Int. J.

Production Economics 234 (2021) 108039

Contents lists available at ScienceDirect

International Journal of Production Economics

journal homepage: http://www.elsevier.com/locate/ijpe

Integrating sourcing and financing strategies in multi-tier supply

chain management☆
Seung Ho Yoo a, Thomas Y. Choi b, DaeSoo Kim c, *
a
Division of Interdisciplinary Industrial Studies, Hanyang University, 222 Wangsimni-ro, Seongdong-gu, Seoul, 04763, South Korea
b
W. P. Carey School of Business, Arizona State University, Tempe, AZ, 85287-4706, USA
c
Department of Logistics, Service & Operations Management, Korea University Business School, Anam-dong, Seongbuk-gu, Seoul, 02841, South Korea

A R T I C L E I N F O A B S T R A C T

Keywords: This study investigates the financial leveraging effect of a final assembler’s sourcing strategies in a multi-tier
Supply chain financing supply chain—a three-tier supply chain consisting of a large final assembler (FA), a first-tier supplier (S1),
Strategic component sourcing and a second-tier supplier (S2). From the perspective of FA, we consider two sourcing and four financing stra­
Trade credit
tegies. The two sourcing strategies entail delegating component procurement to S1 (sequential sourcing) or
Reverse factoring
Quality management
directly procuring from S2 (directed sourcing). The four financing strategies include commercial loan financing,
Multi-tier supply chain factoring, and reverse factoring with or without a payment term extension. Our main objective is to find out the
combination of the sourcing and financing strategies and the relative conditions that would induce better
operational decisions and enhance overall supply chain performance. The results reveal the contingencies when
directed sourcing or sequential sourcing might work well. For instance, when the suppliers utilize factoring as a
financing option, FA, S2, and the supply chain are better off with directed sourcing when S2 is powerful or when
S2’s impact is low but the interest rate is high. Otherwise, sequential sourcing guarantees the better profit for FA,
S2, and the supply chain. Reverse factoring yields more predictable performance, which can be utilized either for
the FA’s benefit with a payment term extension or for the supply chain’s long-term health without a payment
term extension.

1. Introduction becomes increasingly dependent on suppliers and their quality (Lee

The final assemblers have been using their supply chain to increase
return on investment (ROI) and to reduce cash conversion cycle (CCC)
(Forbes, 2018). They have exacted cost concessions from their suppliers,
and they have extended their payment terms. Especially after the global
financial crisis circa 2008, many buyers in the buyer-led supply chains
have used the payment term as the main option to resolve their working
capital problems and boost earnings, thereby extending trade credit
from suppliers (Quick, 2013; Caniato et al., 2016). For example, Apple
extensively utilizes trade credit from its suppliers, with its days of
payable outstanding at 126.6 days in 2018 (Forbes, 2018). Such practice
of demanding more trade credit can put a huge burden on suppliers,
especially when sales are concentrated on a few buyers (Lee et al., 2018;
Wetzel and Hofmann, 2019). The supplier invariably becomes
cash-strapped, and the situation could have negative repercussions on
the performance of the buyer and the entire supply chain, as the buyer
et al., 2018; Wetzel and Hofmann, 2019). Therefore, it is imperative for
the buyer to consider possible backlash from payment term extensions,
and the final assemblers have begun to take an active role in assisting
suppliers to obtain the necessary supply chain financing (SCF) (Tunca
and Zhu, 2018). They are concerned that if pressed, quality would be the
first to suffer (Lee et al., 2018), as it precedes other key indicators such
as safety and continuity of supply (IDC, 2010).
These suppliers do not exist in isolation, as they also work with their
suppliers, and that takes us to the multi-tier supply chain context (Choi
and Linton, 2011). The sourcing decision that spans across multiple
levels of the supply chain is delegation versus control (Choi and Hong,
2002; Kayiş et al., 2013; Bolandifar et al., 2016). The conceptual de­
parture here is that the outsourcing of manufacturing does not neces­
sarily equate to the outsourcing of sourcing. The final assembler has to
make a strategic decision whether to delegate component procurement
to the first-tier supplier or to directly control it at the second-tier. The

☆
This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2016S1A2A2911705).
* Corresponding author.
E-mail addresses: shoyoo@hanyang.ac.kr (S.H. Yoo), thomas.choi@asu.edu (T.Y. Choi), kimd@korea.ac.kr (D. Kim).

