Financing a Quality-uncertain Supplier under Procurement Decentralization

Abstract

Problem definition: This article investigates the optimal combination of financing schemes (bank finance versus buyer finance) and outsourcing structures (consignment versus turnkey) in a three-tier supply chain composed of a capital-constrained quality-uncertain component supplier (SP), a contract manufacturer (CM), and an original equipment manufacturer (OEM).

Academic/Practical relevance: In outsourcing practice, the OEM must decide on whether to procure components directly from the SP (i.e., consignment) or decentralize the component procurement to the CM (i.e., turnkey). However, no paper has yet studied firms’ preferences of all these four combinations of financing schemes and outsourcing structures.

Methodology: To address the above concern, we apply a Stackelberg game setting to characterize the equilibrium product quality, contract prices, interest rates, and firms’ profits.

Results: Our analysis reveals that buyer finance can conditionally outperform bank finance under both consignment and turnkey; however, the benefit of buyer finance is more significantly undercut by the procurement decentralization. Furthermore, the capital-constrained SP may encounter a collateral dilemma under turnkey, in which the SP suffers from possessing a higher asset value. Notwithstanding, firms can benefit from procurement decentralization in both bank finance and buyer finance when the CM’s capital cost is low enough. Such benefit is more significant in bank finance; thus, it is more likely for the OEM to select turnkey over consignment in bank finance than in buyer finance, but at the expense of other firms.

Managerial implications: This study provides some guidelines for OEMs when making their outsourcing and financing decisions. Managers should be aware of that financing schemes and outsourcing structures are not independent of each other, and procurement decentralization should be implemented with consideration of firms’ financial and operational interaction.