4. The value of 3PL financing
In this section, we first discuss the control role case where the
3PL firm provides financial services and then demonstrate the value
of the 3PL firm in the financing of the budget-constrained
retailer.
4.1. The control role
In the control role model, the 3PL firm provides not only logistics
services but also trade credit to the retailer. While the retailer
has insufficient capital to order directly from the supplier, the 3PL
firm procures the products from the supplier for the retailer
through trade credit financing and then transports them to the retailer.
In addition, the 3PL firm can effectively track and monitor
the transaction of products in addition to providing trade credit
to the budget-constrained retailer.
In the first stage of the Stackelberg game, the 3PL firm offers a
trade credit contract (w,rcl(B)), and in the second stage, the retailer
orders Q
clðBÞ from the supplier through the 3PL firm. The retailer’s
decision process is the same as in the traditional role model. The
3PL firm’s profit is given as follows.
Y3PL
cl ðBÞ ¼ max 06rclðBÞ6~rðBÞ
Efmin½min½D; Q
clðBÞ;ðwQ
clðBÞ BÞð1 þ rclðBÞÞ
þ B CclQ
clðBÞg
¼ max 06rclðBÞ6~rðBÞ
E ðw CclÞQ
clðBÞþðwQ
clðBÞ BÞ
þrclðBÞ
ðmin½D;Q
clðBÞ ðwQ
clðBÞ BÞð1 þ rclðBÞÞÞ ð4Þ
where Ccl = wp + cl represents procurement and logistics operational
costs incurred to the 3PL firm and x = min{x, 0}. The above payoff
consists of two components: the operational revenue
ðw CclÞQ
clðBÞ and the financial revenue ðwQ
clðBÞ BÞr
ðmin½D;Q
clðBÞ ðwQ
clðBÞ BÞð1 þ rclðBÞÞÞ. It is straightforward
that the operational profit is positive as long as w > Ccl; however,
the financial profit could end up with a negative value if demand
uncertainty is too high; as a result the retailer could not repay the
trade credit plus interest. Thus, a tradeoff occurs: on the one hand,
the 3PL would like to choose a small rcl(B) to improve operational
performance; on the other hand, the 3PL would like to choose a
large rcl(B) to satisfy his financial motive. The 3PL firm optimizes
its trade credit contract while taking both motives into consideration.
We characterize the optimal interest rate in the following
proposition.
Proposition 2. In the control role model, the optimal interest rate
r
clðBÞ for the 3PL firm financing is
r
clðBÞ ¼
~rðBÞ if clð~rðBÞÞ 6 1;
0 if clð0Þ P 1;
^rclðBÞ if clð0Þ < 1 and clð~rðBÞÞ > 1:
8
><
>:
The unique ^rclðBÞ satisfies cl(rcl(B)) = 1, where clðrclðBÞÞ ¼
FðQ
clðBÞÞ½1HðQ
clðBÞÞþB
whðQ
clðBÞÞ
Ccl½1H½ðwQ
clðBÞBÞð1þrclðBÞÞ and cl(rcl(B)) increases in rclðBÞ2½0; ~rðBÞ.
In Proposition 2, if the order quantity is inelastic to the interest
rate change, where clðrclðBÞÞ 6 clð~rðBÞÞ 6 1 and hence d
Q3PL
cl ðBÞ
drclðBÞ P 0,
the 3PL firm charges the interest rate at the highest level, ~rðBÞ, to
optimize his profit. If the order quantity is very elastic to the interest
rate, where cl(rcl(B)) P cl(0) P 1 and hence d
Q3PL
cl ðBÞ
drclðBÞ 6 0, the
3PL firm achieves its optimum by completely waiving the interest
for the retailer. When interest-demand elasticity is in the medium
range, the 3PL firm can find a unique optimal interest rate that balances
the tradeoff between the financial and operational benefits.
In reality, the benefit of a control role model can be even more significant
because the 3PL firm can reduce logistics costs (cl) by taking
advantage of the economy of scale by grouping many retailers
together.
4.2. Comparison of the 3PL’s roles
We are now in a position to compare the values of 3PL in the
traditional and control roles. For brevity, we assume that the traditional
role has symmetric budget information in the sequel unless
mentioned otherwise.
Lemma 3. The optimal order quantity in the control role model is no
less than that in the traditional role model; while the interest rate in
the control role model is no more than that in the traditional role
model.
