Understanding Consignment Inventory

In a consignment agreement there are two parties involved, the supplier and the retailer (customer). Consignment inventory is inventory that is in the possession of the retailer, but is still legally owned by the supplier. The inventory remains owned by the supplier until it is sold by the retailer. When this happens, the retailer is invoiced for the quantities they have sold and whatever inventory that remains unsold is still owned by the supplier.

The main reason why retailers would carry consignment inventory is they are not required to pay for the inventory until it is sold. This reduces their inventory financing costs, allowing them free up funds that can be used to invest into other areas of the business. The benefit to the retailer is they don't own the inventory, but have direct access to it when needed.

A major benefit to suppliers entering in a consignment agreement is securing long-term business, by sending the retailer a large volume of products. Once the retailer has received their shipment, they will be committed to remain the supplier's customer for at least the duration of the agreement, and that protects the supplier's interests against competitors.

The supplier may also want to get certain products out and in front of customers but the retailer is reluctant to purchase those products as they may not be profitable. To combat this problem, the supplier will offer their products on consignment, this results in reduced risk for the retailer as products that don't sell can usually be returned back to the supplier. It allows the supplier to conduct market testing on their products, where they can identify the profitable products and invest more capital into them. This is something the suppliers may not have been able to do if the retailer were required to purchase the products outright.

Even though the inventory is at the retailer's facility, the supplier will still incur holding costs. This includes the cost of financing the inventory, risk of obsolescence, damage, and theft. The longer the inventory remains unsold by the retailer, the more expensive that inventory becomes. Most companies use some form of debt to finance their inventory that accrues interest over time.

One of the biggest issues for suppliers when it comes to consignment inventory is the lack of visibility over their inventory. It is difficult to reconcile inventory when their inventory is at another location. They have to trust that the retailer is reporting the correct inventory amounts sold.

Undertaking a consignment inventory agreement does have its benefits for both parties. However, for the supplier, they will be taking on more risk due to the lack of visibility over their inventory, so it is important that they do their homework when negotiating the terms of the agreement with the retailer. The agreement should outline contingencies for obsolete and damaged inventory, as well as being able to inspect the inventory periodically. This will help mitigate some of the risks and costs associated with having your inventory stored at a third party's facility.

 

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