Journal of the Operational Research Society (2017) 68, 521–532 ª 2016 The Operational Research Society.

ociety. All rights reserved. 0160-5682/17

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Benefits of working capital sharing in supply chains

Margarita Protopappa-Sieke1* and Ralf W. Seifert2,3
1
Department of Supply Chain Management and Management Science, University of Cologne, Albertus-Magnus-
Platz, 50923 Cologne, Germany; 2 College of Management of Technology, Ecole Polytechnique Fédérale de
Lausanne, 1015 Lausanne, Switzerland; and 3 IMD, Chemin de Bellerive 23, P.O. Box 915, 1001 Lausanne,
Switzerland
Supply chain finance and working capital management are important avenues to reduce supply chain costs. Small
suppliers may not have sufficient working capital to finance their operations and efficiently supply their
customers. We develop a model that captures the fundamental aspects of financial and operational planning in a
two-stage supply chain, with both strong and weak members. A strong member can negotiate for more favorable
financing rates, more advantageous payment terms, and shorter lead times than a weaker member. We investigate
two working capital allocation scenarios. In the dedicated working capital allocation scenario, the members of the
supply chain each have their own working capital. In the joint working capital allocation scenario, the members
of the supply chain have a joint pool of working capital. Our results demonstrate significant benefits when the
members of the supply chain share the working capital. We also show that extending payment delays to a supplier
upstream results in higher overall supply chain costs.
Journal of the Operational Research Society (2017) 68(5), 521–532. doi:10.1057/s41274-016-0009-2;
published online 7 October 2016

Keywords: financial supply chain management; supply chain finance; working capital management; payment delays;
inventory management