https://doi.org/10.1016/j.ijpe.2021.108039
Received 29 July 2020; Received in revised form 27 November 2020; Accepted 15 January 2021
Available online 22 January 2021
0925-5273/© 2021 Elsevier B.V. All rights reserved.
S.H. Yoo et al.
former entails sequential sourcing (delegation), and the latter entails
directed sourcing (control). For instance, when Google outsources the
manufacturing of its Chromecast to Flex as its first-tier supplier, it asks
Flex to make the sourcing decisions involving the second-tier suppliers,
thus engaging in sequential sourcing. However, when Apple outsources
the manufacturing of its smartphones to Foxconn, it maintains authority
to choose its second-tier suppliers, thus engaging in directed sourcing.
In such a strategic sourcing context, trade credit plays an important
role. Trade credit is a short-term loan for a buying firm’s purchase from a
supplier, which appears in the balance sheet as accounts payable on the
buyer’s side and as accounts receivable on the supplier’s. It is reported
that approximately 80% of B2B transactions in the US and the UK are
made with trade credit (Seifert et al., 2013). Specifically, the execution
of sourcing strategies and the subsequent difference in the contractual
relationship structures would directly affect the decision of trade credit
and the management of working capital of each player in the multi-tier
supply chain.
In this study, we consider a three-tier supply chain consisting of a
final assembler (FA) as the focal company that interfaces the consumer
market, a first-tier supplier (S1) that is often a contract manufacturer,
and a second-tier supplier (S2) whose component has a significant
impact on overall product quality. For instance, Largan Precision is a
second-tier supplier to Apple. The quality of phone lenses they manu­
facture would have a significant impact on the overall performance of
Apple phones in the consumer market. Under sequential sourcing, FA
procures a module from S1 and delegates to S1 the procurement of a
component part. S1 would then source the component part from S2. If
FA implements extended payment terms, S1 would naturally look for
ways to release this pressure. S2 is often tapped for this purpose.
Therefore, the trade credit is issued from S2 to S1 and then from S1 to
FA, as in the forward supply chain inventory flow. On the contrary,
under directed sourcing, FA does the sourcing from both S1 and S2—it
procures the module from S1 as well as the component part from S2,
which is then delivered to S1. Therefore, the trade credit is issued from
both S1 and S2 to FA. Each player’s objective is to maximize its expected
profit by controlling not only the market sales and cost but also the
working capital with a focus on the capital incurred through trade
credit. As such, the choice of sourcing strategy affects trade credit and
related working capital management of suppliers; in particular, working
capital issues would affect S2’s quality decision. Therefore, the working
capital problem differentiated by the sourcing strategy addresses how to
engage in supply chain financing, as finance supports real investment in
operations (Zhao and Huchzermeier, 2015).
In this vertical tug-of-war among players in a supply chain, opera­
tions and finance are inextricably intertwined. Therefore, we need to
gain a more comprehensive understanding of the performance dynamics
of sourcing strategies and consider the suppliers’ financing options (Lee
et al., 2018; Tunca and Zhu, 2018). Better financing options would allow
the suppliers to concentrate on their operations, thereby upholding the
quality requirements and avoiding disruptions. As such, we are moti­
vated to find out the answers to our main research questions: Which
combination of sourcing and financing strategies would lead to a better
operational decision and enhance overall supply chain performance, and
under what conditions? What would be the characteristics of each joint
sourcing and financing strategy?
Specifically, we look into four financing options that suppliers utilize
in practice; namely, commercial loan financing, factoring, and reverse
factorings with and without payment term extensions. Commercial loan
financing from an external financial institution (e.g., bank) incurs in­
terest during the credit period, without providing any risk-hedging in­
strument for the uncertainty in the payment period. In factoring, the
supplier sells its accounts receivable to an external financial institution
at a discount. It secures funds immediately so that it is relieved of
financial risks due to uncertainty in the payment period. Reverse
factoring is a buyer-intermediated factoring to support its suppliers. It
can lower the interest rate as it is determined by the buyer’s credit rating
2
International Journal of Production Economics 234 (2021) 108039
and capability. Reverse factoring often accompanies the payment term
extension but not always. For example, a leading high-tech company
that one of the authors in this study works closely with offers reverse
factoring without payment term extensions as a strategy to improve the
health of its supply chain.
The present study considers in tandem sourcing and financing stra­
tegies, and it does so in the multi-tier supply chain context. Specifically,
it aims to reveal which combination of the two sourcing strategies
(sequential and directed) and the four financing strategies (commercial
loan financing, factoring, and reverse factoring with and without a
payment term extension) induces a better operational decision and en­
hances supply chain performance. Despite this practical importance,
however, most previous multi-tier supply chain management (SCM)
studies have not examined the interplay between the sourcing strategies
and the trade credit and financing decisions. Theoretically, this study
contributes not only to the existing knowledge in the multi-tier SCM by
incorporating trade credit issues and financing options, but also to the
emerging literature on supply chain financing by extending the dyadic
buyer-supplier context to the multi-tier supply chain. From a managerial
point of view, the findings provide practicing managers with a guideline
for developing and executing joint sourcing-financing strategies. The
managerial insights from key findings are summarized in Section 5.
The rest of the paper is organized as follows. Section 2 provides a
literature review and discusses the contribution of the present study to
the extant literature. Section 3 presents basic formulation for sequential
and directed sourcing strategies with trade credit. Section 4 develops
eight joint sourcing-financing models by integrating two sourcing and
four financing strategies. Then, we analytically and numerically
compare the optimal solutions and reveal which combination yields best
performance and under what conditions. Section 5 discusses the findings
and managerial insights. Finally, Section 6 summarizes this study and
addresses the limitations of this study and future research directions.
2. Literature review
The present study brings together two research streams; namely, the
component sourcing strategy in a multi-tier supply chain context (e.g.,
Guo et al., 2010; Kayiş et al., 2013) and supply chain financing (SCF),
which involves trade credit issues (e.g., Yang et al., 2017; Tunca and
Zhu, 2018).
The first stream of research on the component sourcing strategy in a
multi-tier supply chain has considered a three-tier supply chain con­
sisting of an original equipment manufacturer (OEM), a contract
manufacturer (CM), and a component supplier. The focus of these
studies is on investigating the OEM’s sourcing strategy decision whether
to delegate or to control the component procurement function. For
example, Guo et al. (2010) examine three outsourcing structures in a
supply chain; namely, the in-house consignment under which the OEM
directly controls both the CM and the supplier, the turnkey under which
the OEM delegates the component procurement to the CM, and the in­
tegrated turnkey under which the OEM makes a contract in alliance with
the CM and the supplier. Deshpande et al. (2011) investigate a
price-masking technology intended to preserve each player’s private
information about the component price and the OEM’s problem of
whether to delegate or control component procurement. Chen et al.
(2012) look into a large OEM’s delegation versus control decision, given
the CM’s additional relationship with a smaller OEM. Kayiş et al. (2013)
examine the effect of price-only and quantity discount contracts on a
manufacturer’s component sourcing decision when there is information
asymmetry in the suppliers’ production costs. Wang et al. (2014)
investigate delegation and control structures with push and pull
ordering policies. Bolandifar et al. (2016) study the OEM’s component
sourcing strategy in a three-tier supply chain with two competing OEMs
and one common CM. Lv (2018) also considers a similar context and
finds the conditions that have a critical impact on the equilibrium out­
comes, such as procurement cost, market size, and competition
S.H. Yoo et al.
intensity. Dong et al. (2018) investigate the OEM’s sourcing decision
when the OEM and the CM have different discount abilities for the
component cost due to the economies of scale. The present study con­
siders the component sourcing decision by incorporating the trade credit
and supply chain financing issues that are affected by the OEM’s or the
final assembler’s component sourcing strategy and subsequent changes
in the relationship structure among supply chain players.
The second stream of research on supply chain financing has dealt
with trade credit or deferred payment issues and the resulting working
capital management and financing problems. While finance literature
shows extensive research on trade credit, supply chain financing has
recently been receiving keen attention. The focus has been on capturing
the real market situation better by relaxing the implicit assumptions of
no payment delay or free inventory financing found in prior supply
chain literature (Lee and Rhee, 2011). These studies can be classified
into two genres—one dealing with the supplier perspective and the
other dealing with the buyer perspective (see Seifert et al. (2013), Zhao
and Huchzermeier (2015), Gelsomino et al. (2016), or Jia et al. (2020)
for detailed reviews).
The majority of studies belong to the first genre—the supplier’s
perspective. These studies focus on the trade credit issued to induce
more orders from the buyer. They address topics ranging from coordi­
nation and contracting to efficiency and flexibility. With many based on
the newsvendor model, they cover the supplier’s supply chain coordi­
nation utilizing the trade credit contract (Lee and Rhee, 2011); the
structure of optimal trade credit contracts (Kouvelis and Zhao, 2012);
and the comparison of various supply contracts under financial con­
straints and bankruptcy costs (Kouvelis and Zhao, 2015). The topics
develop further into the flexible trade credit contract in a two-period
supply chain (Yang et al., 2016); the supply contract coordination in a
financially constrained supply chain (Xiao et al., 2017); and the effect of
external equity and bank financing on the decision of two competing,
financially-constrained retailers (Yang et al., 2017). Most recently, we
have seen topics on the enhancement of supply chain efficiency through
a trade credit contract (Yang and Birge, 2018) and comparisons among
various mechanisms to address the retailer’s credit default problems
(Wang et al., 2018).
The second genre from the buyer’s perspective is more relevant to
the present study. The studies investigate the trade credit as an impor­
tant option to control the supplier’s action and supply chain financing
options. Babich and Tang (2012) examine the buyer’s three mechanisms
(deferred payment, inspection, and combined) to control the supplier’s
product adulteration problem. They show that deferred payment is su­
perior to the inspection and combined mechanisms in deterring sup­
plier’s product adulteration. They also enumerate the factors affecting
the dominance of the deferred payment mechanism. Similarly, Rui and
Lai (2015) compare the deferred payment and inspection mechanisms
intended to deter the supplier’s product adulteration. They too find that
the deferred payment is generally more effective than the inspection
mechanism, especially when the market size is small, or the profit
margin is low. Chen and Hu (2015) investigate the buyer’s payment
scheme to control the supplier’s quality level. The payment scheme
consists of an initial payment and a deferred payment after the use of the
product for a certain period. They find that a high-cost, high-quality
supplier prefers the deferred payment option, and that the buyer has an
incentive to support the supplier’s financing. The present study extends
these studies of trade credit problems in a three-tier supply chain. It
scrutinizes the final assembler’s problem of deciding how to control the
supplier’s moral hazard in the multi-tier supply chain context where the
second-tier supplier’s component quality has a critical impact on con­
sumer demand.
Moreover, some studies in this second genre have been gaining
attention by focusing on the supplier financing options. Tunca and Zhu
(2018) investigate the role and efficiency of the buyer’s intermediation
in supplier financing. They find that the buyer-intermediated financing
benefits both the buyer and the supplier and significantly improves
3
International Journal of Production Economics 234 (2021) 108039
supply chain performance. Tang et al. (2018) explore two
non-asset-based financing methods; namely, purchase order financing
from the bank based on its value and buyer directed financing of directly
issuing loans to the supplier. The study reveals that the two financing
schemes yield identical payoffs for all parties when no information
asymmetry exists between the manufacturer and the bank, while the
performance of the schemes depends on the suppliers’ efficiency and
asset level when information asymmetry is present. Ding and Wan
(2020) investigate a capital-constrained supplier’s two financing op­
tions: bank loan and manufacturer’s advance payment. They reveal that
the manufacturer can benefit from the advance payment by stimulating
the supplier to produce more, and hence the manufacturer is always
willing to prepay to support the supplier’s production. Yan et al. (2020)
compare the loss-averse retailer’s two financing options for a
capital-constrained supplier: loan and investment. They reveal that the
retailer’s loss aversion is an important factor causing lower chances of
achieving Pareto improvements from supply chain financing. Other
studies compare the performance of various financing options (Chen and
Gupta, 2014; Damianos and Alejandro, 2016; Grüter and Wuttke, 2017).
The present study extends these SCF studies by going deeper into
financing options in combination with sequential (delegation) and
directed (control) sourcing strategies in a multi-tier supply chain
context.
Overall, the present study extends the previous studies and fills a
void in the multi-tier supply chain management and supply chain
financing literature by jointly considering sourcing and financing stra­
tegies in a three-tier supply chain. To achieve this, we analyze and
compare eight sourcing-financing cases based on the combination of two
sourcing strategies (sequential and directed) and four financing options
(commercial loan, factoring, reverse factoring with a payment term
extension, and reverse factoring without a payment term extension).
3. Basic formulation: sequential and directed sourcing strategies
with trade credit
In our three-tier supply chain, S1 produces a main module or
component by assembling a quality-critical subcomponent from S2, and
then delivers it to FA. We focus on investigating a supply chain situation
in which S2’s subcomponent quality has a critical impact on the overall
product quality, especially in high-tech or automobile industries. For
example, LG Electronics’ S1 is Qualcomm but its S2 is TSMC, which
manufactures CDMA chips critical for its mobile phones (Choi and Lin­
ton, 2011). Honda gets its center console assembly from CVT (S1) but
the expensive leather parts that go into the center console come from
