A model of trade credit in a capital-constrained distribution channel

In a product market with uncertain demand, we examine a distribution channel consisting of one manufacturer and one capital-constrained retailer. The retailer may fund its business by borrowing credit either from a competitive bank market or from the manufacturer, provided it is also to the latter's benefit to extend trade credit. Under bank credit financing, we show that the channel behaves as if the retailer is not constrained by capital. In a wholesale price contract, we find that trade credit makes both channel members better off and is the unique financing equilibrium; trade credit better integrates the channel than bank credit by centralizing the financing of distribution at the manufacturer. We further compare bank versus trade credit under a classical channel contract, revenue sharing contract. In addition, we present a set of numerical experiments to show how product cost, internal capital, and demand variability impact on the market equilibrium under both bank and trade credits. (C) 2014 Elsevier B.V. All rights reserved.