1. Introduction Even though, there exist a vast amount of literature on

supply chain management, however, financial flows and
Supply chain finance, a rather new and promising discipline, is
operational flows are often treated in isolation (Longinidis
increasingly receiving attention as a powerful instrument to
and Georgiadis, 2011). As ‘‘a company might have no
integrate the operational flows and the financial flows within
knowledge of its suppliers’ cost of capital and little knowledge
supply chains. Such techniques and solutions enable the
of the financial challenges its suppliers face; the typical supply
financing of supply chains. In the automotive industry for
chain is grounded in retailer, logistics and manufacturing
example, the increasing bargaining power of the Original
processes’’ (DiBenedetto, 2007). Efficient working capital
Equipment Manufacturers and the latest economic downturn
management can achieve significant cost savings as it enables
readily resulted in liquidity struggles and high bankruptcy
weaker members to secure the necessary financing. Under-
risks for the suppliers. The constant pressure from customers
standing the impact of upstream and downstream payment
for longer credit windows necessitates the search for new
delays within the supply chain can result in better interactions
financing solutions for supply chains as the availability of
between the supply chain members. Better visibility of both
credit is limited. Many small and medium size companies
cash and product flows can enhance working capital utilization
might not have the working capital reserves needed to finance
and reduce working capital requirements. Through better
their operations and thus cannot efficiently supply their
allocation of risk, supply chain financing solutions which
customers. Such deficiencies can have serious implications
focus on working capital collaboration can ensure a more
for the profitability and responsiveness of a supply chain.
stable supply of products, better relationship between the
According to Aberdeen Group’s 2008 State of Market in
involved parties, and thus new opportunities for business.
Supply Chain Finance, more and more companies are currently
Randal and Theodore Farris (2009) show how supply chain
engaging in supply chain financing solutions and the best in
financial management techniques, such as supply chain
class performers have already integrated the physical and
finance, can reduce overall supply chain costs and perfor-
financial supply chain (Bernabucci, 2008).
mance by benefiting from lower refinancing costs of another
member in the supply chain. However, some companies are
*Correspondence: Margarita Protopappa-Sieke, Department of Supply
Chain Management and Management Science, University of Cologne,
hesitating to adopt supply chain finance solutions because ‘‘it
Albertus-Magnus-Platz, 50923 Cologne, Germany. is unclear how much buyers and suppliers really save,’’
E-mail: margarita.protopappa-sieke@uni-koeln.de (Seifert and Seifert, 2011). Thus, an in-depth overall
522 Journal of the Operational Research Society Vol. 68, No. 5
understanding of the benefits of supply chain financing and
working capital allocation in a supply chain is of substantial
importance.
Motivated by the recent trend of banking products where a
joint cash pool is used among related companies (Danske
Bank, 2016), the purpose of this paper is to better understand
the benefits of interrelating operational and financial aspects
within a supply chain. More financial institutions offer such
cash pools. For example, the People’s Bank of China offers
now cash pool where companies can be connected together
under specific rules (PWC, 2015). Our main objective is to
investigate whether sharing working capital between members
of a supply chain and not just pooling resources between
related companies can demonstrate significant cost savings,
and how different working capital allocation scenarios impact
operational decisions and financial planning. We expect to
find that collaborative working capital approaches exhibit
greater performance than competitive approaches, similar to
the existing literature in supply chain collaboration (Cachon,
2003). We account for financial considerations within the
common setting of a two-stage supply chain. We differentiate
between strong members and weak members in the supply
chain according to their relative bargaining power. A strong
member can negotiate more favorable financing rates, advan-
tageous payment terms, and shorter lead times than a weak
member. In this context, we compare a dedicated working
capital allocation scenario with a joint working capital
allocation scenario. In the dedicated setting, the members of
the supply chain each have their own working capital. In the
joint setting, the members of the supply chain draw financing
from a joint pool of working capital. Such settings would
require a banking platform such as those used already in joint
cash pools offered by major financial institutions such as
Danske Bank, the People’s Bank of China, among others
(Danske Bank, 2016; PWC, 2015). The financial institution
should play the role of a moderator to ensure that limits are set
on the borrowing amount of each company. Our paper
discusses whether joint cash pools among companies are
beneficial. We believe that such platforms can be based on
already existing cash pool platforms or factory payment
platforms. Furthermore, it is also possible that such platforms
are developed by companies such as Demica and PrimeRev-
enue. In our paper, we do not consider any costs for the supply
chain members for using such financial platform; however, our
model can be extended to consider the financial institution
view and adheres to our future research avenues. The main
contribution of our paper is that we examine the collaboration
within supply chain members from a financial perspective.
More specifically, we investigate how collaborative
approaches in working capital allocation may ensure a higher
supply chain performance and lower costs. Furthermore, we
elaborate on the interrelation between operational decisions
and financial planning. Our results demonstrate significant
cost savings when the members of the supply chain share the
working capital. We also show that extending payment delays
to a supplier upstream results in higher supply chain costs.
2. Literature Review
Our paper is positioned at the interface of operations
management and corporate finance and we build on two
literature streams: literature that incorporates financial deci-
sions in inventory models and literature on supply chain
financing methods.
The theoretical foundation for the analysis of multi-echelon
inventory systems is given by Clark and Scarf (1960). Over the
years, there have been numerous extensions and variations;
however, the literature that incorporates financial decisions in
inventory models is rather limited (Hausman, 2002). Many
articles focus on the cash-to-cash conversion cycles as a
natural way to interrelate inventories and cash. Viskari and
Kärri (2012) introduce an inter-organizational working capital
model based on the cash conversion cycle to discuss both
collaborative and non-collaborative approach that is used as
benchmarking. The authors discuss five scenarios that enable
them to realize collaborative working capital management and
reduce the financing costs. From a qualitative perspective,
empirical studies were used to elaborate on working capital,
payment delays, and profitability (Farris II and Hutchison,
2002; Kaplan and Zingales, 1997). From a quantitative
perspective, a first attempt to incorporate asset-based financ-
ing into operational decisions is that of Buzacott and Zhang
