Risk Propagation through Payment Distortion in Supply Chains

The supply chain literature has devoted much attention to studying how the variability of orders propagates upstream. We focus, instead, on how the variability of payments to suppliers propagates upstream, which has a major impact on risk. To do so, we build a supply chain model based on empirical findings from the finance literature. We show that payment variability may occur even if orders are constant, and that this variability may propagate and even increase at upper echelons. We show that this phenomenon is caused by the limited access to debt and identify the factors that drive the propagation of variability—the industry risk, the firm’s operational leverage, the existence of a financial leverage target, and the cost of debt. By studying the limiting distribution of the corresponding Markov chain, we numerically illustrate the impact of these drivers on the risk of upper echelons as well as the interactions between order and payment variability. We provide a number of insights and propose measures for risk management.