Motivated by the practice from Walmart in China, we investigate Buyer-backed Purchase Order Financing (BPOF) contract by considering a supply chain consisting of one capital-constrained supplier and one well-capitalized retailer. The supplier is a small enterprise and cannot get financing from banks independently. In order to get funds for the supplier's production, three parties (the retailer, supplier and bank) reach a BPOF contract. In this contract, the retailer provides credit guarantee for the supplier's loan. As the loan guarantor, the retailer determines the amount of credit guarantee. The bank provides the supplier with the loan as the retailer requests. Then, the supplier gets the loan and determines production quantity. Finally, the market demand is realized and the retailer places order to the supplier. After the supplier delivers products and gets order payment, he can repay the loan. According to BPOF contract, if the order payment is insufficient to repay the loan, the retailer has to compensate the bank for the loss. To identify the optimal decisions for the retailer and supplier, we develop a two-stage Stackelberg game, in which the retailer is leader and the supplier is follower. We find that BPOF contract can help mitigate the supplier's financial distress and improve the retailer's revenue. In addition, we show that how the optimal decisions are affected by the supplier's initial capital and supply chain members' inventory risk. Our study further gives suggestions to supply chain management practices: small suppliers should take advantage of the retailer's high credit for financing, and the retailers who cooperate with small suppliers should maintain a good credit rating.
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