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Trade Credit in Competition: A Horizontal Benefit

Author

Listed:
  • Heikki Peura

    (Imperial College Business School, South Kensington Campus, London SW7 2AZ, United Kingdom)

  • S. Alex Yang

    (London Business School, Regent’s Park, London NW1 4SA, United Kingdom)

  • Guoming Lai

    (McCombs School of Business, University of Texas at Austin, Austin, Texas 78712)

Abstract

Trade credit is a widely adopted industry practice. Prior research has focused on how trade credit benefits firms by improving vertical supply chain relationships. This paper offers a novel perspective by examining whether trade credit benefits suppliers through a horizontal channel. Under the classic Bertrand competition framework, we analyze two competing firms’ price decisions with and without trade credit. We find that when the firms are financially constrained, trade credit softens horizontal price competition. Specifically, with trade credit, the firms will behave less aggressively in setting their prices for fear of incurring additional financing costs, resulting in equilibrium prices above the marginal cost, even if the products are perfect substitutes. Equilibrium profits under trade credit may thus be strictly higher than those under cash contracts. Furthermore, we find that with trade credit, a financially stronger firm may be able to exclude its weaker competitor from the market. We also investigate the relationship between the firms’ financial strength and their physical capacity in the competition with trade credit. We find that the horizontal benefit of trade credit over cash contracts increases as either the firms’ physical capacities increase or their financial status weakens. Therefore, with trade credit, firms’ financial constraints are a partial substitute for the role that physical capacity plays in price competition. Finally, we study the firms’ choice between offering trade credit and cash contracts. We find that trade credit is the equilibrium contract form if customers value trade credit, suggesting that the horizontal benefit of trade credit may complement its vertical roles.

Suggested Citation

  • Heikki Peura & S. Alex Yang & Guoming Lai, 2017. "Trade Credit in Competition: A Horizontal Benefit," Manufacturing & Service Operations Management, INFORMS, vol. 19(2), pages 263-289, May.
  • Handle: RePEc:inm:ormsom:v:19:y:2017:i:2:p:263-289
    DOI: 10.1287/msom.2016.0608
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    3. Yang, Honglin & Zhuo, Wenyan & Shao, Lusheng & Talluri, Srinivas, 2021. "Mean-variance analysis of wholesale price contracts with a capital-constrained retailer: Trade credit financing vs. bank credit financing," European Journal of Operational Research, Elsevier, vol. 294(2), pages 525-542.
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    10. Yan, Nina & Jin, Xuyu & Zhong, Hechen & Xu, Xun, 2020. "Loss-averse retailers’ financial offerings to capital-constrained suppliers: loan vs. investment," International Journal of Production Economics, Elsevier, vol. 227(C).
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    12. Christopher S. Tang & S. Alex Yang & Jing Wu, 2018. "Sourcing from Suppliers with Financial Constraints and Performance Risk," Manufacturing & Service Operations Management, INFORMS, vol. 20(1), pages 70-84, February.
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