Support SME Suppliers through Buyer-Backed Purchase Order Financing

Supporting small and medium enterprises (SMEs) to access finance has received rapidly-rising attention in recent years. In some countries, large buyers in supply chains are considering credit guarantee schemes (CGS) through which the credit coverage can be extended to assist their SME suppliers. While such support is beneficial to the suppliers, an issue arises regarding the motivation of the large buyers to join and support the SME suppliers. In practice, SMEs are often attractive but riskier sources of supply. Supporting SME suppliers through the financial guarantee may bring even more risk concern to buyers. To study the buyers' sourcing and guarantee strategy, we analyze a simplified model where a core enterprise procures components from only two sources: an SME supplier with a lower price and the spot market with a higher price. A novel Buyer-Backed Purchase Order Financing (BPOF) scheme is studied in supporting the supplier's financing. We analyze the effect of the market interest and identify the properties of the buyer's optimal joint sourcing and credit-guarantee decisions. Through numerical experiments, BPOF is shown to significantly improve the core enterprise's profitability.