Consignment stock is a useful arrangement that allows a supplier and a retailer to create a “win-win” scenario through the sharing of risk. Consignment inventory can be both a useful tool and a recipe for disaster depending on the circumstances in which it is employed.
Below is a brief summary of what consignment inventory is, when it’s best used, and some key issues to bear in mind when using it.
What is consignment inventory?
Consignment inventory is stock that is in the retailer’s possession but is still legally owned by the supplier. It occurs where the supplier has placed some products in the retailer’s control and allows them to sell or use the goods directly from their stock. Only once the product has been consumed or resold by the retailer is the inventory then purchased from the supplier.
So, while the retailer still incurs costs related to storing and maintaining the stock, they do not have to tie up their capital in purchasing it. In the right situation, consignment inventory can have significant benefits for both the retailer and the supplier.
How does it work?
Consignment describes the situation where the owner of goods (the consignor) sends those goods to an agent (called the consignee).
Depending on the consignee’s business model, the consignor might allow the consignee to sell or consume goods directly from his inventory. The consignee only purchases the stock that it sells or uses. At the point that an item is consumed or sold, the consignee is deemed to have purchased it.
The question of ownership
The main consideration when working with consignment inventory is when the transfer of ownership occurs. The four-basic transfer of ownership arrangements are:
- Pay as sold, a real-time payment, where a sale transaction triggers a payment to the consignor for the goods sold.
- Pay as sold during a pre-determined period, requiring payment for goods sold within a set timeframe such as weekly, monthly or quarterly payments.
- Order to order consignment, where a previous consignment is billed when a new order is placed.
- Ownership changes after a pre-defined period regardless of whether goods are sold.
Agreeing the fine-print
Before undertaking consignment inventory arrangements, it is necessary to discuss and agree on several factors such as:
- Responsibility for freight and shipping costs
- Liability for insurance, damage, loss and return policy
- Timeframes for which the consignee is prepared to keep stock
- Consignee commission or percentage of sale price.
Consignment inventory example: Real-life application
Consignment inventory works well when the shared risk/shared benefit scenario exists.
For example, a new watch manufacturer attempting to enter the market may try to stock their watches with an established jeweler by consignment inventory.
The manufacturer benefits, as the watch market is competitive, and it would otherwise be difficult to get their product in front of customers in a meaningful way.
The jeweler benefits as they don’t have to tie up their capital in this stock, and instead have an extra product for consumers while having funds to purchase stock from more established brands.
The situation is therefore a “win-win” for both the manufacturer and jeweler.
A contrasting scenario could be where the jeweler is attempting to negotiate with a manufacturer of a more established watch brand so that they will provide stock through consignment inventory. Whether they will be able to achieve this will depend on the bargaining strength of the parties – few established manufacturers are likely to agree to this.
Consignment inventory negotiations are crucial for getting all parties on the same page prior to signing a contract.
3 advantages of consignment stock
1. Reduced inventory costs
One obvious advantage to retailers of holding consignment stock is the opportunity to save on inventory costs. In not having to pay the supplier until the goods are sold, the business is able to use this capital on other projects and benefit from the increase in cash flow.
2. Share the risk
Convincing the retailer to stock your products can be difficult where they are unwilling or unable to purchase stock because they don’t want to invest in a risk that may not sell. Consignment stock creates a shared risk – the supplier risks the capital investment that is associated with the stock, while the retailer risks setting aside retail space for the product.
This effectively allows suppliers and retailers to ‘test the waters’ on a product without running the risk of a significant financial loss. It works out better for both parties to figure out what products sell best in which markets before investing more capital into them.
3. Shorter lead times
A benefit for both the retailer and supplier when it comes to consignment inventory is that it generally reduces the lead-time on products. As it is in both the supplier and the retailer’s best interests to keep the inventory at a functioning level, it is usually replaced as soon as it is sold, eliminating any loss of business due to a lag time between goods.
The downside of consignment stock
One major problem with consignment inventory is the difficulty in recording it when it comes to inventory management.
The core concept of consignment – that change of ownership doesn’t occur until the goods are sold (rather than shipped), is contrary to the basic design of most inventory/accounting systems’ transactional processes.
Many inventory management systems don’t handle this well. This leads some businesses to manage consignment inventory with time and resource-consuming manual processes, however there are inventory management software programs that can accommodate this. These programs are not only faster, but they are also far less error-prone.
Consignment inventory is only paid for when the customer needs it, making it a helpful tool in managing cash flow.
Is consignment stock for your business?
Consignment stock is usually best applied to a particular type of product. Those products that are new and unproven or expensive goods with unknown sales potential are prime examples.
It may also be used constructively in the introduction of pre-existing product lines into new sales channels. The outcome is a combination of how confident both the supplier and the retailer are that the product will sell.
So, depending on your business, selling goods by consignment may or may not be an appealing proposition. It can be used for market testing, or as a fairly inexpensive way of finding out if a new product will sell.
It does, however, keep the supplier’s capital invested until the product is sold, and places the responsibility for the care and maintenance of the stock in the hands of the retailer. This situation where the retailer does not have any funds invested in the stock comes with inherent risks, and it is important to ensure the potential risks are not greater than your resources are able to absorb.
Keep your staff in the loop
A final consideration is that consignment inventory will be invisible to most workers because the inventory is still produced and shipped to the customer like normal goods.
It is important that those employees who need to appreciate the difference (i.e., the stock is not actually sold) are aware of this. This might range from staff responsible for order processing to high-level decision makers who aren’t familiar with inventory processes.
Keeping all these people informed with help consignment inventory to run smoothly, if you decide that it is right for your business.
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This article was updated in July 2023 to reflect current trends, new information, and changed statistics.