Lemma 3 suggests that the optimal interest rate in the control
role is no higher than that in the traditional role. The optimal order
quantity in the control role is no less than that in the traditional
role. The inequality holds when interest-demand elasticity is in
the medium range. This result occurs because the 3PL firm shares
a higher risk of demand uncertainty through the financial service
and would like to reduce the interest rate to stimulate a higher order
from the retailer. If interest-demand elasticity () is either too
large or too small for both traditional and control roles, the optimal
interest rates are reached at the boundary; thus, the optimal interest
rates and order quantities are the same in both cases.
From the proof of Lemma 3, we can obtain additional technical
details, as illustrated in Table 1. The itemized results in Table 1 are
determined by the interplay of interest-demand elasticity rates in
both the control and traditional roles. From the proof of Lemma 3,
we know that, for any given interest rate, interest-demand elasticity
in the control role is no less than that in the traditional role. If
both interest-demand elasticity rates are low, a low interest rate
does not stimulate much demand; thus, the 3PL/bank will charge
the interest rate at its highest level in both the control and traditional
models. In contrast, if both interest-demand elasticity rates
are high, the benefit from a higher demand will overweigh the
X. Chen, G. (George) Cai / European Journal of Operational Research 214 (2011) 579–587 583
benefit of a higher interest rate; in this case, the 3PL/bank will
charge a zero interest rate in both the control and traditional role
models. If interest-demand elasticity is in the medium range, the
interest rates in both models will differ in the four subcases, as
shown in Table 1. Nevertheless, the optimal interest rate in the
control role is no more than that in the traditional role; while
the optimal order quantity in the control role weakly dominates
that in the traditional role.
Owing to a higher order quantity in the control role, we may expect
that the entire supply chain will be more efficient in the control
role, which is confirmed by the following proposition.
Proposition 3. For the 3PL firm, retailer, and supplier, the control role
model outperforms the traditional role model.
Proposition 3 is a natural result from Lemma 3, because in the
control role model, compared with the traditional role model, the
3PL firm more significantly shares the risk of demand uncertainty
with the retailer when offering the trade credit and logistics services
together. Thus, the retailer benefits from a lower interest rate,
the supplier benefits from a larger order quantity, and the 3PL firm
benefits from the integration of the financing and its traditional
logistics services. This result provides theoretical support to the
practice of 3PL firms integrating their logistics services with financial
services, such as UPS and others.
Because of the budget constraint, one might expect that neither
of our above models can outperform the classic newsvendor model
(without budget constraint) in terms of overall supply chain profit.
Note that overall supply chain profit includes the profits of the supplier,
retailer, 3PL, and/or the bank and, hence, can be written as
follows.
P
i ðBÞ ¼ Efmin½D;Q
i ðBÞ ðcp þ clÞQ
i ðBÞg
where the subscript i = t, cl, N. The following result delivers a somewhat
counterintuitive message.
Proposition 4. Compare overall supply chain profits in the traditional
role, control role, and classic newsvendor models.
1. The classic newsvendor model outperforms the traditional role
model (i.e., P
tðBÞ 6 P
NðBÞ).
2. The control role model outperforms the classic newsvendor model
(i.e., P
clðBÞ P P
NðBÞ), as long as Ccl is sufficiently low (i.e.,
Ccl 6 wðwQ
clðBÞBÞhðQ
t ðBÞÞ
1H½ðwQ
clðBÞBÞð1þr
clðBÞÞ).
The first statement of Proposition 4 suggests the traditional role
model cannot outperform the classic newsvendor in terms of entire
supply chain efficiency, which is intuitive because the retailer
bears additional financial risk plus the same demand uncertainty
as in the classic newsvendor model. As for the control role model,
the second statement of Proposition 4 indicates that overall supply
chain profit in the control role model outweighs the classic newsvendor
model. The rationale behind is that the 3PL firm shares the
risk of demand uncertainty with the retailer by lowering the
interest rate, such that the retailer orders a larger quantity that
consequently yields a higher profit for the entire supply chain.
Compared with the traditional role model, the 3PL in the control
role model coordinates the supply chain by integrating the financial
and logistics services. A lower combined value of product
wholesale price and logistics operational cost (Ccl) enables the
3PL firm to charge a lower interest rate than in the traditional role
model. This result conveys the message that an integrated service
of financing and logistics can coordinate the budget constrained
supply chain, and thus is a win–win-win solution to the retailer,
the 3PL firm, and the supplier. However, if Ccl is too high, the burden
of the budget constraint would outpace the benefit of 3PL
coordination, such that the classic newsvender model would outperform
the control role model in terms of overall supply chain
efficiency.
5. Su