Trade Credit in Competition: A Horizontal Benefit

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Title: Trade Credit in Competition: A Horizontal Benefit
Author(s): Peura, HE
Yang, SA
Lai, G
Item Type: Journal Article
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 can benefit 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. Specifi- cally, 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.
Publication Date: 7-Oct-2016
Date of Acceptance: 4-Oct-2016
URI: http://hdl.handle.net/10044/1/41392
ISSN: 1526-5498
Publisher: INFORMS (Institute for Operations Research and Management Sciences)
Journal / Book Title: M&SOM-Manufacturing & Service Operations Management
Keywords: Operations Research
0102 Applied Mathematics
1503 Business And Management
1505 Marketing
Publication Status: Accepted
Appears in Collections:Imperial College Business School



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