What is Consignment Inventory?
With eCommerce taking the world by storm and complex, continent-spanning supply chains the new normal in retail, selling goods on consignment is gaining popularity across diverse manufacturing sectors. In this post, we look at what is consignment inventory and weigh its pros and cons.
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What is Consignment Inventory?
Consignment inventory, or consigned goods inventory, is stock that an individual, a retailer or another company holds and sells on behalf of the stock’s owner. The supplier who owns the goods is called the consignor and the company or individual marketing and selling them is the consignee. Therefore, consignment is a supply chain management strategy wherein a consignor entrusts certain goods to be held, marketed, and sold by a consignee.
In a consignment agreement, the ownership of the goods does not change when handing over the goods. Until a sale is made, the goods belong to the consignor. A good deal of mutual trust needs to be established between both parties. On the one hand, the consignor ships goods to a retailer without receiving any money for them. On the other, the consignee takes on the responsibility for the storage, security, and condition of the goods.
The owner of the consignment stock only gets paid when a sale is made. The consignee then pays the consignor an agreed-upon sum per unit sold for the consignment sales. The consignee makes money by way of a percentage commission. If no sales are made during the consignment period, the goods are returned to the consignor or the agreement is extended. It pays to note that consignment is a viable strategy pretty much only for make-to-stock manufacturers.
Consignment Inventory vs. Vendor-Managed Inventory vs. wholesale
Consignment should not be confused with Vendor Managed Inventory (VMI). VMI is an inventory management model wherein a supplier is given the authority to keep a company’s inventory optimally stocked on behalf of the company itself. As such, VMI is not really a market strategy but a method for delegating large parts of inventory management to a supplier.
Wholesalers selling their stock in bulk to retail stores also do not constitute consignment inventory. For a consignor, the consignee is a contractual intermediary between the producer and the end client. For a wholesaler, however, the retailer is the end client.
Manufacturers who have well-established business relationships with retailers willing to regularly purchase large amounts of their finished goods do not have much to gain from consignment. A good example would be a building materials producer that has a long-term contract for selling goods in bulk to a large department store chain. In contrast, businesses just starting out, needing to break into new markets, or active in sectors with fierce competition often do well to look into consignment partnerships.
Read more about Vendor-Managed Inventory
Advantages of Consignment Inventory
Both the consignor and the consignee have a lot to gain from a well-thought-out consignment agreement.
Pros for Consignors
The biggest perk of a consignment agreement for a supplier or manufacturer is money saved. By entrusting the goods to a consignee, a company can significantly cut sales and marketing costs, and crucially – shipping, warehousing, and inventory holding costs. There is also no need to rent or purchase retail store space or hire clerks. Furthermore, having your products on retailers’ shelves at little to no cost is a good way to test their popularity and determine the demand for new designs. These savings to the cost of doing business decisively outweigh the hefty commissions retailers demand from consignment sales.
Another key strength for consignors is product visibility and brand recognition. When a retailer with an established client base and marketing mix takes on a consignor’s inventory, the latter’s goods are automatically exposed to a large potential audience. This helps to build brand awareness and break through to new markets. It is for this reason that consignment is a popular avenue for up-and-comers or companies trying to make it in highly competitive commercial sectors like cosmetics, household goods, apparel, etc.
Pros for Consignees
For retailers and other companies taking on consignment inventory, the biggest benefit is alleviating financial risk. In a consignment agreement, the consignee does not need to purchase the goods upfront in order to be able to market them. This means there is no need to worry about markdowns should the items not sell – the unsold goods can simply be returned to the consignor. There are still holding and other expenses, but no more risk of having to unload surplus stock at little to no markup.
The other chief reason why many retailers choose to take on consignment inventory is an expanded product selection and a potential for increasing clientele. Large chains with many sale points often diversify their assortment based on location, holidays, and buyer segments. When properly managed, a big product diversity means more playing room for retailers to ensure maximum sales across its channels. Consignment also helps to alleviate the risk of general stockouts.
Cons of Consignment Inventory
Naturally, the consignment business model also includes a number of potential drawbacks to guard against for both consignors and consignees.
For consignors, the big tradeoff is added risk and loss of control. In a consignment agreement, suppliers will not receive any money for their goods upfront. There is also no clear timeline as to when or even if the goods will be sold at all. Since the consignor is essentially trusting someone else to market and make sales on their behalf, a lot of control over the inventory and revenue is lost. This can exacerbate planning out production capacities and forecasting cash flow and demand.
For consignees, taking on consignment inventory naturally incurs added carrying and holding costs. Physical storage and retail space needs to be cleared or expanded to accommodate the added inventory. The retailer is furthermore responsible for guaranteeing security and held liable if the goods are damaged or stolen. Although negotiable, they usually also bear the shipping costs.