(2004). The authors quantify available cash as a function of
assets and liabilities and demonstrate the necessity of jointly
considering production and financing decisions. Randall and
Theodore Farris (2009) show how cash-to-cash financial
techniques can help increase profitability in a supply chain
setting. Gupta and Dutta (2011) study the cash flows in a
supply chain and propose different heuristics that could be
used to solve real life dynamic problems. Li et al (2013)
present a dynamic model that jointly considers inventory and
financial decisions to maximize dividends under financial
constraints. We extend the research of Protopappa-Sieke and
Seifert (2010) who develop an inventory model that consol-
idates working capital restrictions and payment delays. The
authors quantify the benefits of joint consideration of physical
and financial flows, focusing on a single echelon setting.
Various supply chain financing solutions have been consid-
ered in the literature, such as trade-credit, factoring, reverse
factoring, and supplier subsidy. Trade-credit is an essential
element of cash management, especially in times of economic
downturns when payment delays are used means of alleviating
high working capital requirements. One of the first papers to
introduce payment delays was Goyal (1985) who presents an
economic order quantity model with permissible delays in
settling the amount owned to the supplier. More and more
studies included trade-credit in operational decisions in supply
 Margarita Protopappa-Sieke and Ralf W. Seifert—Benefits of working capital sharing in supply chains
chain management. Maddah et al (2004) and Seifert et al
(2013) provide an insightful literature review on trade-credit
along with future avenues for research. Gupta and Wang
(2009) present a discrete-time stochastic inventory model with
trade-credit and finance charges. The authors prove that the
credit terms do not affect the structure of the optimal policy.
Kouvelis and Zhao (2012) examined the structure of trade-
credit contracts and the optimal financing of the members in a
supply chain, where they compare different supplier and
banking financing scenarios. Motivated by the financial
struggles of Delphi Corporation and Visteon, Babich (2010)
discusses a form of financing where a company subsidizes its
financial ailing supplier. He uses a dynamic, stochastic,
periodic-review model to find the optimal capacity ordering
and subsidy policy.
An increasing number of papers exist that discusses the
importance of factoring in supply chains. Factoring is a form
of supply chain financing where a company exchanges its
accounts receivables with cash at a specific fee (Mian and
Smith, 1992; Sopranzetti, 1998; Klapper, 2006). Since
factors have to evaluate the buyers before agreeing to
exchange the accounts receivables, factoring is often con-
sidered an expensive form of financing and is often used in
emerging markets (Seifert and Seifert, 2011). An extension
of factoring that overcomes these difficulties is reverse
factoring or else known as supply chain finance. Tanrisever
et al (2012) study and quantify the value of reverse factoring
for the involved members in the supply chain. Wuttke et al’s
(2013) is one of the first papers to discuss the adoption of
reverse factoring in supply chains. Van der Vliet et al (2015)
introduce a periodic-review inventory model to investigate
whether reverse factoring is profitable. Wuttke et al (2016)
consider the adoption of reverse factoring using a diffusion
model and discuss how timing and payment terms can
influence adoption decisions. Our paper is discussing a
similar form of supply chain financing where the involved
parties share a joint pool of cash. We are interested in
investigating how working capital restrictions affect the
operations of a supply chain and how different working
capital allocation scenarios influence the operational and
financial flows in a two-stage supply chain. Motivated by the
aforementioned studies in trade-credit, we are also interested
how demanding longer payment delays impacts the overall
supply chain performance.
3. Model
To capture the essential aspects of financial and operational
planning in a two-stage supply chain, we consider a finite-
horizon, periodic-review inventory model. Our supply chain
consists of one retailer and one supplier. Customers place
orders with the retailer (Stage 1), who places orders with the
supplier (Stage 2). The supplier places orders with an outside
523
supplier who has infinite capacity. Both stages have working
capital restrictions and cannot always satisfy all the orders
demanded from downstream. For each stage, there is an
upstream and a downstream payment delay. More precisely,
when customers place an order with the retailer, they pay for
their order after d1 periods, which corresponds to the
downstream payment delays of Stage 1. When the retailer
places an order with his upstream supplier, he pays for his
order after u1 periods, which corresponds to the upstream
payment delays of Stage 1. Similarly, an order placed by the
supplier with his external supplier is paid after u2 periods,
which corresponds to the upstream payment delays of Stage 2.
Naturally, d2 = u1.
The unit ordering cost is ck , where k = 1, 2 is the number of
stages in the supply chain. The unit revenue for all orders sold
downstream is rk . Leaving aside transportation cost, the unit
ordering cost of the retailer equals the unit revenue cost of the
supplier, i.e., c1 = r2. Customers’ demand nn in period n is
independently and identically distributed, with a probability
distribution function u(.) with mean l and standard deviation
r. When orders are placed upstream, we assume that they
arrive after a delay of Lk periods. All unsatisfied orders are
backlogged with a unit penalty cost pk per period. Excess
inventory at the end of a period results in a unit holding cost at
stage k which is denoted as hk : In our model, we consider
backorders in the system.
The sequence of events per period is as follows: (1) the
inventory position and working capital position for both
stages are reviewed; (2) an order from each stage is placed
upstream constrained by the expected working capital posi-
tion when the payment for this order is due; (3) previously
ordered shipments arrive at both stages; (4) backorders at
both stages are satisfied; (5) customers’ demand occurs; (6)
orders placed at both stages are satisfied, or else they are
backlogged; (7) revenue is received in both stages from
satisfied backorders and downstream orders of d1, d2 periods
ago; (8) holding and shortage costs of this period at both
stages are realized and paid directly; (9) the order placed
upstream u1, u2 periods ago for both stages is paid; and (10)
working capital restrictions are enforced and cash positions,
which exceed a certain permissible threshold value, are send
to an external depository, to avoid an undue accumulation of
working capital in the system overtime. Figure 1 illustrates
the two-stage serial supply chain considered in our model
with the key assumptions.
The order amount for each stage in period n is qk;n ; where
qk,n C 0. The ordering decision in period n for each stage
depends on the optimal ordering decision of that period zk,n
and the expected available working capital when the payment
is due. We denote as q~k;n the amount sent to Stage k in period
n. For the supplier, the order amount and the amount received
are the same, i.e., q2;n ¼ q~2;n . This is because the outside
supplier has infinite capacity and therefore can satisfy all
orders from the supplier. Conversely, the order placed by the
524 Journal of the Operational Research Society Vol. 68, No. 5

