An inventory model on compounding interaction effects between quality uncertainty, human inspection fallibility, credit financing strategies, and bad debt losses

Abstract

Purpose This study aims to propose a three-tier inventory model in which the upstream and downstream trade credit strategies differ, and the concept of bad debts is applied to downstream credit financing. In addition, the model incorporates the supply of defectives from the manufacturer’s side, which is handled via an error-prone inspection process at the wholesaler’s end. Companies can customize this model to predict potential financial losses from uncollectible debts in imperfect supply chains.

Design/methodology/approach A mathematical model is formulated under specific assumptions regarding flexible credit limits, bad debts, defectives and inspection inaccuracies. Six different cases of credit arrangements are analyzed, and closed-form expressions are derived for each case mathematically using calculus and concavity tests. A robust parametric analysis is used to understand the influence of changes in defect rates, error rates and credit limits on order size, profit function and cycle time.

Findings Findings suggest that permissible delays in payments serve as a balancing tool to offset losses resulting from the presence of defective products and inspection errors, with profit margins increasing as the number of reliable retailers increases.

Originality/value The study reveals interaction effects between quality, inspection, credit and defaults that change optimal policies in nonobvious ways. Also, it enables answering strategic questions that are fundamental to practice but impossible with prior fragmented models. It also provides the analytical framework for bad debt provisioning when quality uncertainty and credit risk interact. Finally, it offers a practical decision tool for real problems facing wholesalers like Big Bazaar, Walmart and Shoppers Stop.