Garden State (S2) (Choi and Hong, 2002). Therefore, to FA, S2 can be as
important as its top-tier supplier S1, and FA would be motivated to find
the optimal sourcing-financing strategy to manage the three-tier supply
chain effectively.
Moreover, facing the market, FA would not have total control over
what happens there and, in that regard, the impact of S2’s quality-
critical subcomponent on the sales price of the final product could be
limited. In 2013, Apple launched iPhone 5S with a new feature, Touch
ID, the fingerprint sensor which was supplied by its second-tier supplier,
TSMC. Many consumers welcomed this innovative feature, and since
then, many other smartphones have incorporated biometric options for
user convenience and safety (GlobeNewswire, 2020). However, when
Apple launched iPhone 5S, its price was the same as that of iPhone 5
without the Touch ID (Grandoni, 2012; Apple, 2013). Therefore, the
sales price of the final product is assumed to be exogenously determined,
and that the buying intentions of consumers are directed at the quality of
the product, given the price, as it is important for the FA to differentiate
its product on quality. In this context, we define the consumer demand
as shown below, which is negatively affected by the price while posi­
tively affected by the product quality as found in many previous studies
(Banker et al., 1998; Sridhar and Pradeep, 2004).
S.H. Yoo et al.
q = 1–p + δx,
where p is the sales price of the product, x is the product quality affected
mainly by subcomponent quality from S2, and δ is the demand sensi­
tivity to product quality. The assumptions for this study are summarized
in Table 1.
Many supply chains are led by large buyers (e.g., Apple, Honeywell,
etc.). Here, a buyer (FA or S1) devises the contract term for its supplier
(S1 or S2). We consider that the contract is based on a simple wholesale
price contract. Under sequential sourcing in Fig. 1(a), FA makes a
contractual relationship with S1, while delegating the procurement of
S2’s subcomponent to S1. Therefore, the market profits of FA, S1, and S2
(with subscript A, 1, and 2) are: MSA = (p–w1 )q, MS1 = (w1 –w2 )q, and
MS2 = (w2 –cx)q, where q = 1 – p + δx in (1), w1 and w2 are the unit
wholesale prices of S1 and S2, respectively, and the superscript S de­
notes the sequential sourcing strategy.
We consider cx the quality-dependent unit production cost of S2 with
the coefficient c and quality level x, as similarly defined in Banker et al.
(1998) and Reyniers and Tapiero (1995). In practice, it is often impos­
sible to control quality by leveraging the fixed investment, such as the
cost of R&D or facilities since they are already a sunk cost. Rather, the
supplier’s response to the buyer’s policy change would commonly be to
control its variable cost (cx in this study), for example, by adopting a
cheaper component, reducing the material content, removing a treat­
ment step, etc. Note that we do not consider the production cost of FA
and S1 and focus on the subcomponent quality at S2. Also note that if we
consider that S1’s wholesale price w1 consists of S1’s purchase cost w2
and its own share (margin) m, i.e., ws1 = w2 + m, the market profits in
sequential sourcing become: MSA = (p–w1 )q = (p–w2 –m)q, MS1 =
(w1 –w2 )q = mq, and MS2 = (w2 –cx)q, where q = 1 – p + δx in (1).
Each player’s objective is to maximize its expected profit by con­
trolling not only sales and cost but also working capital. Among various
sources of working capital, we focus on the capital incurred through
trade credit. Trade credit appears in the balance sheet as accounts
payable on the buyer’s side and as accounts receivable on the supplier’s
side. In practice, the supplier charges no related interest during the
buyer’s payment delay period or charges much less interest than what a
bank does (Yang et al., 2016; Lee et al., 2018). Thus, the buyer may be
motivated to utilize the accounts payable and extend payment terms to
save the time value of money by accumulating sales revenue and earning
interest (Yang et al., 2016). Meanwhile, the accounts receivable on the
supplier’s side incurs interest or opportunity cost during the delay
period. Therefore, the total profit of a player i can be described as Πi =
market profit M – costs from accounts receivable (AR) + savings from
accounts payable (AP). Utilizing the basic market profit functions dis­
cussed above, we formulate the profits of the players under the
sequential sourcing strategy with trade credit incorporated as below.
Profits under the Sequential Sourcing Strategy with trade credit:
Π SA =market ​ profitM + savings ​ from ​ AP =(p–w1 )q+iA DA w1 q= (p–w2 –m)q
+iDA (w2 +m)q,
Table 1
Summary of assumptions.
1. The sales price of the final product is externally determined.
2. Product quality is mainly affected by S2’s subcomponent quality.
3. In the buyer-led supply chain, a buyer (FA or S1) devises the contract term for its
supplier (S1 or S2).
4. The risk premiums for S1 and S2 are similar, while FA’s interest rate is risk-free.
5. Under directed sourcing, FA devises the same payment terms for both S1 and S2.
6. Wholesale price has already been set under the long-term, strategic relationships
among players.
International Journal of Production Economics 234 (2021) 108039
(1)
Fig. 1. Two sourcing strategies (thin arrow: inventory flow; bold arrow: con­
tract offer and payment).
= market ​ profit M–costs ​ from ​ AR + savings ​ from ​ AP
Π S1 = (w1 –w2 )q–i1 DA w1 q + i1 D1 w2 q (3)
= mq–(i ​ + ​ r)DA (w2 + m)q + (i ​ + ​ r)D1 w2 q, and
Π S2 = market ​ profit M– costs ​ from ​ AR = (w2 –cx)q–i2 D1 w2 q
(4)
= (w2 –cx)q– (i + r)D1 w2 q,
where q = 1 – p + δx in (1). Again, under the sequential sourcing
strategy, wS1 = w2 + m. Additionally, iA, i1, and i2 are the respective in­
terest rates, and we set iA = i for FA, and i1 = i2 = i + r for S1 and S2,
given the risk-free interest rate i and risk premium r. DA and D1 are the
credit period terms determined by FA and S1 for transactions with S1
and S2, respectively.
Given the prevalence of trade credit in a buyer-supplier relationship,
FA’s procurement cost w1q is equivalent to the amount of FA’s AP, and it
is paid to S1 after the credit period DA. Therefore, FA earns interest from
AP by iADAw1q during DA with DA > 0 in (2). Note that we do not specify
the sign of the credit period DA, since we consider not only FA’s late
payment (DA > 0) but also FA’s prepayment for its supplier (DA < 0) as in
practice. Especially in the high-tech industry, many companies (e.g.,
Apple and Boeing) have long utilized prepayments to support suppliers’
operations and technology investment by relieving their financial
pressure or to secure long-term supply agreements of critical compo­
nents (Niu, 2017; Levine-Weinberg, 2020; Ding and Wan, 2020). In fact,
Apple announced in 2011 that it would prepay $2.4B to key suppliers
(Clarke et al., 2019). If FA utilizes the prepayment (DA < 0), the interest
of iADAw1q is incurred at FA in (2). Later in Proposition 1, we reveal the
conditions for FA’s prepayment.
Since we consider FA with strong market power and high credit
rating, we assume its interest rate to be risk-free (i.e., iA = i). FA’s AP
corresponds to S1’s AR, and it incurs interest (or opportunity loss) for S1
by i1DAw1q in (3). Even though both S1 and S2 are considered financially
healthy, most suppliers are less endowed with resources compared to FA
and would likely not obtain cheaper financing than FA (Babich and
Tang, 2012; Klapper et al., 2012). Thus, the interest rates for S1 and S2
are: i1 ≈ i2 = i + r, assuming the similar risk premiums for FA’s two
strategic partners. Note that our focus is on studying the interaction
among players in the three-tier supply chain. Therefore, the external
(2) financial institution’s decisions of i and r are not within the scope of this
study. Under sequential sourcing with trade credit (DA > 0), S1 pays
interest of (i + r)DAw1q from AR incurred in the transaction with FA in
(3), but it enjoys the savings of (i + r)D1w2q from AP in the transaction
with S2, while the corresponding AR incurs interest at S2 in (4).
Therefore, this financial cost influences S2’s decision on its component
performance. Also note that if FA adopts the prepayment (DA < 0), S1
can earn interest of (i + r)DAw1q from the transaction with FA in (3), and
S1 also can pay to S2 in advance.
Since S2’s subcomponent has a critical impact on the overall quality
of the product, FA may engage in directed sourcing by directly con­
trolling S2 in addition to S1. Under directed sourcing (as shown in Fig. 1
(b)), FA devises the contract terms for S1 and S2 and pays to both, while
the inventory flow is the same as in sequential sourcing. Therefore, the
4
S.H. Yoo et al.
market profits are MDA = (p – w1 – w2)q, MD1 = w1q, and MD2 = (w2 – cx)q,
where the superscript D denotes the directed sourcing strategy. Since FA
directly pays w2 to S2, FA’s procurement cost wD1 paid to S1 in directed
sourcing needs to exclude w2. That is, wD1 = wS1 – w2 = (w2 + m) – w2 = m
under directed sourcing, while wS1 = w2 + m in sequential sourcing.
Therefore, the market profits become: MDA = (p – w1 – w2)q = (p – w2 – m)
q, MD1 = w1q = mq, and MD2 = (w2 – cx)q. We formulate the profits of
players (i.e., Πi = market profit M – costs from AR + savings from AP)
under the directed sourcing strategy with trade credit incorporated as
below.
Profits under the Directed Sourcing Strategy with Trade Credit:
Π DA = (p–w1 –w2 )q + iA DA w1 q + iA DA w2 q = (p–w2 –m)q + iDA (w2 + m)q,
Π D1 = w1 q–i1 DA w1 q = mq– (i + r)DA mq, and
Π D2 = (w2 –cx)q–i2 DA w2 q = (w2 –cx)q– (i ​ + ​ r)DA w2 q.
Under directed sourcing, FA devises the payment terms for both S1
and S2, including the credit periods, since S2 is also an important,
strategic partner of FA like S1, supplying a critical component. There­
fore, it is reasonable to set these credit periods the same as DA for both S1
and S2. In fact, it is evidenced by Samsung’s supplier management
practice. In 2016, Samsung made mutual growth agreements with its
suppliers to offer support and cooperation programs, and since then
Samsung has paid its suppliers within 10 days of cutoff (Samsung SDI,
2016). This arrangement has been applied to all its strategic suppliers
regardless of their tiers.
4. Integrated sourcing-financing strategies
We integrate four financing options with two sourcing (sequential
and directed) models in (2) through (7). Of the four financing options
(commercial loan financing, factoring, reverse factoring with a payment
term extension, and reverse factoring without a payment term exten­
sion), the first two are supplier-initiated, and the second two are buyer-
initiated. We analyze how different combinations of sourcing and
financing strategies affect operational decisions and overall supply chain
performance.
4.1. Cases S and D: sequential and directed sourcing with commercial
loan financing
In practice, many buyers often do not pay on the due date for many
reasons, such as financing issues, sales problems, quality, or product
defect control (Tunca and Zhu, 2018). Actually, it is estimated that
around 20% of invoices are paid late (Invoicebus, 2020) and 16% are
even unpaid (Rampton, 2017). In the situation with the buyer’s frequent
payment delay, the commercial loan financing option does not provide
suppliers with any risk-hedging instrument for this uncertainty in the
payment period, while it only incurs interest during the credit period.
This is different from factoring and reverse factoring which can hedge
the suppliers’ financial risks (see Sections 4.2 and 4.3). The delay can
occur regardless of the payment type, whether the buyer originally
promised the prepayment (DA < 0) or the contract allows the late pay­
ment with trade credit (DA > 0). However, the unexpected payment
delay of trade credit exacerbates the suppliers’ financial risks, leading to
additional interest payment, cash flow shortage, default, profit damage,
or even bankruptcy (Wang et al., 2018). Therefore, the suppliers can be
more prone to risk aversion compared to the buyers (Lee et al., 2018).
This is especially true when their sales are highly concentrated on a few
major buyers (Lee et al., 2018).
Therefore, we incorporate the suppliers’ risk aversion behaviors into
two sourcing models with commercial loan financing without a risk-
hedging mechanism, given risk-neutral FA. We adopt an exponential
International Journal of Production Economics 234 (2021) 108039
utility function for the suppliers’ risk aversion that exhibits constant
absolute risk aversion, which has been widely used due to its mathe­
matical tractability (e.g., Norgaard and Killeen, 1980; Holmstrom and
Milgrom, 1987; Feng and Xie, 2012). The suppliers’ risks arise from
uncertainty in the buyer’s payment date, and hence we consider the
credit periods DA and D1 random variables. Considering the buyer’s
frequent payment delay in practice, a simple, symmetric normal distri­
bution would not be a suitable choice for DA or D1. Rather, it is
reasonable to consider a right-skewed distribution. Norgaard and Kill­
een (1980) suggest that when the tails of a normal distribution do not
reflect reality, a truncated normal distribution is a convenient substitute,
defined in μ – k1σ < x < μ + k2σ for a normal random variable X (in this
case of the payment delay, k1 would be a small number, while k2 is
(5) large). Actually, the truncated normal distribution has been adopted in
many areas, such as the inventory model with a random variable de­
(6) mand (Dey and Chakraborty, 2012), the theory of queues (Pender,
2015), pricing for options (Zhu and He, 2018), etc. Norgaard and Killeen
(7) (1980) also reveal that in the truncated normal model the expected
utility is approximately a linear function of μ and σ , i.e., μ – kσ with an
appropriate coefficient k to represent the amount of risk aversion (it is
typically a form of μ – kσ 2 with the simple normal distribution, usually k
= a/2 with the absolute risk aversion coefficient a). Therefore, based on
Norgaard and Killeen (1980), we consider that the credit periods DA and
D1 follow truncated normal distributions with their respective means
and variances, i.e., DA ~ N(dA, σ2A) and D1 ~ N(d1, σ21). Then, from (2)
through (7), we obtain the mean-risk models below in the linear form of
μ – kσ, where a1 and a2 are the respective risk aversion coefficients of S1
and S2.
Expected Utilities in Case S: Sequential Sourcing Strategy with
Commercial Loan Financing:
[ ]
E Π SA = Π SA = (p–w2 –m)q + idA (w2 + m)q, (8)
[ ] ( )
E Π S1 = Π S1 − a1 σ Π S1 = mq– (i + r)dA (w2 + m)q ​
+ (i + r)d1 w2 q–a1 (i + r)(w2 + m)qσ A , (9)
[ ] ( )
E Π S2 = Π S2 − a2 σ Π S2 = (w2 –cx)q– (i + r)d1 w2 q–a2 (i + r)w2 qσ1 . (10)
Expected Utilities in Case D: Directed Sourcing Strategy with Com­
mercial Loan Financing:
[ ]
E Π DA = Π DA = (p–w2 –m)q + idA (w2 + m)q, (11)
[ ] ( )
E Π D1 = Π D1 − a1 σ Π D1 = mq–(i + r)dA mq–a1 (i + r)mqσA , and (12)
[ ] ( )
E Π D2 = Π D2 − a2 σ Π D2 = (w2 –cx)q– (i + r)dA w2 q–a2 (i + r)w2 qσA , (13)
where q = 1 – p + δx in (1).
In buyer-led supply chains under long-term relationships for critical
components (see Choi and Hong (2002) for how Honda manages their
core suppliers at second- and third-tier levels), FAs typically know
suppliers’ cost elements to a certain degree, and do not allow suppliers
to set component prices by themselves (Handfield, 2006). Rather, many
large FAs set the wholesale price at a level that only guarantees the
supplier’s minimum reservation level of profit. Moreover, wholesale
price is often part of a long-term agreement among supply chain players
and can be locked in for several years (Tang et al., 2020). Therefore,
many buyers, such as Apple and Unilever, are now using the payment
terms as the main option to resolve their working capital problems in an
uncertain economic climate (Quick, 2013; Caniato et al., 2016; Forbes,
2018). Reflecting these practices, we focus on the payment term decision
and its impact on quality and overall performance of a supply chain. We
assume that wholesale price has already been set depending on the
bargaining power of the buyer and the supplier under the long-term,
strategic relationships among players.
Therefore, the decision sequence of Case S under sequential sourcing
5
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

