Financing equilibrium in a green supply chain with capital constraint

Highlights

• We study a green supply chain with a capital-constrained manufacturer.

• We introduce a mixed financing incorporating green credit financing and prepayment.

• The manufacturer with higher initial capital will reduce production quantity.

• The retailer is willing to provide prepayment, but the manufacturer may reject it.

Abstract

Green supply chain management has received significant attention from both academic and industrial fields with the development of ecological economics. However, the fact that upstream manufacturers may have insufficient capital for greening and operational decisions is ignored. This study investigates a green supply chain financing (GSCF) system consisting of one capital-constrained manufacturer, one retailer, and one bank. A green manufacturer can obtain loans through two financing scenarios: green credit financing (GCF) and mixed financing (combining a partial prepayment from the retailer and GCF). We derive the financing equilibriums of the GSCF system under GCF and mixed financing, then compare them against a benchmark under which the manufacturer has sufficient capital to invest in green production. The analytical and numerical results reveal that the manufacturer is willing to undertake green investment, while the retailer is better off providing a partial prepayment. However, when the consumer’s environmental awareness is relatively lower or the manufacturer’s initial capital is relatively higher, the manufacturer is not willing to accept the prepayment due to the squeeze from the retailer.

Introduction

Green supply chain management has attracted increasing attention from both academic and industrial fields, thus becoming an important component of the development of environmental sustainability. To improve the performance of the entire green supply chain, downstream enterprises attach importance to the greening decisions of upstream partners. For example, Ford Motor Company requires upstream partners to obtain the ISO 14,001 certification to ensure the environmental performance of the supply chain (Ageron, Gunasekaran, & Spalanzani, 2012). In addition, harmful materials or products provided by upstream partners may cause supply disruption risks. For example, nearly 1.3 million units of Sony’s best-selling PlayStation have been stopped at the Dutch border in 2001, as the consoles contained unsafe levels of cadmium (Aston, Reinhardt, & Tiplady, 2005).

However, most upstream enterprises are small- and medium-sized enterprises (SMEs), thus facing the challenge of securing sufficient working capital for their operational decisions. According to survey data based on 2700 enterprises in China (World Bank Group, 2012), 62% of enterprises were SMEs, of which 54.5% required loans. Therefore, SMEs must obtain loans, but have limited access to finance. For example, 38% of the SMEs in Greece, 25% in Spain, 24% in Ireland, and 21% in Portugal considered access to finance as their most pressing problem (European Central Bank, 2013). Furthermore, banks are usually reluctant to provide loans for SMEs, since they have less publicly available information (Baas & Schrooten, 2006). If SMEs opt for green investment, their capital constraints will be even more severe.

However, there is a high likelihood of green SMEs obtaining loans from banks to promote green investment and production since some financial institutions have taken steps to improve environmental performance. For example, the International Finance Corporation (IFC) announced a voluntary agreement in 2003 known as the Equator Principles (EPs, equator-principles.com) to encourage financial institutions to incorporate financing activities into environmental sustainability. Furthermore, the Chinese government has been implementing green credit policy since 2007 to encourage banks to provide green credit financing (GCF) for SMEs to jointly promote economic and environmental development (China Banking Regulatory Commission, 2012). Therefore, SME manufacturers may be willing to make green investments with financial assistance from banks, even if they suffer severe capital constraints.

Apart from financial assistance from banks, capital-constrained manufacturers may receive partial prepayments from retailers to manufacture products and improve environmental performance. For example, US Apparel & Textiles, an apparel supplier for Levi Strauss & Co., joined the IFC supply chain finance program to improve environmental and social performance in 2015 (International Finance Corporation, 2018). Under this program, US Apparel & Textiles can obtain working capital financing from IFC as well as receive early payments from Levi Strauss & Co., thus improving its environmental and social performance by 40%.

According to the aforementioned examples, green supply chain financing (GSCF) poses some new research questions as follows.

• What are the equilibrium strategies of the supply chain members, when the capital-constrained manufacturer who bears inventory risk borrows loan to choose green production under GCF and mixed financing (combining a partial prepayment from the retailer and GCF) scenarios, respectively?

• Should the retailer make a partial prepayment to the green manufacturer? If the retailer is willing to make a prepayment to assist the green manufacturer, does the manufacturer always benefit from the prepayment?

• What is the influence of the manufacturer’s initial capital and the consumer’s environmental awareness (CEA) on the equilibrium strategies of the supply chain’s members as well as their expected profits?

To answer these questions, we consider a GSCF system consisting of one capital-constrained manufacturer, one retailer, and one bank. The manufacturer obtains the loans to execute operational and greening decisions through two financing scenarios: GCF and mixed financing. Under GCF, the manufacturer obtains the loan from the bank and initiates green production to promote environmental sustainability, while the bank charges an interest rate considering the bankruptcy cost (Lai et al., 2009, Kouvelis and Zhao, 2016). If the manufacturer goes bankrupt, the bank assumes ownership of the manufacturer, pays the bankruptcy costs, and only obtains the residual value (i.e., the difference between revenue of the bankrupt manufacturer and bankruptcy cost). The bankruptcy costs include administrative fees, such as legal expenses and auction fees (Xu and Birge, 2004, Kouvelis and Zhao, 2016). Conversely, under mixed financing, the manufacturer receives a partial prepayment from the retailer before green production and obtains the remaining loans through GCF. For easier comparison, we consider a benchmark scenario in which the manufacturer has sufficient capital to invest in green production. The transaction between the manufacturer and retailer is based on the pull contract (Cachon, 2004), where the manufacturer bears the inventory risk. We construct a three-stage Stackelberg game and derive the equilibrium strategies under benchmark and the two financing scenarios, and then analyze the interactions between the decisions of the supply chain members. Finally, we conduct a numerical study to demonstrate the influences of the manufacturer’s initial capital and the CEA on the equilibrium strategies of the manufacturer and the retailer, as well as their profits.

The contributions of this study are summarized as follows. First, we bridge the literature gap between supply chain finance and green supply chain management, and consider a GSCF system with a capital-constrained upstream manufacturer who bears the inventory risk (Cachon, 2004). Second, we derive the green financing equilibriums of the GSCF system under GCF and mixed financing scenarios and further analyze the interactions between the decisions of supply chain members. We find that the capital-constrained manufacturer who holds a higher initial capital makes a more conservative decision on the production quantity because of limited liability. Third, we provide some managerial insights for the manufacturer and retailer in terms of the manufacturer’s initial capital and the CEA. We find that the retailer is willing to provide a partial prepayment. However, when the manufacturer’s initial capital is relatively higher or the CEA is relatively lower, it is detrimental to the manufacturer to accept the prepayment because of the squeeze from the retailer.

The remainder of this paper is organized as follows. In Section 2, we review and discuss related literature. Section 3 introduces the model description, notations, and assumptions, while Section 4 outlines how the financing equilibriums of the GSCF system are derived under benchmark and the two financing scenarios. In Section 5, we conduct a numerical study to present management insights for manufacturers and retailers. In Section 6, we present the conclusions and suggestions for future research.