Is Consignment Inventory the Right Choice for Your Business?

What is Consigned Inventory?

To put it simply, consignment inventory is the opposite of traditional inventory practices. In traditional inventory, the seller — a retailer or distributor — pays for the product at the time they take possession, and then recoups the investment selling directly to customers. With consignment inventory, the producer of the stock retains ownership until the product is sold to the consumer or consumed in the business. At the same time, the retailer buys the product from the producer. The retailer or user doesn't pay for the product until it's sold.

The consignment approach shifts inventory-carrying costs from the retailer to the producer. It's a common arrangement for big-ticket inventory in retail, such as furniture or sporting goods. Retailers may not have the cash flow to support buying a range of luxury sofas that could take months or years to sell off the floor. The retailer can return stock that doesn't sell to the distributor without losses.

It's also found in medical and pharmaceutical settings. For example, a medical device company may stock a set of high-dollar devices, but pays for them only when one is removed from the supplier's inventory.

Keep in mind it takes specialized systems set up to track the consignment inventory and payments as most standard accounting systems are set up for traditional inventories.

There are several types of consignment inventory management depending on when ownership is transferred and whether the inventory physically changes locations.

Ownership models

Real-time: Payment is made with the product is sold.

Periodic: Payment is made after an agreed-upon period of time.

Order to Order: The previous order is billed when a new order is placed.

Tracking models

Transfer: Inventory moved to seller's facility.

Accounting: Inventory stays in one location and is tracked when sold.

Quantities: Quantities are tracked, either overall or linked to the original consignment arrangement.

Consignment inventory can add a layer of complexity to your business, and as a consigner, your company shoulders much of the risks without a comparable rise in revenues. The consignment arrangement should be transparent to the end customer -- the buyer often doesn't consider who gets paid or when.

Consignment Inventory Best Practices

Consignment inventory has its place as a business practice, but as mentioned above it adds a layer of complexity and risk. Unfortunately, some retailers see it as a way to reduce their inventory carrying costs by shifting the risks to the supplier. Because of the added complexity in inventory management and accounting, the net cost reduction is usually much lower than anticipated.

For a consignment inventory arrangement to work, it should be beneficial for both parties and utilize technology to minimize additional costs and risks.

Consignment Inventory Agreements

A solid contract is the basis for a successful consignment arrangement. Both parties must understand terms, including when payments will be made, any time limits, shipping and returns responsibilities and which party is liable for damage or lost products.

The agreement must include how the inventory will be counted and managed and require regular inventory updates, depending on the ownership model. Any deposits or commission requirements must be spelled out as well. Of course, the sellers must agree to make good faith efforts to sell or use the consignment inventory in a timely fashion.

Consignment Inventory Technology

Managing consignment inventory typically requires a specialized system to track and invoice because payment or change of ownership disconnected from the shipment process. A spreadsheet or paper-based system won't be able to keep up, except perhaps in a small specialty retail environment like a gift shop or craft store.

It's especially important to use a system that will manage any discrepancies between the consignor and consignee for increased inventory accuracy. A robust system will provide data such as sell-through rates and track inventory at multiple locations. The goal is to have maximum visibility into the inventory for all parties involved in the relationship.

Collaboration

Consignors and consignees should work together on marketing, advertising and sales to generate and meet the demand for the products. All parties benefit when the inventory turnover increases.

Sales Channels

Most sellers should use more than the consignment sales channel. It's easier than ever to get involved in e-commerce, and traditional inventory arrangements are also desirable and usually available. Selling via multiple channels reduces the seller's risk and increases revenue opportunities.

Pros and Cons of Selling Inventory on Consignment

Should your business sell inventory on consignment? The answer is, it depends. Consignment inventory has been a standard practice in some industry sectors for decades. The boom in e-commerce has led to a new wave of consignment relationships as well. That said, consigned inventory doesn't make sense for every business.