is as follows: (1) FA devises the payment term for S1, dA, (2) S1 decides (2) dDA < 0 if δw(w2 +m)(c(1− p)+δw2 ) (w2 +m)(c(1− p)+δw2 )
< 1, dDA < 0 if δw > 1 and
2 (π A +i(w2 +m)a2 σ A ) 2 (π A +i(w2 +m)a2 σ A )
on the payment term for S2, d1, given dA, and (3) S2 determines its [ ]
(w2 +m)(c(1− p)+δw2 ) (w2 +m)(c(1− p)+δw2 )
quality level x, given dA and d1. The decision sequence is summarized in r > i δw 2 (π A +i(w2 +m)a2 σ A )
− 1 , and dDA > 0 if δw 2 (π A +i(w2 +m)a2 σ A )
>1
Fig. 2. [ ]
(w2 +m)(c(1− p)+δw2 )
By following backward induction, we begin with S2’s decision. From and r < i δw 2 (π A +i(w2 +m)a2 σ A )
− 1 , where πA = p – w2 – m.
the first-order necessary condition (FONC) of E[Π S2 ] in (10), we obtain
the quality x as a function of d1: Proposition 1 reveals the conditions that determine the characteris­
w2 (1 − (i + r)(d1 + a2 σ1 )) 1 − p tics of FA’s payment term decision, between the prepayment to support
S
x (d1 ) = − . (14) their operations (i.e., dA < 0) and the late payment to resolve its own
2c 2δ
working capital problem (i.e., dA > 0). FA is motivated to prepay
Then, plugging x in (14) into E[Π S1 ] in (9), d1 is obtained from FONC
regardless of the sourcing strategy when FA’s unit profitability (πA = p –
of E[Π S1 ] as w2 – m) is sufficiently high. This is possible when FA’s market power is
c(1 − p) (w2 − m) (w2 + m)dA a1 (w2 + m)σ A − a2 w2 σ1 strong (high p) or its relational power is strong when compared to S1 or
d1S (dA ) = + + + . S2 (low m or w2). In addition, FA offers prepayment when the suppliers
2δ(i + r)w2 2(i + r)w2 2w2 2w2
(15) are highly risk averse (high a1 or a2) or suffer from high risk premium
(high r). This supports highly profitable buyers, such as Apple and
The above x and d1 guarantee the concavity of profit functions. Then, Boeing, adopting the prepayment in the high-tech industry where the
from FONC of E[ПSA], we obtain the optimal payment term of FA as buyers are technologically dependent on their suppliers or are interested
c(1 − p) + δ(w2 + m) πA a1 (w2 + m)σ A + a2 w2 σ1 in assisting the suppliers in new technology development by relieving
dAS = − − . (16) the suppliers’ financial pressure (Niu, 2017; Levine-Weinberg, 2020).
2δ(i + r)(w2 + m) 2i(w2 + m) 2(w2 + m)
According to a senior purchasing manager at a multinational electronics
Following a similar track, we also obtain the optimal solution of Case company, they offer prepayment to avoid supply disruption and to
D, but with the two-step decision process in Fig. 2 by omitting S1’s secure its quality reputation by financially supporting their strategic
decision, i.e., S2’s decision on x given dA: suppliers providing key inputs. This is consistent with Banerjee et al.
δ(w2 (1 − (i + r)dA ) − a2 (i + r)w2 σ A ) 1 − p (2004) and Lee et al. (2018) in that major buyers pay more promptly or
xD (dA ) = − . (17) demand less trade credit to avoid supply disruptions and risks when
2δc 2δ
suppliers are in financial distress.
Then, FA decides on the payment term dA for both S1 and S2:
In addition, we observe a pass-through effect (Boissay and Gropp,
dAD =
c(1 − p) + δw2
−
πA
−
a2 σ A
. (18) 2013) in the context of a three-tier supply chain. The prompt payment of
2δ(i + r)w2 2i(w2 + m) 2 FA can also prompt S1 to pay earlier, enabling S2 to invest more in
The closed-form optimal solutions of Cases S and D are summarized ensuring its product quality, i.e., ∂dS1 /∂dSA > 0 and ∂xS/∂dS1 < 0 in (14)
in Table 2. and (15). If FA is not in a sufficiently good position either outside (low p)
Next, we analyze the properties of FA’s payment terms as below. or inside its supply chain (high m or w2), if the suppliers are not highly
risk averse (low a1 and a2), or if the risk premium of the suppliers is not
Proposition 1. dSA and dDA have the following properties: sufficiently high (low r), FA would extend its payment term. Then, a
longer payment cycle also affects S1 and consequently may discourage
(c(1− p)+δ(w2 +m))
(1) dSA < 0 if < 1, dSA < 0 if
δ(π A +i(a1 (w2 +m)σ A +a2 w2 σ 1 )) and even stop S2 from investing in its product quality, i.e., ∂xS/∂dS1 < 0,
[ ]
(c(1− p)+δ(w2 +m)) (c(1− p)+δ(w2 +m)) while ∂dS1 /∂dSA > 0, and ∂xD/∂dDA < 0 in (14), (15), and (17).
δ(π A +i(a1 (w2 +m)σ A +a2 w2 σ 1 )) > 1 and r > i δ(π A +i(a1 (w2 +m)σ A +a2 w2 σ 1 )) − 1 ,
Moreover, we find that the suppliers’ risk aversion under commercial
(c(1− p)+δ(w2 +m))
and dSA > 0 if δ(πA +i(a (w +m)σ A +a2 w2 σ 1 )) > 1 and r< loan financing has a critical impact on overall supply chain perfor­
[ ] 1 2 mance. This means that the supplier’s risk aversion negatively affects
(c(1− p)+δ(w2 +m))
i δ(πA +i(a1 (w2 +m)σ A +a2 w2 σ 1 ))
− 1 , where πA = p – w2 – m. product quality, market, and profit performance of all players and the

