A game-decision-theoretic approach to optimize the dynamic credit terms in supply chain finance

An optimal credit term decision in supply chain finance often needs to be made in a dynamic way considering the varying market demand among other factors. We study the dynamic credit term optimization problem (DCTOP), where a supplier determines the credit term in conjunction with its production and inventory decision, while anticipating a buyer’s order quantity in a leader-follower game setting. The DCTOP is first approached to using a continuous time optimal control model, with analytical results characterizing the structural properties of the optimal solution. To complement the structural properties, we then develop a discrete time bilevel programming model to provide computationally tractable and implementable numerical solutions. A comprehensive computational study shows significant advantage of our optimal solutions over the heuristic credit term rules in practice, and provides managerial insights regarding the impacts of key problem parameters on the optimal solutions and coordination scheme.