Consignment inventory – benefits and risks

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Consignment inventory can be a useful tool for inventory management, when used in the right situations. With so much capital tied-up in inventory, it’s not surprising that businesses devote a lot of time and expertise to improving and perfecting their inventory management processes. Every part of the supply chain generates operating costs – from purchasing, freight and storage, to shipping, insurance, and the dangers of obsolescence or loss. The ability to optimize and streamline these processes understandably carries a high value for inventory managers, shareholders and business owners.

There are a wide variety of tools available to help businesses achieve their inventory goals. Though just as important as implementing them, is knowing how and when to use them to their best advantage. Let’s take a look at what consignment inventory is, how it works and what benefits and downsides there are for businesses looking to utilize it.

What is consignment inventory?

Put simply, consignment inventory is inventory that is still owned by a vendor but is held as stock by a business. Depending on the type of arrangement between them, the inventory will be paid for only once used or sold. This can include parts used in manufacture or retail items on display.

For vendors looking to gain exposure for unknown or high-end products, and retailers and manufacturers looking to minimize their tied-up capital, consignment inventory can provide a useful solution. But like most inventory management techniques, consignment inventory practices are only as good as their users. Implementing a good technique for the wrong reason is an easy trap to fall into, and sometimes a costly one.

How is it set-up?

Generally, as an agreement between vendor and business. Many consignment agreements will stipulate how the inventory is tracked and paid for. Manufacturers will usually pay for all items used by the end of a certain period, whereas retailers may pay as they go, per item sold.

A beneficial exchange

As a general rule, the use of consignment inventory should facilitate the meeting of a necessity, something that can’t be achieved by existing inventory practices. A simple way to check if its use won’t be negative is to weigh the predicted benefits against the costs.

In most cases, the obvious benefits favour the business – a minimization of tied-up capital, less risk of obsolescence – though there are some upsides for the vendor also. A common example of this is the use of consignment stock to generate product exposure.

Product exposure for vendors

If a vendor has new, unknown or high-end products that businesses are reluctant to stock in case their customers won’t buy them, the vendor may offer to supply the goods on consignment. The risk for the business is thus minimized and the vendor gets needed exposure for their goods, benefiting both sides.

And the downsides?

A common downside for both vendor and business is the potential for difficulties in accounting, handling and tracking of consignment items. As many inventory management and accounting systems are not designed to account for stock on consignment, there is the danger of increased labor costs and double handling.

It’s common for businesses, when using consignment stock, to side step the normal inventory processes, increasing the chances of stock and accounting errors.

Negative leverage

Sometimes a business will try to use consignment arrangements negatively against the vendor. By exaggerating the threat of taking their business elsewhere, they can pressure vendors to provide more stock on consignment, thus cutting their own inventory costs. This can create some serious problems for the vendor if their goods are slow to sell, or a lot of items come back damaged. It can also set a negative precedent, where the vendor feels compelled to offer stock on consignment just to please their customers.

To use or not to use

As a guiding principal, if stock demands are reasonably predictable, then the use of consignment inventory is not recommended. Think of it more as a way to guard against unpredictable inventory costs, not as a means to minimize your regular inventory costs.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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