Fig. 2. Sequence of events.

6
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

supply chain, i.e., ∂x/∂a2 < 0, ∂q/∂a2 < 0, ∂E[ПA]/∂a2 < 0, ∂E[П1]/∂a2 <

× (mw2 ((i + r)πA + i(w2 + m)) − i(w2 + m)w2 RD1 )

0, ∂E[П2]/∂a2 < 0, and ∂E[П]/∂a2 < 0 in Cases S and D (see the solutions
in Table 2). Therefore, in the following sections, we delve deeper into
other financing options to consider eliminating the negative effect of the
suppliers’ risk aversion by hedging financial risks from the variability of
the buyer’s payment terms.

4.2. Cases SF and DF: sequential and directed sourcing with factoring

Suppliers often use factoring as a financing option, in which they sell

their accounts receivable at a discount to a financial institution
(commonly known as the factor), such as a bank or a FinTech. Through
m(ΦD − δi(w2 + m)RD2 )
2 factoring, suppliers can get funds quickly, generally within 24 h, espe­
8δi w2 (w2 + m) c
2 cially without incurring additional debt. Therefore, factoring is a quick
and effective financial instrument by which the supplier converts its

(ΦD − δi(w2 + m)RD2 )

receivable asset into cash. Moreover, by selling off their accounts re­

4i2 w2 (w2 + m)2 c

ceivable, the risk associated with trade credit is no longer with the
2

suppliers, but with the factor often known as the risk taker which earns
profits by bearing the risks (Ma et al., 2020). Therefore, factoring is
× (mw2 ((i + r)πA + i(w2 + m)) − iw2 (w2 + m)RD1 ) −

considered risk-transferring channel (Klapper, 2006), which mitigates

and even eliminates the supplier’s risks associated with the buyer’s
+
]

unexpected payment delay. It helps the supplier to concentrate on op­

(i + r)w2 2i(w2 + m) iw2 (w2 + m)

erations without the burden of financial risk.

m

In factoring, however, the supplier bears a fee and a discount to the

face value of the receivable, and the interest rate for discount is gener­
ally high. Further, the supplier’s advance rate is typically 85–90% of the
−

face value, as the factor holds the other 10–15% as reserve, although the
1

reserve is rebated when the receivable is paid. Meanwhile, since the

Note: πA = p – w2 – m, RS1 = a1(i + r)(w2 + m)σ A, RD1 = a2(i + r)w2σ 1, ΦS = i(c(1 – p) + δw2) + δ(im + (i + r)πA), RD1 = a1(i + r)
2i(w2 + m) 2(i + r)w2

factor considers the capability and credit risk of the buyer as well as
+
RD2

4c
(i + r)w2 πA 3c(1 − p) − δw2 RD2

those of the supplier, the interest rate can be lowered when the buyer is
the large FA with strong market power as in this study (Klapper, 2006).
−

1
−

Moreover, the use of FinTechs nowadays allows the supplier to access

[
×

funding at a lower interest rate more easily (Rogers et al., 2016).

4δc
πA

8δi(i + r)w2 (w2 + m)c

2

2
(ΦD − δi(w2 + m)RD2 )

(ΦD − δi(w2 + m)RD2 )

(ΦD − δi(w2 + m)RD2 )

(ΦD − δi(w2 + m)RD2 )

Therefore, we assume that the interest rate for discount in factoring is

16δi2 (w2 + m)2 c
4i w2 (w2 + m) c
ΦD − δi(w2 + m)RD2

8δi(w2 + m)c

not higher than that of the suppliers’ commercial loan financing, which
4i(w2 + m)c
−
c(1 − p) + δw2

adds up the risk premium, and hence we set i1, i2 = i + r as in Cases S and
−
2δ(i + r)w2

4i(w2 + m)c

D with commercial loan financing. Furthermore, given both S1 and S2 as

Case D

the healthy, strategic suppliers of FA in this study, we consider that

2

85–90% of advance cash inflow is sufficient for S1 and S2 to resolve the

risks associated with the variation in the buyer’s payment term. Hence,
the standard deviations of the payment terms become σA = 0 and σ1 = 0.
Then, by applying σA = 0 and σ1 = 0 to the solutions of Cases S and D
in Table 2, the risk-related terms of S1 and S2, RS1 , RS2 , RD1 , and RD2 ,
2 = a2(i + r)w2σ A, and Φ = i(w2 + m)(c(1 – p) + δw2) + δ(i + r)w2π A.

become zero, and we obtain the solutions of Cases SF and DF with the
2i(w2 + m) 2(i + r)(w2 + m)

following properties:
RS1 + RS2

Proposition 2. Comparing the solutions between factoring and commer­

(i + r)πA 7c(1 − p) − δ(w2 + m) RS1 + RS2

cial loan financing, we obtain:

4iw2 4(i + r)w2
3R2 − RS1

8c
S

SF
(1) Under sequential sourcing, comparing Cases SF and S, dSF S
A > dA , x
−

2
(4i + 3(i + r))(ΦS − δi(RS1 + RS1 ))

> x , q > q , Π A > Π A , Π 1 > Π 1 , Π 2 > Π 2 , and П > П S.

S SF S SF S SF S SF S SF
−
πA

πA

dSF S SF S
1 > d1 if 3a2w2σ 1 > a1(w2 + m)σ A, and d1 < d1 , otherwise.
−

8δc
3c(1 − p) + δ(3w2 − m)

64δi2 (i + r)c

DF
(2) Under directed sourcing, comparing Cases DF and D, dDF D
A > dA , x
−

>
c(1 − p) + δ(w2 + m)

2
2δ(i + r)(w2 + m)

D DF D DF D
(ΦS − δi(RS1 + RS1 ))

(ΦS − δi(RS1 + RS1 ))

(ΦS − δi(RS1 + RS1 ))

DF D DF D DF D
x , q > q , Π A > Π A , Π 1 > Π 1 , Π 2 > Π 2 , and П > П .
4δ(i + r)w2

ΦS − δi(RS1 + RS2 )

16δi(i + r)c

32δi2 c

64δi2 c

The results of Proposition 2 illustrate the benefits of factoring.

Optimal solutions of Cases S and D.

8ic
−

Compared to the cases with commercial loan financing, those with

Case S

8ic

factoring can enhance the overall performance, including the product

quality, market demand, and profits of all players and the entire supply
chain. Interestingly, these benefits are ascertained, regardless of the FA’s
sourcing strategy as observed in Propositions 2. The benefits are from
the change in the suppliers’ risk attitude of adopting a better financing
option. The adoption of factoring eliminates the suppliers’ risks associ­
ated with the buyer’s payment delay, thereby enabling them to invest in
mσA, RD
Table 2

E[ПA]

E[П1]

E[П2]

their product quality. Moreover, FA can financially amplify these ben­

E[П]
dA

d1

efits once again by extending the payment term, i.e., dSF S

x

A > dA , and
q

7
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

dDF D
A > dA .
δ(1− w2 /m)(p− w2 − m)
i < r c(1+w ), or if (w2/m < 1 and
2 /m)(1− p)− δp(1− w2 /m)
Next, we investigate the performance of two sourcing strategies with
δ > c(1+w 2 /m)(1− p)
p(1− w2 /m) ).
factoring.
SF DF
(3) Π A > Π A if max[0, i1] < i < min[i2, 1], and Π DF SF
A > Π A if i > min
Proposition 3. Comparing the solutions of Cases SF and DF, we obtain: [i2, 1] or i < max[0, i1],
√̅̅̅̅̅̅̅̅̅̅̅̅̅ √̅̅̅̅̅̅̅̅̅̅̅̅̅ √̅̅̅̅̅̅̅̅̅̅̅
(1) For the payment term for S1, dDF SF
A > dA always.
c(1− p) 1+w /m((w /m) 1+w2 /m −
where i1 = c(1− p)(1+w 2/m)(c(1−2 p)(2+w /m)+2δpw
2w2 /m )− δp(w2 /m)(1− w2 /m))
2 2 and i2 =
DF SF DF 2 /m)− δ p (w2 /m)(1− w2 /m)
qSF if (w2/m > 1), or if (w2/m
√̅̅̅̅̅̅̅̅̅̅̅̅̅ √2̅̅̅̅̅̅̅̅̅̅̅̅̅ √̅̅̅̅̅̅̅̅̅̅
2 ̅
(2) dSF
1 > d DF
A for S2, x > x , and q > c(1− p) 1+w2 /m((w2 /m) 1+w2 /m + 2w2 /m )− δp(w2 /m)(1− w2 /m))
.
< 1, δ < c(1+w 2 /m)(1− p) δ(1− w2 /m)(p− w2 − m) DF SF
p(1− w2 /m) , and i > r c(1+w2 /m)(1− p)− δp(1− w2 /m)). dA > d1
c(1− p)(1+w /m)(c(1− p)(2+w /m)+2δpw /m)− δ2 p2 (w /m)(1− w /m)
2 2 2 2 2

SF DF
for S2, x > x , and q > q SF DF
if (w2/m < 1, δ < c(1+w2 /m)(1− p) Proposition 3 shows that the directed sourcing strategy does not al­
p(1− w2 /m) , and
ways outperform the sequential sourcing strategy even with the

Fig. 3. Profit comparison of FA, S1, S2, and the supply chain in Cases SF and DF (x-axis: δ ∈ [0.03, 0.4], y-axis: i ∈ [0.03, 0.2]; Case SF: blue, Case DF: orange). (For
interpretation of the references to colour in this figure legend, the reader is referred to the Web version of this article.)