Pros of Consignment Inventory

A consigned inventory model works best when the supplier has high confidence that the products will sell if they can get in front of the target consumer. It makes sense for new product launches, small businesses that don't have the capital to scale up distribution on their own, or high-ticket items with a long sales cycle. Some retailers, including medical companies, like consignment because they can offer a more extensive array of products than they otherwise could not afford to stock.

It's also common in service and repair businesses where it's unknown how long a part will sit on the shelves. The service business can have access to the part and respond to their customer faster without inventory costs or paying for expedited shipping.

Consignment makes the most sense when demand for a product is uncertain, at least for a period of time. That may be due to a new product or brand, or the introduction of a new product into existing lines. The retailer will be more inclined to carry the product because their risk is minimal, essentially opportunity cost from allocating shelf space to an unproven product. If the product sells, then both parties benefit. The supplier can reduce their inventory costs because at least a portion of the inventory is stocked on the retailer's shelves.

Cons of Consignment Inventory

Consignment inventory made more sense in the days before e-commerce. Brick-and-mortar retail was the main channel, and mail order delivery based on catalogs and advertising filled the gaps. Today, with so many channels, there are many ways to get products in front of customers.

Products with consistent demand - staples in the grocery store, for example - don't make much sense for consignment. The vendor and seller can count on consistent inventory turnover. It's the same situation with consumables like copier toner or paper. There's a relatively steady consumption that sustains a traditional supply chain.

Shifting to consignment inventory for products that a retailer or seller already consistently stocks is not a mutually beneficial option. Typically the seller is seeking to shift inventory costs to the supplier for their own benefit. Of course, if a seller represents a large segment of the revenue stream, the supplier may not have much choice.

One of the keys to a successful consignment relationship is to make sure the seller is putting effort into selling the items. Since they don't cost the seller anything, there may be less incentive to move the products.

Of course, the biggest con against consignment inventory is the financial risk carried by the supplier. The supplier's inventory costs are tied up at sellers outside of its control. There may be loss or damage, or merely slow sales that leave inventory investment languishing on the shelf.

Why Should You Minimize Consigned Inventory?

The use of consigned inventory depends on your business strategy and financial situation. For some companies, it's the most economical way to bring new products to market or enter a new territory. It can be a cost-effective way to promote your products in a wider geographic area than you could reach otherwise. Or if you have seasonal products, you can reach markets for a specific time period and then easily withdraw the inventory until the next market opportunity. You can jumpstart sales, as sellers may be more inclined to sell the products due to the lesser risk.

The main issue with consignment inventory is the imbalance of risk. The supplier may end up losing control of their revenue stream, leaving too much to sellers who don't have a lot of incentive to turn over the inventory. Costs tend to rise for both parties due to additional inventory control and accounting, supply chain complexity and potential loss or damage.

One alternative, if sellers are seeking better terms, is to work with them on longer payment terms, volume commitments or other variables. You may be able to accomplish essentially the same objective without shouldering as much of the risk and cost of managing consignment inventory. Cash flow may be uncertain as suppliers wait for payments from sellers. Also, suppliers must count the inventory they own for financial and tax purposes, so accurate counts are essential.

Use Last-Mile Logistics to Minimize Consignment Inventory

Rather than step into the world of consignment inventory, improved supply chain management may be a better solution.

A well-designed last mile logistics plan can deliver some of the benefits of consignment, including shorter lead times and responsiveness, without giving up control of the inventory. A last-mile focused supply chain will move the product to the customer when and where they need it. The supplier can replenish stock quickly with a traditional inventory agreement, ensuring a predictable cash flow. A distributed warehouse system can pre-position products in major markets, allowing for rapid inventory replenishment or even direct fulfillment to the end user.

Your inventory carrying costs will be lower, and the overall supply chain will be less complicated. With more than 10,000 mini warehouse locations across the country, Warehouse Anywhere can help your company take control of your inventory while still exceeding customer expectations.

Talk to us today if you'd like to learn more about last-mile logistics and reducing reliance on consignment inventory.