Finally, consignment inventory management can be a good deal more complex than the inventory management solutions that companies have set up. For consignees, consignment means having to manage and track stock that is not owned by the company holding it. For consignors, it means having to keep account of inventory that the company does not have in stock. Inventory management software and systems need to be carefully set up to be able to cater to these intricacies.
Managing Consignment Inventory and Best Practices
Successfully managing the consignment process mostly comes down to good preparation. Here are some recommendations to help make sure the advantages decisively outweigh any downsides.
Consignment is not a great option for some types of goods and manufacturing workflows. For example, without reliable sales channels or predetermined buyers, goods with very niché markets or short shelf lives incur added risks. Make-to-order producers also have little to gain as they usually keep only a small safety stock or no finished goods inventories.
Make sure both your operation and product are suitable for a consignment model before committing.
Find a great business partner
A big part of the success of consignment agreements relies on having a mutually beneficial relationship between the interested parties. While both the supplier and retailer have individual interests at play, success is truly compounded when the partners work in tandem to aim for a win-win situation.
For consignors, this means supplying the highest quality product at reliable and dependable lead times. For the consignee, going the extra mile to market the goods and get them in front of the right customers. Consider collaborating on marketing or ad campaigns and be flexible in catering to each other’s requirements.
Draft a thorough Consignment contract
Once the consignor and consignee are ready to go into business together, the next crucial step is to draft a consignment contract that is legally sound and reflects both parties’ interests as precisely as possible. In the real world, things rarely end up going exactly as planned. No matter how good the relationship between the would-be business partners, take extra care in ensuring that the contract is vetted and really goes into details as to agreements and expectations.
When drafting the contract, make sure to consider the following:
- What is the freight policy and who pays the shipping costs?
- Is the proposed sale commission rate suitable for both parties and for all goods?
- How long is the consignment period and is there a minimum time period the consignee is obligated to keep the products on the shelves?
- Is the price per product fixed or flexible for the consignee? If flexible, is there a minimum price with which they are allowed to sell the goods?
- What are the details of the return policy for unsold products?
- Which party is responsible for insurance coverage at each stage of the consignment period?
- How are transactions processed and when will the consignee pay for sold goods?
Invest in inventory management software
As stated above, managing consignment inventory can be tricky. It is therefore important to make sure that the adopted inventory management solution is up to the task or that your company has the time and funds to invest in capable software before considering a consignment agreement.
At the very least, installed inventory management systems need to be set up accordingly. However, if the solution in use lacks the functionality to accommodate tracking consigned items or distinguish item ownership, new inventory management software needs to be procured and implemented.
For example, MRPeasy can be set up to handle consignment inventory and regular inventory side by side. The built-in tracking and reporting features help make sure that all relevant data on the movement and sales of consignment stock is visible at all times. As for accounting, MRPeasy includes a standard accounting module and enhanced reporting tools, helping to make sure that the books stay in balance. The app also features built-in integrations with Xero and QuickBooks.
Also read our dedicated blog post on how to manage consignment inventory in MRPeasy as a consignee.
- Consignment inventory is stock that a retailer or other company holds, markets, and sells on behalf of the stock’s owner.
- The consignment agreement is agreed upon between the consignor – a supplier or manufacturer entrusting the goods, and the consignee – a retailer or distributor responsible for selling them.
- Unlike in wholesale, the ownership of the goods does not change when goods are handed over to the retailer – the goods belong to the consignor until a sale is made.
- Best practices for consignment inventory include ensuring that the selected products are suitable for consignment, finding the right business partner and forming a mutually beneficial agreement, being thorough with drafting the consignment contract, and making sure the adopted inventory management solution is up to the task.
- Managing consignment inventory can be tricky and often relies on intricate software such as a capable manufacturing ERP system.
Frequently Asked Questions
Do you include consignment in inventory?
Consignment stock is not part of a retailer’s (the consignee’s) regular inventory. This is because consignment items remain the property of the consignor until they are sold to end clients.
How do you account for consignment inventory?
Consignment inventory accounting differs from regular inventory management. Since the goods do not change ownership as they are moved to the consignee, consignment stock appears as inventory on the consignor’s side. For sales, the consignor records the sale amounts and removes the inventory with a debit to COGS. The consignor also makes a commission payment to the consignee upon receiving payment from the sale.
What is the difference between inventory and consignment?
The main difference between inventory and consignment is that inventory consists of all items that a company owns, whereas consignment comprises items that a company holds on behalf of another company or individual, per a consignment agreement.
What are consignment items?
Consignment items are stock, usually finished goods, that a manufacturer or an individual has given to a distributor or retailer to hold, market, and sell on their behalf.
What are the advantages of consignment inventory?
For the consignor, usually, the manufacturer, the chief advantages of using consignment inventory are cut costs from not having to market and sell the goods. For the consignee, usually a retailer, the main advantages include less financial risk from not having to buy the goods upfront and an expanded product selection to market.
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