8
S.H. Yoo et al.
elimination of S1’s double marginalization. If we consider financial is­
sues in the sourcing strategy decision, such as working capital man­
agement issues and the subsequent financing option decision, the choice
of sourcing strategy is not that simple. A closer look at Proposition 3
reveals a decision mechanism that involves three important factors: (1)
the positional factor (i.e., the relative importance of the lower-tier
supplier S2 in a supply chain, w2/m), (2) the technological factor (i.e.,
the impact of S2’s component on market demand, δ), and (3) the
financial factor (i.e., the interest rate i).
As observed in Proposition 3(2), these three factors jointly affect the
decision on the payment term for S2, d1 determined by S1 under
sequential sourcing and dA by FA under directed sourcing, and the
payment term decision directly affects the quality and market perfor­
mance, x and q. The shorter credit period induces better performance,
while delaying trade credit can backfire on the entire supply chain by
deteriorating the quality and market performance.
When S2 has a strong positional power, i.e., w2/m > 1, FA’s directed
sourcing strategy with factoring (Case DF) can help S2 better manage its
working capital, i.e., dDF SF
A < d1 . Therefore, S2 can invest more in its
component quality, thereby inducing better market performance, i.e.,
xDF > xSF and qDF > qSF. When S2 does not have sufficient positional
power even with FA’s high technological dependency on S2, i.e., w2/m
< 1 with the high technological factor δ, FA’s adoption of the directed
sourcing strategy renders FA to offer a longer payment term to S2, i.e.,
dDF SF
A > d1 . Thus, the sequential sourcing strategy becomes more attrac­
tive, as xSF > xDF and qSF > qDF. When S2 has low positional power and its
impact is also low (i.e., w2/m < 1 with a low δ), the sourcing decision
would then depend on the external financial factor, i.e., the interest rate
i. Hence, directed sourcing is recommended for the overall supply chain
performance when i is high, while sequential sourcing is when i is low.
Fig. 3 illustrates the dominance of the profit performance in Propo­
sition 3(3) between Cases SF and DF, given a numerical setting: p = 0.7,
c = 0.01, r = 0.02, w2/m = 0.8, 0.95, and 1.1 (m = 0.2 and w2 = 0.16,
0.19, and 0.22), δ ∈ [0.03, 0.4], and i ∈ [0.03, 0.2]. This setting is to
guarantee the concavity of all models, while showing the results
comprehensively. The profit performance of the players is consistent
with the quality and market performance as shown in Proposition 3(2)
and is also affected by the three factors as shown in Proposition 3(3).
When S2 garners strong positional power and is regarded as important in
the supply chain, i.e., w2/m > 1, FA, S2, and the supply chain are always
better off with the directed sourcing strategy with factoring as shown in
Fig. 3(c, i, l). If w2/m < 1 as shown in Fig. 3(a, b, g, h, j, k), directed
sourcing guarantees better profits to FA, S2, and the supply chain only
when S2’s impact δ is low and the interest rate i is high, whereas
sequential sourcing is better with high δ and low i. However, as shown in
Fig. 3(d–f), S1 is always worse off with directed sourcing with factoring.
In addition to the well-recognized disadvantages for S1, such as sur­
rendering sourcing authority and losing its cost control, directed
sourcing can result in the deterioration of S1’s profit under a longer
payment term as in Proposition 3(1). Also, FA has a higher probability to
be better off than the other players and the supply chain with the
directed sourcing strategy with factoring, when comparing the areas
where Case DF dominates Case SF in Fig. 3. In this numerical example, in
the range of δ around (0.2, 0.3) as shown in Fig. 3(b), FA can pursue its
superior profit with directed sourcing with factoring (Case DF). How­
ever, in this range, S1, S2, and the entire supply chain are worse off with
directed sourcing as shown in Fig. 3(e, h, k). In contrast, FA may be
motivated to maintain a healthy status of its supply chain as Lee et al.
(2018) point out. Then, FA can choose the sequential sourcing strategy
with factoring (Case SF), possibly by conceding its profit share to the
suppliers.
Overall, in the multi-tier supply chain management, the impact of
integrated sourcing and financing decision on performance can have
both the “competitive” and “collaborative” aspects, as Lee et al. (2018)
point out. That is, the shorter trade credit term for S2 under the directed
9
International Journal of Production Economics 234 (2021) 108039
sourcing strategy induces higher profits for both FA and S2. However, in
the multi-tier supply chain, what is good for one player can occur at the
other player’s expense. In this case, FA and S2 gain at the expense of S1
as shown in Fig. 3, suggesting a negative effect of vertical competition.
However, the adoption of factoring makes all the parties better off even
including S1, as shown in Proposition 2. Therefore, the appropriate
combination of sourcing and financing strategies can offer the supply
chain the opportunity to enhance its profitability. Moreover, the
financing option, such as factoring, can play an important role of
compensating for S1’s disadvantages from FA’s directed sourcing
strategy decision.
4.3. Cases SR and DR: sequential and directed sourcing with reverse
factoring
Another financing option for suppliers frequently used in practice is
reverse factoring. It is a type of factoring intermediated by the large
buyer to support its strategic supplier’s finance by selling the approved
invoices to a factor (Rogers et al., 2020). The buyer has an information
advantage over the external financial institutions regarding the sup­
plier’s reliability and financial status, and this allows the buyer to help
mitigate the strategic supplier’s capital problem (Tang et al., 2018;
Tunca and Zhu, 2018). As evidence, one multinational corporation
specializing in power generation and industrial automation indicates
that they invite only their strategic suppliers with a long-term rela­
tionship to participate in reverse factoring (Rogers et al., 2020). The
notable difference from factoring initiated at the supplier’s side is that
the interest rate in reverse factoring is determined entirely based on the
buyer’s credit rating and capability. Thus, the supplier can better resolve
its capital problem at a lower interest rate, while having better access to
funds (Grüter and Wuttke, 2017).
With FA initiating reverse factoring, S1 and S2 can utilize FA’s lower
interest rate; hence, we set i1, i2 = iA = i without the risk premium r in
Cases SR and DR, while i1, i2 = i + r in Cases S, D, SF and DF. By applying
r = 0 to the solutions in Table 2 in addition to σ2A = 0 and σ 21 = 0 as in
factoring, we readily obtain the solutions of Cases SR and DR with the
following properties:
Proposition 4. In Case SR, x, q, П A, П 1, and П 2 are independent of i and
w2/m, and in Case DR, they are not affected by i, while they are all affected
by δ. The values of dA and d1 depend on all three factors, w2/m, δ, and i, in
both Cases SR and DR.
The results of Proposition 4 are quite interesting. With reverse
factoring, the quality x, market demand q, and profit performance ПA,
П1, and П2 of all players become independent of the external financial
factors, not only the risk premium r but also the interest rate i, regardless
of the sourcing strategy. This is because the optimal decision on the
payment terms dA and d1 makes the amount of working capital inde­
pendent of i, while dA and d1 are negatively affected by i, e.g.,dSR A =
[ ]
c(1− p)−
1
2i 1 + δ(w2 +m) . In addition, if FA chooses the sequential sourcing
δπ A
strategy with reverse factoring (Case SR), the performance becomes free
from the positional power of S2, w2/m. Therefore, Case DR is affected by
both the positional factor w2/m and the technological factor δ, while
Case SR is affected only by δ. This is different from the factoring case in
which overall performance can be seriously affected by both the interest
rate and supplier’s credit rating determined externally, i.e., i and r, as
well as w2/m. Given the dynamic business environment driven by new
technologies, FA would tend to rely more on technologically capable
suppliers, and reverse factoring would clearly provide FA with an
advantage such that it can expect more predictable and reliable
performance.
Proposition 5. Comparing the optimal solutions between reverse factoring
and factoring, we obtain:
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

