The over-ordering problem in trade credit: Role of return policies

Keywords Inventory; Trade credit; Over-ordering; Financially constrained; Newsvendor Highlights * Study inventory in a supply chain where supplier issues trade credit to retailer. * Examine the role of return policies to control over-ordering in trade credit. * Analyze generalizable return policies to develop managerial insights. * Quantify impact of key parameters on the supply chain partners' decision variables. Abstract This paper explores the role of return policies on trade credit offered by suppliers to retailers. Traditional trade credit agreements, wherein a supplier extends a short-term loan to a retailer, can lead to over-ordering by the retailer even though she is financially constrained (FC), and this can affect supply chain efficiency. With ever-increasing product-handling costs, such over-ordering can have a severe impact on the supply chain profit. Motivated by our work with an industry partner, we design a game-theoretic model to evaluate optimal stocking decisions and wholesale prices in an FC supply chain, analyze the traditional trade credit model, and establish the reasons for over-ordering by the retailer when trade credit is deployed. We then examine how product returns, prevalent in the industry, can be used to control over-ordering. We design three different mechanisms incorporating returns in a trade credit model: quantity-limit-based returns, partial refund based returns, and marginal refund based returns. We find that returns-based policies improve profits for all members of the supply chain by driving inventory reduction and reducing over-ordering when trade credit is used. We also perform numerical analysis to quantify the impact of key parameters on the optimal decision variables. Our paper contributes by suggesting easy-to-implement mechanisms for improving trade credit deployment in supply chains and provides useful insights to decision makers to incorporate returns in trade credit policies. Author Affiliation: (a) Operations Management Area, Indian Institute of Management (IIM) Raipur, Atal Nagar, P. O. - Kurru (Abhanpur), Raipur, Chattisgarh 493661, India (b) Department of Information Systems, Supply Chain & Decision Making, NEOMA Business School, 1 Rue du Maréchal Juin, Mont-Saint-Aignan 76130, France (c) Department of Information and Operations Management, Mays Business School, Wehner Building, Texas A&M University, 4113 TAMU | 210 Olsen Blvd, USA (d) Research Chair Professor, IIM Udaipur, Balicha Campus, Udaipur, Rajasthan, 313001, India * Corresponding author. Article History: Received 23 July 2022; Accepted 7 January 2023 Byline: Bhawna Priya [bpriya@iimraipur.ac.in] (*,a), Indranil Biswas [indranil.biswas@neoma-bs.fr] (b), Anupam Agrawal [anupam.agrawal@iimu.ac.in] (c,d)