Infinite Lead time L2 2

L1 1 Customers’
capacity Payment delays demand
u2 d2 u1 d1 ( n)
Unit revenue: r2 r1
Unit ordering cost: c2 c1
Unit holding cost: h2 h1
Unit shortage cost: p2 p1

Key assumptions
• Finite-horizon, periodic-review inventory model
• Excess orders are backordered
• Stochastic working capital capacity restrictions for both stages

Figure 1 Our two-stage supply chain.

retailer might not always be satisfied due to working capital Table 1 Model parameters
constraints the supplier is facing and can lead to under-
Indices
stocking at Stage 1. The distinction between the order amount k Stage; k = 1, 2
and the actual amount sent is necessary for cost accounting n Time period; time horizon of N periods
purposes. Additionally, let bk,n be the amount on hand plus on Parameters
order xk,n after q~k;n . is sent but before downstream demand is Lk Lead time
uk Upstream payment delays
realized, bk;n ¼ xk;n þ q~k;n . The inventory position at the end of
P 1 1 dk Downstream payment delays
period n at the retailer’s site is b1;n  nn  Li¼0 q~1;ni , while ck Unit ordering cost
PL2 1 rk Unit revenue
at the supplier’s site is b2;n  q1;n  i¼0 q2;ni . Table 1
hk Unit holding cost
presents the notation of our model. pk Unit penalty cost
nn End customer demand; mean l; standard
deviation r
zk,n Optimal ordering decision
3.1. Joint Working Capital Allocation xk,n Amount on order
bk,n Amount on hd plus on order after q~k;n is sent but
In the joint allocation scenario, the members of the supply
before nn is realized
chain have a joint pool of working capital. In our model, Ik,n Inventory value
working capital accounts for on-hand inventory and cash Ck,n Cash generated
from an existing pool of cash, accounts receivables, and WPn, WPk,n Working capital position
accounts payables. Let Ik,n be the inventory value of stage k at A, An Working capital allowance
Dn, Dk,n External depository
the end of period n. The inventory value for each stage is
 P 1 1 þ a, ak Discount factor
I1;n ¼ ck b1;n  nn  Li¼0 q~1;ni for the retailer and WPln, WPk,n
l
Liquid working capital
 PL2 1 þ p, pk Accounting penalty cost
I2;n ¼ ck b2;n  q1;n  i¼0 q2;ni for the supplier, where s, sk Cash outflow target
i0 , i0 k Financing interest rate
(x)+ = max(0, x). We do not attribute any value for negative
Decision variables
inventory position. Let Ck,n be the cash generated by stage k in qk,n Order placed
period n after all cash transactions have been completed. The q~k;n Inventory sent to stage k
cash generated by the retailer is given in Eq. 1, while by the
supplier is given in Eq. 2, where (x)- = max(0, -x). In Eq. 1,
the first three terms represent the cash inflow for the retailer
for all sales he captured in period n - d1 given that his sales shortage costs. Similarly, for Eq. 2, the first three terms
are restrained by the external customer demand, his order to correspond to the cash inflow from sales to the retailer in
the supplier, and the product availability at the supplier. The period n - d2, given that his sales are restrained by the
fourth term is his cash outflow for his order to the supplier, retailer’s demand, his order to the supplier, and the product
while the last two terms are the corresponding holding and availability at the supplier.
 Margarita Protopappa-Sieke and Ralf W. Seifert—Benefits of working capital sharing in supply chains 525

!þ ! chain across all periods. We define the financial cost as the

X
nd 1 1

C1;n ¼ r1 min nnd1 ; b1;nL1 d1  ni cost of financing and the depository cash outflow cost. By cost
i¼nL1 d1 of financing, we mean the cost of financing our operations. In
!þ !
X
nd1 1 our model, we have assumed that the initial endowment equals
þ r1 min q~1;nL1 d1 ; x1;nL1 d1 þ ni the allowance. The cost of financing is Ni0 A, where i0 is the
i¼nL1 d1 financing interest rate and N corresponds to the number of
!þ
LX
1 1 periods taken into account. To account for cash outflows to the
 c1 q1;nu1  h1 b1;n  nn  q~1;ni depository, we assume that in each period we need to meet a
i¼0
! cash outflow target, s; to the depository. If insufficient cash is
LX
1 1
generated to reach this target, then the system’s performance is
 p1 b1;n  nn  q~1;ni ð1Þ
i¼0
penalized by an accounting penalty cost p. The total account-
P
N
!þ ! ing penalty cost is p ðs  Dn Þþ : The objective function is
X
nd 2 1 n¼1
C2;n ¼ r2 min q1;nd2 ; b2;nL2 d2  q1;i presented in Eq. 3.
i¼nL2 d2
!þ ! " !þ
X
nd2 1
X
N LX
1 1
þ r2 min q2;nL2 d2 ; x2;nL2 d2 þ q1;i min n
a h1 b1;n  nn  q~1;ni
i¼nL2 d2 q;A
n¼1 i¼0
!þ !
LX
2 1 LX
1 1
 c2 q2;nu2  h2 b2;n  q1;n  q2;ni þp1 b1;n  nn  q~1;ni
i¼0 i¼0
! !þ
LX
2 1 LX
2 1
 p2 b2;n  q1;n  q2;ni ð2Þ þh2 b2;n  q1;n  q2;ni ð3Þ
i¼0 i¼0
! #
LX
2 1
The working capital position, WPn at the end of period n is the þp2 b2;n  q1;n  q2;ni
aggregation of cash and inventory values. While working capital i¼0
can be build-up over time, we assume an upper limit on the X
N
working capital position at the end of any period, i.e., working þ Ni0 A þ p ðs  Dn Þþ
capital allowance A which cannot be exceeded. For simplicity, n¼1