(1) dSR SF SR
A > dA , d1 > d1 , x
SF SR
< xSF , qSR < qSF , Π SR SF SR
1 < Π 1 , and Π 2 <
in FA’s favor as in Cases SR and DR, while S1, S2, and the entire supply
SF SR SF SF SR SF
Π 2 hold always.Π A > Π A if dA > 0, while Π A < Π A if dA < 0 SF chain can be worse off. Nonetheless, it is worth noting from Fig. 4(a–c)
(see the conditions for dSF SF that the joint consideration of sourcing and financing strategies is
A > 0 and dA < 0 in Proposition 1(1), where
SF S crucial. This is because if S2’s positional power is weak in a supply chain
dA = dA ).
(low w2/m) as shown in Fig. 4(a), there is a high possibility that Case SF
(2) dDR DF
A > dA , x
DR
< xDF , qDR < qDF , Π DR < Π DF , and Π DR DF
2 < Π 2 hold or SR with sequential sourcing induces the best profit performance for
(1 )1
always.Π DR DF rπ A FA. In contrast, if S2’s power is very strong (high w2/m) as in Fig. 4(c), it
A > Π A if w2 + m < π A 1 + ip and δ1 < δ < δ2 , or if
( ) is always better for FA to choose directed sourcing with reverse factoring
(Case DR).
w2 + m > πA 1 +rip πA
and δ > δ1 , and Π DR DF
A < Π A if w2 + m <
( ) ( ) In sum, the results of Propositions 4 and 5 and Fig. 4 suggest that
buyers need to make a prudent decision, especially when initiating
π A 1 +ripπA and (δ > δ2 or δ < δ1 ), orif w2 + m > π A 1 +ripπA and
reverse factoring. Reverse factoring has a clear advantage for FA, not
0 < δ < δ1 , only guaranteeing its superior profit performance, but also inducing
more predictable overall performance, especially in an uncertain eco­
√̅̅̅̅̅̅̅̅̅ √̅̅̅̅̅̅̅̅̅
(1− p)Wc(iW− π A i(i+r)) (1− p)Wc(iW+πA i(i+r)) nomic climate, by not being affected by the exogenous financial envi­
where δ1 = w2 (ipπ A − ipW+rπ A 2 )
and δ2 = w2 (ipπA − ipW+rπ A 2 )
with πA =
ronment, i.e., interest rate i and risk premium r. However, it needs to be
p – w2 – m and W = w2 + m. understood that the payment term extension with reverse factoring can
The results of Propositions 5 are interesting in that they are contrary backfire by hindering the suppliers’ proper investment in their opera­
to the observations made in previous studies, such as Tunca and Zhu tions and in turn devastating the entire supply chain, particularly when
(2018). It seems that the implementation of reverse factoring should be FA is heavily dependent upon its suppliers’ quality. In fact, there have
good for the suppliers. However, our analysis conducted in the multi-tier been such cases of suppliers refusing to participate in Nestlé’s reverse
supply chain suggests something different. In the multi-tier context, the factoring offer, since they knew that Nestlé’s offer would be accompa­
buyer intermediation in supplier financing does not always improve but nied by the payment term extension (Corsten, 2010; Tunca and Zhu,
can deteriorate the supply chain performance, even though there is an 2018).
advantage of predictable performance shown in Proposition 4. Even
with the benefit of the lower interest rate, reverse factoring can deteri­
orate the quality, market demand, and profit performance of both S1 and 4.4. Cases SRF and DRF: sequential and directed sourcing with reverse
S2 compared to factoring, regardless of the sourcing strategy choice. factoring without a payment term extension
Fig. 4 illustrates the profit performance dominance in Proposition 5
among Cases SF, DF, SR, and DR, given the same parameter setting for We now consider a case of reverse factoring without a payment term
Fig. 3 in Section 4.2. Note that we include only FA’s profit comparison extension in practice. A leading high-tech FA that one of the authors
result in Fig. 4, since the profit comparison of S1, S2 and the supply works closely with practices this arrangement. This FA does not extend
chain yields the same dominance relationships as in Fig. 3(d–l). In other payment terms due to their corporate level policies, and they offer
words, factoring always yields better profit performance for S1, S2, and reverse factoring to a few suppliers selected based on their supplier
the supply chain than reverse factoring. This result is mainly due to FA’s assessment results. The assessment is not limited to the first-tier sup­
opportunistic behavior to exploit the suppliers by extending the pay­ pliers and includes suppliers from lower tiers. The selected suppliers
ment term extensively, i.e., dSR SF DR DF
A > dA and dA > dA . This in turn hinders
tend to be those with technology expertise and critical impact on
the supplier’s proper investment in its operations, i.e., xSR < xSF and xDR product quality. Maintaining the focus on technology, the intent of this
< xDF. Taken together, FA’s behavior looks rather ambivalent. On the FA is not to exact the benefits of reverse factoring as discussed in Section
one hand, FA supports the suppliers with reverse factoring, but on the 4.3. Therefore, the payment terms for suppliers with reverse factoring
other hand, FA also exploits them by stretching out the payment term. In are treated in the same way as those with factoring. With no payment
practice, we see many of such examples of large buyers such as Unilever term extension, the suppliers with reverse factoring can concentrate
(Lekkakos, 2016) exhibiting these behaviors. One main reason why they more on quality, while enjoying the benefits of reverse factoring such as
initiate reverse factoring is to relieve their own working capital prob­ the lower interest rate and easy access to financing.
lems through a payment term extension (Damianos and Alejandro, In Cases SRF and DRF, we utilize the payment term with factoring by
2016). following the high-tech company case discussed above. Therefore, to
reflect the reverse factoring situation in a similar way as in Cases SR and
Proposition 5 and Fig. 4 show that the only player that can benefit
DR, we set σ 2A = 0, σ 21 = 0 and r = 0 in the players’ expected utilities in
from reverse factoring is FA, especially if the payment term is extended
(8) through (13). Then we obtain the decision of S2 and subsequently S1

Fig. 4. Comparison of FA’s profit in Cases SF, DF, SR, and DR (Profit comparison results of S1, S2 and the supply chain are the same as in Fig. 3(d–l); x-axis: δ in
[0.03, 0.4], y-axis: i in [0.03, 0.2]; Case SF: blue, Case DF: orange, Case SR: green, Case DR: red). (For interpretation of the references to colour in this figure legend,
the reader is referred to the Web version of this article.)

10
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

by backward induction. They are identical to xS(d1), dS1 (dA ) and xD(dA) in performance for S1, S2, and the entire supply chain, compared to Cases
(14), (15) and (17) if we apply σ 2A = 0, σ21 = 0, and r = 0 to them. Then, SR and DR, but they can deteriorate FA’s profit. Therefore, from the sole
following the high-tech company case, FA decides on its payment term perspective of FA, it would be desirable to adopt reverse factoring with a
in the same way as in Cases SF and DF, i.e., dSRF = dSF DRF payment term extension. Nonetheless, it should be noted that FA’s profit
A A in (16) and dA =
dDF in (18). Applying d SRF
and d DRF
to d SRF
and xDRF
(d ) and then loss from the fixed payment term is not so severe, especially in light of
A A A 1 (dA ) A
the possible gains of the entire supply chain and suppliers. Specifically,
xSRF(d1), we obtain the solutions of Cases SRF and DRF which are
in this example, with Cases SRF and DRF, FA needs to bear the profit loss
different from those of Cases SR and DR. Table 3 summarizes the nu­
at 2.92% and 3.19% on average, compared to Cases SR and DR,
merical solution results of Cases SRF and DRF, along with those of other
respectively. In contrast, S1’s profit increases by 31.74% and 42.03% for
cases for comparison. The reason for adopting a numerical example is
Cases SRF and DRF, respectively. S2 can also enjoy the profit gain of
due to the mathematical difficulties of analytically comparing the so­
31.74% and 33.28%, while the entire chain’s profit increases by 11.94%
lutions of Cases SRF and DRF, applying the solutions of factoring cases in
and 12.29% on average. These results indicate that Cases SRF and DRF
reverse factoring cases, with other cases. The parameter setting is the
can also be considered a viable option, and that reverse factoring can be
same as for Figs. 3 and 4, while differentiating the three important
utilized either for FA’s own benefit with a payment term extension
factors in Proposition 3 as low and high, i.e., the positional power w2/m
(Cases SR and DR) or for the supply chain’s long-term health without a
= 0.8 and 1.1, the technological factor δ = 0.03 and 0.4, and the
payment term extension (Cases SRF and DRF).
financial factor i = 0.03 and 0.2. For Cases S and D with the suppliers’
Fig. 5 shows the dominant cases in terms of the profits of FA, S1, S2,
risk aversion, we additionally set the risk aversion coefficients a1 = 0.05
and the entire supply chain according to the three environmental fac­
and a2 = 0.1 and the standard deviations σA = 2 and σ1 = 4.
tors, given the results in Table 3. We find that commercial loan financing
Table 3 summarizes the profit solutions of the eight integrated
(Case S or D) does not show superior profit performance in any situation,
sourcing-financing strategies. First, regarding the two types of reverse
indicating that other financing options such as factoring or reverse
factoring, Cases SR and DR are not affected by the interest rate i (or the
factoring are more attractive. However, this does not mean that com­
positional power w2/m) as already shown in Proposition 4. In contrast,
mercial loan financing in Case S or Case D always yields the worst profit
Cases SRF and DRF without a payment term extension show different
result. Rather, it should be understood that the wrong combination of
behaviors. Overall, Cases SRF and DRF always induce better profit
sourcing and financing strategies can deteriorate the profit performance

Table 3
Numerical results of integrated sourcing-financing strategies (shading: best profit performance).

