The impact of switching costs on vendor financing

We show that vendor financing appears in equilibrium as the result of repeated trade interactions between a buyer and a supplier when changing supplier is costly. Competition between suppliers forces them to offer a rebate before the relationship is initiated and switching costs allow the buyer to borrow from the supplier in the first period and to roll over the debt until the end of the relationship. The sequence of transfers is similar to a long-term financing structure. Our model suggests that switching costs allow small business owners to smooth their dividend income by using vendor financing.