we assume A to be known and constant for all periods. Any

working capital in the form of cash that exceeds this threshold is
sent to an external depository Dn , where Dn = max(0, WPn -
A). An example of such a depository could be a dividend paid to
the shareholders. Cash sent to the depository cannot be used to
finance further operations of the system. Note, however, that if
at the end of period n we have backorders in a stage, this
assumption is relaxed. We include a discount factor a 2 ð0; 1Þ
which corresponds to the cost of capital.
We define as liquid working capital, WPln, the part of
working capital that is tied up as cash at the end of period n
after all working capital restrictions have been taken into
account and excess cash has been sent to the depository. With
joint allocation, the working capital is shared between the
supplier and the retailer and cash resources come from a joint
pool of cash, where the working capital position is WPn ¼
1 l
P2 P2
a WPn1 þ k¼1 Ck;n þ k¼1 Ik;n for all n, and the liquid
 P
working capital is WPln ¼ min 1a WPln1 þ 2k¼1 Ck;n ; A
 allowances, Eq. 4. The depository target for each member is
P2
k¼1 I k;n for all n. Our principal objective is to minimize
the total cost which includes the total operational cost and the
total financial cost, with respect to the ordering decision and
the allowance. The operational cost is the expected net present
value of the total holding and shortage costs of the supply
3.2. Dedicated Working Capital Allocation
In this allocation scenario, the members of the supply chain
each have a separate working capital pool and face individ-
ually working capital restrictions. We also assume that each
member can have a different discount factor ak 2 ð0; 1Þ:
Differences in the discount factor between the members of the
supply chain might depend on bargaining power and access to
capital. Each member of the supply chain makes separate
decisions about his own allowance, Ak. The working capital
position is WPk;n ¼ a1k WPlk;n1 þ Ck;n þ Ik;n for all k, n and

liquid working capital is WPlk;n ¼ min a1k WPln1 þ Ck;n ; A

Ik;n for all k; n: As with the joint pool, we seek to minimize
the expected net present value of the total cost of the whole
supply chain with respect to the ordering decisions and the
P  þ
pk Nn¼1 sk  Dk;n , where the depository in this case is
Dk,n = max(0, WPk,n - Ak). For the dedicated case, the inter-
est rate differs for each member in the supply chain and is
defined as i0 k. The financing cost for each member in the
supply chain is Ni0 kAk. In our model, the decomposition
526 Journal of the Operational Research Society Vol. 68, No. 5

technique of Clark and Scarf (1960) cannot be used (Heyman Figure 2 illustrates the optimal allowances for various CVs
and Sobel, 1984). Due to the dynamic nature of working and CRs. In the dedicated allocation, the supplier has a
capital, we resort to numerical analysis and simulation in order significantly lower optimal allowance than the retailer. This
to address our research questions and derive managerial difference is more pronounced the higher the CV. The
insights. retailer’s inventory value is higher due to the higher unit
" !þ ordering cost. Therefore, a higher allowance is required to
XN LX
1 1
compensate for the higher inventory value. Furthermore, the
n
min a1 h1 b1;n  nn  q~1;ni
q;A difference in optimal allowances between the members of the
n¼1 i¼0
! supply chain increases for a higher CV. High-demand
LX
1 1

þan1 p1 b1;n  nn  q~1;ni volatility results in peaks in revenue inflows to the retailer.
i¼0 If for example we have high demand in a period, the retailer
!þ needs the next period to meet the demand. If, in the next
LX
2 1

