Possession may be “nine tenths of the law”, but not when it comes to consignment inventory. Consignment inventory refers to stock that a business holds but does not own. Instead, a supplier has provided the vendor with stock for sale or use but maintains legal ownership of that stock. Consignment inventory is a relatively popular approach to procuring stock, and for good reason. Consignment spreads the risk of stocking a product and can benefit the supplier and stockist alike.
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.
Our business is thinking of holding stock on a consignment basis – should we?
An easy-to-identify benefit for retailers of holding consignment stock is the reduced cost of acquiring inventory. Because the consignee only pays for the stock once it has been consumed or sold, it does not need to sink as much money into inventory. Cash flow is improved, because less capital is tied up in a large inventory; more money is then available to finance the rest of the business. This is not to say that inventory-carrying costs are eliminated altogether. The consignee still remains responsible for other carrying costs such as storage, handling and transport.
Cash flow is not the only motivation for businesses to structure costs as operating costs rather than as capital in nature. Pre-purchasing a large amount of stock involves taking on a significant degree of risk. A potentially large investment could be wasted if the product sells less well than projected. Holding stock on a consignment basis can mitigate this risk. Retailers in particular can benefit from being able to make experimental or ‘risky’ inventory decisions; a retailer can take a chance where a product has an uncertain payoff because the cost and risk is shared with the consignor if the product sells poorly.
Because sharing risk with the consignor allows the consignee to stock products it may otherwise not consider, a consignment arrangement is mutually beneficial when it comes to new and unproven products or product lines. On the other hand, consignment inventory is much less effective where the economic case already stacks up for the consignee to stock a product. This is because consignment can share risk between parties but should not, ultimately, shift costs to the consignor. Economic theory suggests that (in a competitive market) a consignor with an existing supplier relationship with a consignee would increase its prices to cover its additional costs.
When it comes to new and uncertain products, consignment inventory can be an effective approach. It can get products on shelves where suppliers would otherwise find it difficult to convince their clients of a product’s viability. But it is not a universal solution – especially if the product is a sure bet.