Trade Credit Can Help the Supply Chain, or Hurt It

Trade credit—suppliers letting customers buy now and pay later—can bind companies in a chain together, or cause widespread disruption.

“Trade credit serves many important purposes including being used as a bargaining tool, a method to price discriminate, and a way to allow customers the time to verify the quality of goods before they make payment,” says Chicago Booth’s Anna Costello.

This type of financing eases the constraints of trading partners, enabling cash-strapped companies to obtain goods from a supplier—say, an automobile component—without paying immediately, thereby giving them time to sell products and collect cash they can use to repay suppliers. This makes the flow of goods more efficient by reducing financing constraints.

Suppliers typically set credit terms—for example, allowing for a payment delay of either 30 or 60 days—that balance the time period between when a business must pay cash to its suppliers and when they receive cash from selling its product to customers (also known as the cash-to-cash cycle). Or they may aim to balance the amount of trade credit they offer with their other available liquidity, such as a bank loan. When suppliers set their terms, they need timely payments to keep everything in balance.

Trade credit can disrupt a supply chain when customers delay payment, throwing off the supplier’s liquidity management, and echoing up and down the chain.

“If a supplier doesn’t get paid on time, he or she also delays payments to the next upstream supplier, and so on,” Costello says. “Conversely, when suppliers shrink the trade credit they offer to downstream customers, those customers also shrink the supply of credit that they offer downstream, and so on. Because the supply chain is so interlinked, the actions of one party have important economic consequences on the economy as a whole.”

One of those consequences has been discrimination against Black and female trade-credit officers. “Delayed payments happen all the time,” Costello says, “but we find that during the COVID-19 pandemic, payments were even more delayed to Black and women suppliers than they were to other suppliers.”

Using a data set that tracked transactions between suppliers and customers, Costello and Booth’s Michael Minnis find that, on average, suppliers with trade-credit officers that were female or Black saw a larger increase in past-due accounts during COVID-19, as compared with suppliers whose lead credit officers were white men. And not only is payment discrimination hurting the Black- and women-led companies themselves, but it could have drastic impacts on the liquidity of the supply chain as a whole, because of how delayed payment to one company causes spillover effects on its supply-chain partners.

Antibias training could help, Costello says. More broadly, contagion can be contained. Trade-credit insurance or alternative financing companies that provide fast cash can cover suppliers when their customers lapse on payment. But that can be expensive, she says, and insurance companies are typically more willing to work with larger, more transparent companies than the smaller companies that tend to need liquidity protection the most. “In the next few years,” Costello says, “look for the entry of more sophisticated fintech lending companies to fill this gap and serve the supply chain’s smallest businesses.”