þan2 h2 b2;n  q1;n  q2;ni
i¼0
! #
LX
2 1
þan2 p2 b2;n  q1;n  q2;ni
i¼0
X
2 2 X
X N  þ
þ Ni0k Ak þ pk sk  Dk;n
k¼1 k¼1 n¼1
4. Managerial Insights
In this section, we present our numerical results. The base
model parameters we consider are based on the Hewlett
Packard printer data (Seifert et al, 2006), adjusted in order to
capture the two-stage supply chain nature of our setting, h1 ¼
0:06; p1 ¼ 0:24; c1 ¼ 2:6; r1 ¼ 3:6; h2 ¼ 0:06; p2 ¼ 0:24; and
c2 ¼ 1:6; r2 ¼ 2:6: For the dedicated scenario, we assume
that both stages have the same accounting penalty cost
p1 ¼ 0:05; p2 ¼ 0:05. Furthermore, we assume that the depos-
itory target is s1 = 0.2A1 and s2 = 0.2A2. For the joint
scenario, the corresponding parameters are p = 0.05 and
s = 0.2A. Customers’ demand follows a Lognormal distribu-
tion with mean l = 100 and standard deviation r = 30. A
wide range of model parameters is considered when perform-
ing sensitivity analysis on the Critical Ratio (CR) and the
Coefficient of Variation (CV). A different CR is capturing the
sensitivity analysis on the product parameters and is defined
similar to Porteus (2002) as p/(p ? h). A different CV is
capturing the sensitivity analysis on the demand and is defined
as r/l. The considered interest rates are 1, 5, and 10%.
We base our numerical analysis and simulation on a
modified base-stock policy which is a policy that follows a
base-stock policy when possible and produces to capacity
when the prescribed production quantity exceeds the capacity
(Federgruen and Zipkin, 1986). We do not claim that base-
stock policies are optimal in our setting, but we recognize that
the implementation of the optimal policy is too complicated
because of the stochastic nature of working capital. We
develop a discrete improving local search algorithm imple-
mented in MatLab. Large neighborhoods and various search
directions were considered in order to increase the robustness
of the algorithm. We consider a simulation time horizon of 100
periods and 50 repetitions (confidence interval of 90%).
ð4Þ period, the customer demand is not as high, then the revenue
inflow is low and more working capital is required for the
retailer to finance his operations. Additionally, if the optimal
allowance of the retailer was low, then the aforementioned
revenue peaks would have been sent to the depository. Further
we conclude that a higher CR requires a higher optimal
allowance, because a higher unit shortage cost requires a
higher inventory on stock.
Table 2 illustrates the cost savings achieved with the joint
allocation compared with the dedicated allocation. It can be
seen that a joint pool of working capital demonstrates
significant cost savings. Our main insights are summarized
in the following observations.
Observation 1 The supplier has a lower optimal allowance
than the retailer.
Observation 2 The joint allocation scenario demonstrates
significant cost savings compared with the dedicated
allocation. These savings increase as the CV increases.
4.1. Both Members Equally Strong
Figure 3 demonstrates the optimal allowance and the total cost
for various interest rates for both allocations. The supplier’s
optimal allowance is lower than the retailer’s. However, the
optimal allowance is robust as the interest rate increases. We
see that significant cost savings are achieved when the
members of the supply chain have a joint pool of working
capital. The cost savings decrease as the interest rate increases;
however, we have to mention that the discounting formula
contributes to this as well.
Since we have assumed that the members of the supply
chain are equally strong, they can negotiate trade-credit terms
equally well, u1 = u2. Figure 4 demonstrates the percentage
change in total cost for both allocation scenarios, compared
with a case of no payment delays. Longer payment delays
result in higher total cost, because the impact of downstream
payment delays is more significant than that of upstream
payment delays. Longer downstream payment delays increase
the supply chain costs. The cost increase for the dedicated
allocation is more pronounced than that with the joint
allocation scenario. This is similar to a phenomenon known
 Margarita Protopappa-Sieke and Ralf W. Seifert—Benefits of working capital sharing in supply chains 527

2500 1000

900

Optimal allowance
Optimal allowance

2000 800

700

1500 600

500

1000 400

300

500 200

100

0 0
Dedicated Joint Dedicated Joint Dedicated Joint Dedicated Joint Dedicated Joint Dedicated Joint

0. 3 0.5 0.7 0. 2 0. 5 0.8

CV CR
(a) Supplier Retailer Joint (b)
Figure 2 Sensitivity analysis.

Table 2 Difference between joint and dedicated allocation

CR Optimal working capital allowance Total cost

CV CV

0.3 0.5 0.7 0.3 0.5 0.7

0.2 25.6% 13.7% -23.0% -14.5% -14.6% -32.0%

0.5 24.6% 10.0% -19.1% -12.1% -15.3% -30.0%
0.8 18.9% 3.0% -18.1% -14.3% -15.1% -36.9%

1000 1200

900 -12.6%
1000
800 -14.3%
Optimal allowance

-16.4%
700
800
Total cost

600

500 600

400

300 400

200
200
100

0
Dedicated Joint Dedicated Joint Dedicated Joint 0
1% 5% 10%
1% 5% 10%
Interest rate
Interest rate
(a) (b)
Supplier Retailer Joint Dedicated Joint
Figure 3 Allowance and cost for symmetric interest rates.

as ‘‘double-marginalization’’ observed in decentralized supply delays result in higher optimal allowances, because longer
chains. With the dedicated allocation, the supplier is penalized payment delays result in higher total cost. Working capital
twice: (1) by the downstream payment delays he allows the utilization deteriorates with the dedicated allocation and
retailer and (2) by the downstream payment delays the retailer ameliorates with the joint allocation. Since with the joint
allows his customers. allocation scenario the penalization of the downstream
Figure 5 illustrates the corresponding percentage change in payment delays is only once, the working capital utilization
the optimal allowance. It can be seen that longer payment is better.
528 Journal of the Operational Research Society Vol. 68, No. 5

Dedicated Joint
Difference in total cost

Difference in total cost

50% 50%

40% 40%

30% 30%

20% 20%

10%
10%

0%
0%
1% 5% 10%
1% 5% 10%
Interest rate Interest rate
(a) (b)
3 periods payment delay 5 periods payment delay

Figure 4 Cost of symmetric payment delays.

Dedicated Joint

Difference in optimal
4%
Difference in optimal

30%

25%
3%
allowance
allowance

20%

15% 2%

10%
1%
5%
1%

0% 0%
1% 5% 10% 1% 5% 10%

Interest rate Interest rate

(a) (b)
3 periods payment delay 5 periods payment delay
Figure 5 Allowance for symmetric payment delays.