11
S.H. Yoo et al.
Fig. 5. Dominant cases with superior profit performance (of FA/S1/S2/supply chain).
of the players and the supply chain. For example, FA’s profit ПA is the
lowest in Case DRF at i = 0.03, w2/m = 0.8, and δ = 0.4, while Cases SR,
DR, SRF and DRF also yield the supply chain profit П lower than Case S
or D. Therefore, the practitioners need to make a cautious choice among
integrated sourcing-financing strategies—we warn against buying
companies blindly adopting directed sourcing simply because that is
what Apple does or reverse factoring because that is what some of the
leading companies do (Rogers et al., 2020).
As shown in Fig. 5(a–b), we find that S1 always benefits most out of
sequential sourcing regardless of environmental changes, while the
preferred financing option can be factoring (Case SF) or reverse
factoring without a payment term extension (Case SRF). In contrast, the
other players’ and the supply chain’s preferences are dependent upon
internal and external environments. As shown in the upper right cell in
Fig. 5(a–b), sequential sourcing is preferred by all players and the supply
chain when S2’s positional power is low in a supply chain even with its
technology expertise and quality impact on consumers. In this situation,
factoring (Case SF) is the best financing option for the suppliers and the
supply chain, regardless of the external environment (interest rate),
although FA needs to choose the financing option between factoring and
reverse factoring (Cases SF and SR) for its own profit. Except this situ­
ation, when S2’s technological impact on consumers is low or S2’s po­
sitional power is high, directed sourcing always enhances the profit
performance of FA, S2, and the entire supply chain, while S1 always
prefers sequential sourcing. In this situation, initiating reverse factoring
with a payment term extension (Case DR) is always the right choice for
FA. Both S2 and the supply chain also prefer reverse factoring without a
payment term extension (Case DRF) or factoring (Case SF). There is no
“one-size-fits-all” strategy when considering multiple players in the
multi-tier supply chain context. The focus should be on choosing the best
integrated sourcing-financing strategy, and that would depend on
environmental factors such as the positional power, the technological
factor, and the financial factor.
5. Discussion
In this study, we bring together two research streams of multi-tier
supply chain management and supply chain financing. The study ex­
amines the multi-tier supply chain management by incorporating trade
credit issues and financing options. It extends the supply chain financing
typically considered in the dyadic buyer-supplier context to the multi-
tier supply chain. Its goal is to investigate the financial leveraging ef­
fect of the final assembler’s sourcing strategies in the multi-tier supply
chain, involving a large final assembler (FA), a first-tier supplier (S1),
and a second-tier supplier (S2) whose component quality has a critical
12
International Journal of Production Economics 234 (2021) 108039
impact on consumers’ buying decision and hence the overall perfor­
mance. Thus, FA needs to find ways to manage its supply chain, looking
beyond its direct partner S1.
We have disclosed which combination of the two sourcing and four
financing strategies and under what conditions induces a better opera­
tional decision and enhances overall supply chain performance, while
also revealing the characteristics of each joint strategy. We now discuss
their managerial implications. First, in finding the best combination of
sourcing and financing strategies in a multi-tier supply chain context in
terms of the profits of FA, S1, S2, and the entire supply chain, there is no
“one-size-fits-all” strategy. The choice must be based on the thorough
assessment of the three crucial environmental factors: the positional
factor (i.e., the relative importance of S2), the technological factor (i.e.,
the impact of S2’s component on consumer demand), and the financial
factor (i.e., the interest rate). The first two factors involve the presence
of S2, and thus can only be ascertained in the multi-tier supply chain
setting, not in the dyadic buyer-supplier context. As revealed in our
analytical results, in reality, all three factors jointly affect the payment
term decision, subsequently impacting the quality, market and profit
performance of the entire supply chain.
Second, the impact of FA’s payment term decision in the multi-tier
supply chain is different from what one might encounter in a buyer-
supplier dyadic context. Our analytical investigation reveals that FA
can be motivated to support the suppliers’ operations by prepayment
when FA is highly profitable, suppliers are highly risk averse, or sup­
pliers suffer from a high interest rate from an excessive risk premium.
Otherwise, FA can extend the payment term to enhance its own working
capital management and boost earnings. In this case, FA’s payment
decision induces a pass-through effect in the multi-tier supply chain.
FA’s payment term extension affects S1 to extend its payment term for
S2 and, consequently, may discourage S2 from investing in its product
quality.
Third, our results confirm that the buyer’s unexpected payment
delay of trade credit can exacerbate the suppliers’ financial risks.
Compared to commercial loan financing, factoring reduces the negative
effect of the suppliers’ risk aversion by hedging the variability of the
buyer’s payment terms, and hence enhances overall performance
regardless of sourcing strategies. When the suppliers utilize factoring as
a financing option, FA, S2, and the supply chain are better off with
directed sourcing when S2 is powerful or when S2’s impact is low but
the interest rate is high. Otherwise, sequential sourcing guarantees the
better profit for FA, S2, and the supply chain. While S1 is always worse
off with directed sourcing, factoring can play an important role of
compensating for S1’s disadvantages from FA’s directed sourcing
decision.
S.H. Yoo et al. International Journal of Production Economics 234 (2021) 108039

Fourth, reverse factoring guarantees more predictable performance
in an uncertain economic climate. Specifically, with reverse factoring,
the quality, market, and profit performance of all players becomes in­
dependent of the interest rate, regardless of sourcing strategies. Inter­
estingly, however, the only player that can benefit from reverse
factoring is FA. On the surface, reverse factoring may appear to benefit
suppliers because FA is taking an active role in devising a lower interest
rate for the suppliers. Different from conventional wisdom, our results
show that reverse factoring always results in deteriorating the quality,
market, and profit performance of both S1 and S2, compared to
factoring, regardless of sourcing strategies. This can be attributed to FA’s
ambivalent behavior in adopting reverse factoring, that is, offering the
suppliers with the lower interest rate on the one hand and exploiting
them by extending the payment term of trade credit on the other.
Lastly, reverse factoring without the payment term extension gua­
rantees the significant profit enhancement of the suppliers and entire
supply chain, while FA needs to bear some profit loss compared to
reverse factoring with the payment term extension. Therefore, reverse
factoring can be utilized either for FA’s own benefit with the payment
term extension or for the supply chain’s long-term health without the
payment term extension.
6. Concluding remarks
decision whether to delegate component procurement to S1 by adopting
a sequential sourcing strategy or to directly control it at S2 through a
directed sourcing strategy. These sourcing strategies differentiate the
contractual relationship structure among the players, and directly affect
the decision of trade credit and the management of working capital of
each player. Furthermore, the financing strategy needs to be considered
for S2’s proper investment in its operations. In this study, looking into
four financing options the suppliers can utilize in practice (commercial
loan financing, factoring, reverse factoring with a payment term
extension, and reverse factoring without a payment term extension), we
reveal which combination of sourcing and financing strategies and
under what conditions induces a better overall supply chain perfor­
mance, while also revealing the characteristics of each joint strategy.
This study has limitations. For example, this study considers S2’s
quality-dependent production cost only to focus on the multi-tier supply
chain situation in which the management of the lower-tier supplier is
critical. However, if we considered S1’s production cost as well, we
might find some other interesting results. Further, we do not consider
the external financial institution’s decision on interest rates in order to
focus on the interactions among players in the three-tier supply chain.
We look forward to future studies that alleviate such assumptions and
discover new findings beyond what we are able to offer in this study.

All FA’s that interface consumer markets wrestle with a strategic

Appendix. Proofs of Propositions

[ ]
(c(1− p)+δ(w2 +m))
Proof of Proposition 1. To have dSA < 0 in Table 1, we need r > i δ(π A +i(a1 (w2 +m)σ A +a2 w2 σ 1 )) − 1 . Since r > 0 always, dSA < 0 always holds if the term in

(c(1− p)+δ(w2 +m))

the bracket is negative, i.e., δ(πA +i(a1 (w2 +m)σ A +a2 w2 σ 1 ))
< 1. If the term in the bracket is positive, dSA can be either positive or negative depending on the

value of r. We also obtain the conditions of dDA by following a similar track. Therefore, Propositions 1(1) and 1(2) hold.
Proof of Proposition 2. We obtain the solutions of Cases SF and DF by setting RS1 = 0, RS2 = 0, RD1 = 0, and RD2 = 0 in Table 1. Then, it is easy to
directly observe the relationships summarized in Proposition 2. For the comparison of dSF S SF S S S
1 and d1 , sign[d1 − d1 ] = sign[3R2 − R1 ] = sign[3a2w2σ 1 –
SF S
a1(w2 + m)σA]. Therefore, the relationship of d1 and d1 is established.
mc(1− p)
Proof of Proposition 3. Comparing the solutions of Cases SF and DF, dDF SF
A − dA = 2δ(i+r)(w2 +m)w2 > 0, and thus, Proposition 3(1) holds. We also obtain

sign[dDF SF
A − d1 ] = sign[x
SF
− xDF ] = sign[DSF − DDF ] = δr(m − w2 )(p − w2 − m) − i(c(w2 + m)(1 − p) − δp(m − w2 )), and from this, we obtain the
conditions summarized in Proposition 3(2). In addition, solving Π DF SF DF SF
A − Π A with respect to i, Π A = Π A at i = i1 and i = i2, and thus, Proposition 3(3)
holds.
Proof of Proposition 4. By applying σ2A = 0, σ21 = 0 and r = 0 to the solutions in Table 1, it is straightforward to see the result of Proposition 4
c(1− p)+δ(w2 +m)
Proof of Proposition 5. Differentiating dSF
A = 2δ(i+r)(w2 +m) −
πA
2i(w2 +m) with respect to r, we obtain ∂dSF SR SF SR
A /∂r < 0. Therefore, dA > dA since dA is

defined by applying r = 0 into dSF SF SR SF

A , while dA is with r > 0. In this manner, the relationships d1 > d1 , x
SR
< xSF , qSR < qSF , Π SR SF SR
1 < Π 1 , and Π 2 < Π 2
SF
(
SF SF SF SF c(1− p)+δ(w
are also obtained since ∂dSF SF SF
1 /∂r < 0, ∂x /∂r > 0, ∂q /∂r > 0, ∂Π 1 /∂r > 0, and ∂Π 2 /∂r > 0. For Π A , we obtain ∂Π A /∂r > 0 if r > i
2
δ(p− w2 − m)
+m)
−
)
SR
1 , and this condition is identical to have dSA < 0, while dSF S S
A = dA , as shown in the proof of Proposition 1. Therefore, if dA < 0, Π A with r = 0 is larger

than Π SF SR SF
A with r > 0. Otherwise, Π A > Π A . Therefore, Proposition 5(1) holds.
DF DF
Similarly, differentiating variables in Case DF yields ∂dDF DF DF
A /∂r < 0, ∂x /∂r > 0, ∂q /∂r > 0, ∂Π 1 /∂r > 0, and ∂Π 2 /∂r > 0. Therefore, the re­
lationships dA > dA , x < x , q < q , Π 1 < Π 1 , and Π 2 < Π 2 hold, since r = 0 in Case DR. Comparing Π A and Π DF
DR DF DR DF DR DF DR DF DR DF DR
A , we obtain δ = δ1 and δ =
δ2 in Proposition 5(2) for the solutions making Π DR DF DR DF
A and Π A identical, while the curve of Π A − Π A can be concave or convex with respect to the value
of the term, ip(p – w2 – m) – ip(w2 + m) + r(p – w2 – m)2. From this, we obtain the conditions for ПA. Therefore, Proposition 5(2) holds.

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