturer is high, or the weak retailer’s initial capital is low, insurance is preferredin commercial

trade. However, in contrast to insurance in the one-retailer case, in this two competing retailer case,

insurance is not always desirable for the weak retailer due to a competition between two retailers.

Moreover, as the demand substitution rate rises, the manufacturer is more likely to prefer insurance

due to a larger benefit.

Our research contributes to the literaturein three respects. First, this study attempts to explorethe

impact of insurance on operating and financial decisions in a supply chain through mathematical

analysis.It provides important managerial and policy instructions on firms’ operations management.

Second, we focus on how insurance affects the revenue and the risk of different participants in a

supply chain. It indicates that risk-sharing mechanism, as the core concept of supply chain finance,

1China Export & Credit Insurance Corporation, http://www.sinosure.com.cn/xwzx/xbsa/2018/01/186299.shtml.

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2020 The Authors.

International Transactionsin Operational Research C

2020 International Federation of OperationalResearch Societies