Dedicated Join t
600% 600%
Difference in total cost
Difference in total cost

500% 500%

400% 400%

300% 300%

200% 200%

100% 100%

0% 0%
1% 5% 10% 1% 5% 10%

Interest rate Interest rate

(a) (b)
3 periods lead time 5 periods lead time
Figure 6 Cost for symmetric lead times.

We assume that strong members can have same lead times. time. As expected, longer lead times result in higher total cost
Figure 6 illustrates the percentage difference in total cost for for both allocation scenarios, with the increase being more
various symmetric lead times, compared with a case of no lead pronounced for the dedicated allocation. Figure 7 presents the
 Margarita Protopappa-Sieke and Ralf W. Seifert—Benefits of working capital sharing in supply chains 529

Dedicated Joint

Difference in optimal
Difference in optimal

350% 350%

300% 300%

allowance
allowance

250% 250%

200% 200%

150% 150%

100% 100%

50% 50%

0% 0%
1% 5% 10% 1% 5% 10%

Interest rate Interest rate

(a) (b)
3 periods lead time 5 periods lead time
Figure 7 Allowance for symmetric lead times.

corresponding percentage increase in the optimal allowance. allocation scenario and (2) higher working capital uti-
Longer lead times result in higher allowances for both lization for the joint allocation scenario.
allocation scenarios. A higher allowance is required to hedge
Observation 6 onger symmetric lead times result in (1)
against the higher uncertainty a longer lead time entails, as
higher total cost, (2) higher optimal allowance, and (3)
both members need more inventory on stock to satisfy
lower average depository cash outflows, for both alloca-
customers’ demands as lead time increases.
tion scenarios.
The following observations summarize our main findings.
Observation 3 The joint allocation achieves significant cost
4.2. Strong Member vs. Weak Member
savings compared with the dedicated allocation scenario.
Those significant cost savings decrease when symmetric In this section, we investigate the impact of asymmetric
interest rates increase. interest rates, payment delays, and lead times on a supply
chain consisting of a strong and a weak member.
Observation 4 Longer symmetric payment delays result in
First, we look at the impact of asymmetric interest rates. We
(1) higher total cost, (2) higher optimal allowance, and
consider three different interest rate values: (1%, 5%), (5%,
(3) lower average depository cash outflows, for both
5%), and (10%, 5%). Figure 8 demonstrates the corresponding
allocation scenarios.
total cost and optimal allowance. Significant cost savings are
Observation 5 Longer symmetric payment delays result in observed with the joint allocation. The optimal allowance is
(1) lower working capital utilization for the dedicated robust in interest rate changes.

1000
-16.0% 1000
-10.6%
Optimal Allowance

900 -5.7% 900

16.8% 16.8% 16.8%
800
800
Total Cost

700
700
600
600
500
500
400
400
300
300
200
200
100
100
0
[1%,5] [5%,5%] [10%,5%] 0
Dedicated Joint Dedicated Joint Dedicated Joint
[1%,5] [5%,5%] [10%,5%]

Interest rates Interest rates

(a) (b)
Dedicated Joint Supplier Retailer Joint
Figure 8 Cost and allowance for asymmetric interest rates.
530 Journal of the Operational Research Society Vol. 68, No. 5

1600

1600 1400

Optimal allowance
1400
1200
-42.8%
Total cost

1200
1000
-33.3%
1000
-6.9% -16.1% 18.9% 20.5%
800 800

600 600

400
400
200
200
0
(0, 0) (0, 3) (3, 0) 0
Dedicated Joint Dedicated Joint Dedicated Joint

(0, 0) (0, 3) (3, 0)

(u1 , u 2 ) (u1 , u 2 )
(a) (b)
Dedicated Joint Supplier Retailer Joint

Figure 9 Cost and allowance for symmetric payment delays.

We assume that the strong member can negotiate for longer allocation. When the upstream payment delays increase, a
upstream or shorter downstream payment delays. We consider higher optimal allowance is required such that the cash benefit
three payment delays schemes: (1) no payment delays, (2) from the lower cash outflows is not sent to the depository.
3-period upstream payment delay for the supplier, and (3) When the retailer has upstream payment delays, a lower
3-period upstream payment delay for the retailer. We demon- optimal allowance is required for the joint allocation. The
strate our results for an interest rate of 5%. We examined both main reason is the dual role of these payment delays. On the
interest rates of 1% and 10% with similar results. Figure 9 one hand, the retailer requires a higher allowance in order to
illustrates the total cost and the optimal allowance. Significant compensate for his higher cash position due to his upstream
cost savings are achieved with the joint allocation, which are payment delays. On the other hand, the supplier requires a
more significant the more constrained the supply chain, significantly higher optimal allowance to make up for his
(u1 = 3, u2 = 0). Extending payment delays results in higher reduced cash inflows.
supply chain costs. When the retailer extends his upstream We assume that the strong member has shorter lead time.
payment delays, the total cost is higher for both allocation We consider three lead time schemes: (1) no lead time,
scenarios. When the supplier has upstream payment delays, the (2) 3-period lead time for the supplier, and (3) 3-period lead
optimal allowance increases for the joint allocation. This is time for the retailer. We demonstrate our results for a
because the upstream payment delays of the supplier are the symmetric interest rate of 5%. Figure 10 illustrates the
upstream payment delays of the whole supply chain in the joint corresponding total cost and optimal allowance. Significant

