A Supply Chain Theory of Factoring and Reverse Factoring

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Author Information : Panos Kouvelis, Olin Business School, Washington University in St. Louis
Fasheng Xu, Whitman School of Management, Syracuse University

Year of Publication : Management Science (Forthcoming)

Summary of Findings : We develop a supply chain theory of (recourse/non-recourse) factoring and reverse factoring showing when these post-shipment financing schemes should be adopted and who really benefits from the adoption.

Research Questions : 1. How should the supplier choose between recourse and non-recourse factoring?
2. When should the retailer offer reverse factoring program? Who are the suppliers to target?

What we know : Reverse factoring has often been argued as an effort by the credit-worthy buyers to compensate smaller capital-constrained suppliers for an aggressive lengthening of payment terms. However, our work shows that reverse factoring might not be preferable for suppliers with high credit ratings, and could be dominated by non-recourse factoring for a given payment extension when the retailer's credit rating is higher than a threshold. Our result provides a supply chain micro foundation to observations of supplier's postponement of reverse factoring adoption.

Novel Findings : We find recourse factoring is preferred when the supplier's credit rating is relatively high, while non-recourse factoring is preferred within a certain medium range of credit ratings. Further, we find that reverse factoring may not be always preferred by suppliers compared to recourse and non-recourse factorings. Retailers should only offer reverse factoring to suppliers with low, but above a threshold, to medium credit ratings. More importantly, contrary to conventional wisdom, our theory implies that reverse factoring could be adopted even when the retailer has no credit rating advantage over the supplier and could benefit the retailer even without extending payment terms.

Implications for Practice : Contrary to conventional wisdom in practice, our theory implies that: (1) reverse factoring could be adopted even when the retailer (buyer) doesn't have any credit rating advantage over the supplier (seller); and (2) reverse factoring could benefit the retailer even without extending payment terms.

Implications for Policy: Our results also shed light on the implications of recent trade-credit regulation reforms undertaken in the United States and the European Union which aimed at accelerating payments to small businesses. For example, the trade credit regulation reform in France (went into effect in 2006) prevented French trucking firms from extending to their customers' payment terms in excess of 30 days. As a cautionary tale, such regulation may limit the potential value of reverse factoring adoption, and its value should be reassessed based on whether those sellers have access to reverse factoring programs.

Implications on Research: In future work we hope to investigate empirically the additional predictions that our theory generates, in particular, those involve supply chain decisions (e.g., wholesale price, inventory). The theory itself might also be extended in several directions by admitting, for example, a richer information structure (e.g., information asymmetry between financial institutions and supply chain firms), a more nuanced model of liquidity risk and benefit, and a more general supply chain (network) structure (e.g., multiple competing suppliers). The modeling framework can also be adapted to study other types of post-shipment financing schemes (e.g., dynamic discounting, invoice trading).

Full Citations : Kouvelis, P. and Xu, F., 2020. A supply chain theory of factoring and reverse factoring. Management Science (Forthcoming).

Abstract : Factoring is a financial arrangement where the supplier sells accounts receivable to the factor against a premium and receives cash for immediate working capital needs. Reverse factoring takes advantage of the retailer's payment guarantee and the credit rating differential between small supplier and large retailer, enabling the supplier to receive financing at a more favorable rate. We develop a supply chain theory of (recourse/non-recourse) factoring and reverse factoring showing when these post-shipment financing schemes should be adopted and who really benefits from the adoption. We find recourse factoring is preferred when the supplier's credit rating is relatively high, while non-recourse factoring is preferred within a certain medium range of ratings. Both factoring schemes, if adopted, benefit both the supplier and the retailer, and thus the overall supply chain. Further, we find that reverse factoring may not be always preferred by suppliers compared to recourse and non-recourse factorings. Retailers should only offer reverse factoring to suppliers with low, but above a threshold, to medium credit ratings. The optimally designed reverse factoring program can always increase the retailer's profit, but it may leave the supplier indifferent to current factoring option when followed by an aggressive payment extension. More importantly, contrary to conventional wisdom, our theory implies that reverse factoring could be adopted even when the retailer has no credit rating advantage over the supplier and could benefit the retailer even without extending payment terms.

Fasheng XU
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