3000 1800

-41.2% 1600
2500
Optimal allowance

1400

1200 -36.8%
Total cost

2000
1000
-13.9%
18.9%
1500
-16.6%
800

600
1000
-6.9%
400

500 200

0
0 Dedicated Joint Dedicated Joint Dedicated Joint
(0,0) (0, 3) (3,0)
(0,0) (0,3) (3,0)

( L1 , L2 ) ( L1 , L2 )
(a) (b)
Dedicated Joint Supplier Retailer Joint

Figure 10 Cost and allowance for asymmetric lead times.

 Margarita Protopappa-Sieke and Ralf W. Seifert—Benefits of working capital sharing in supply chains
cost savings are achieved with the joint allocation. These cost
benefits are higher when there is lead time between the retailer
and the supplier, i.e., -41.2% compared with -16.6%. The
optimal allowance decreases with the joint allocation scenario
compared with the dedicated allocation for asymmetric lead
times. From Figure 10b, it can be observed that the optimal
allowance with the joint allocation is less than with the
dedicated allocation.
Observation 7 Extending payment delays to a supplier
upstream results in higher supply chain costs.
Observation 8 Significant cost savings are achieved with the
joint allocation for a supply chain with a strong and a
weak member.
5. Conclusion
Efficient working capital management in a supply chain can
achieve significant cost savings as it enables weak members to
secure the necessary financing. Better visibility of cash and
product flows results in better utilization of working capital
and a supply chain that is more responsive to market needs. In
this paper, we investigate the benefits when the members of a
supply chain may make use of a joint pool of working capital,
compared to current practices where each member of a supply
chain has its own dedicated working capital. We investigate
the impact of interest rate, payment delays, and lead time on
the supply chain costs. We also examine two settings of a two-
stage supply chain. The first consisting of two strong members
and the second consisting of one strong and one weak member.
A strong member can negotiate better in terms of capital
financing, trade-credit, and lead time than a weak member.
In our paper, we illustrate how working capital restrictions
affect the operations of a supply chain and how different
working capital allocation scenarios influence the operational
flows and the financial flows. More specifically, we demon-
strate that collaborative approaches can actually benefit the
operations of the supply chain. Our results demonstrate
significant cost savings with a joint allocation compared with
a dedicated allocation. These cost savings are greater for
higher coefficient of variation. Since innovative products are
characterized by high-demand uncertainty (Fisher, 1997), it is
even more profitable for the members of a supply chain to
share working capital when the products delivered from this
supply chain are innovative. Last, we want to examine how
payment delays impact the overall performance and the supply
chain costs. Through our results, we identify an effect similar
to the ‘‘double-marginalization,’’ due to the double penaliza-
tion of the supplier from the customers’ downstream payment
delays. One important finding is that extending payment
delays to a supplier results in higher supply chain costs and,
thus, a company should consider the overall impact on the
supply chain total cost when deciding to extend their payment
delays to their supplier. Our findings are aligned to those of
531
Viskari and Kärri (2012) who present five scenarios that
enable inter-organizational collaborative working capital man-
agement and reduce the financing costs. The authors also find
reduction of approximately 10%–20% depending on the action
taken with respect to the cash conversion cycle.
The contribution of our paper is threefold: First, we discuss
a promising way of financing the supply chain that can be used
to increase liquidity among the involved supply chain partners
and is based on a joint cash pool. Second, we discuss and
quantify different working capital allocation scenarios and
show their impact on operational decisions and financial
planning. Third, we discuss a very practical problem that is
highly intertwined to the existing supply chain financial
solutions and we are able to quantify its benefits. We present a
base model for including such allocation scenarios on
inventory decisions. Many limitations exist for this study
due to the dynamic nature of working capital and the payment
delays. The optimality of a base-stock policy cannot be
proven, which necessitates the use of simulation. In our model,
we do not allow the members of the supply chain to resort to
any external financing from a bank, apart from the initial
endowment. Furthermore, we only include cash and inventory
and exclude vital constituents of working capital. Many
promising future research avenues exist, for example, dynamic
risk considerations, i.e., dynamically varying interest rates,
financing terms, and working capital financing. In our
research, we have assumed that the unit ordering and
purchasing cost do not depend on the payment delay terms.
However, a more representative approach would be to allow
for unit ordering and purchasing costs to vary according to the
payment terms, i.e., a common trade-credit is 2–10 net 30
which indicates a 2% discount if payment is received within
10 days and that payment is expected in 30 days, or even to
consider external sources of financing.
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Received 1 February 2016;
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