Consignment Inventory: What It Is, Pros and Cons
As a retailer, do you worry about tying up capital in stock that won’t sell, hence choking your cash flow? Or maybe you are a supplier and you are about to test a new market, but want to test the market first before diving in head first? Consignment inventory is the way to go! In consignment inventory, the retailer pays the supplier only after a sale is made to the customer.
This arrangement serves as both a business model and a supply chain strategy, enabling manufacturers, suppliers, and retailers to optimize inventory management and improve supply chain efficiency.
Consignment inventory management, a strategic arrangement between suppliers and retailers, allows the latter to stock goods without immediate purchase, paying only when a sale occurs.
This model can significantly reduce upfront costs and risks for retailers, especially in industries like apparel where trends frequently change. It is a cost-effective approach that provides less financial risk for retailers by minimizing upfront investments and sharing the risk with suppliers.
Consignment inventory works by having suppliers provide goods to retailers without transferring ownership until the point of sale, which is typically governed by contract terms that outline profit sharing and risk reduction for the retailer.
In this post, we will spotlight the concept of consignment inventory to help you develop a deeper understanding of it and also share tips to make the most of it for your business.
What is Consignment Inventory?
Otherwise known as consignment stock, consignment inventory refers to merchandise that is sent to a retailer by a supplier but remains the property of the supplier until it is sold.
This arrangement, often called a consignment deal, is an agreement with specific terms regarding sales, unsold items, and commission. It’s a collaborative strategy where both the retailer and the supplier, as business partners, share the risk and rewards associated with selling the products.
Consignment inventory helps retailers align stock with actual customer demand, reducing the risk of unsold goods. Unsold inventory can be returned to the supplier without penalty for the retailer, minimizing financial risk. Additionally, consignment inventory allows suppliers to reach new customers and test new products in different markets.
How Does Consignment Inventory Work?
The process of consignment inventory typically follows these steps:
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Establishing the Partnership:
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Supplier and Retailer Agreement: The first step involves a supplier and a retailer entering into a consignment agreement. This agreement outlines critical details such as the range and quantity of products, consignment period, pricing strategy, and the terms for payment and unsold inventory.
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Stocking the Inventory:
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Delivery to Retailer: Based on the agreement, the supplier delivers the consigned products to the retailer. Despite the physical transfer, the supplier retains ownership of the merchandise until it is sold.
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Retail Display: The retailer incorporates these consigned goods into their inventory, displaying them in-store or listing them online alongside products they own outright.
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Selling the Merchandise:
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Customer Purchase: Customers shop and purchase items as they typically would. The key difference in consignment selling is that the retailer does not pay the supplier upfront for these items. Instead, the payment is deferred until the sale occurs.
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Reconciliation and Payment:
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Sales Reporting: Regular intervals are set within the agreement for the retailer to report sales of consigned goods to the supplier. This process is crucial for maintaining transparency and trust between both parties.
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Payment for Sold Items: After reporting sales, the retailer pays the supplier for the merchandise sold during the period, as per the pre-determined wholesale price or percentage of the sale price agreed upon.
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Return of Unsold Goods: Depending on the agreement, unsold consigned goods may be returned to the supplier after a certain period or subjected to discounted selling to clear the inventory.
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Example of Consignment Inventory
Let’s say you produce stylish winter jackets, but lack the sales channel to find customers. So you find a clothing store willing to carry your products and sell them together with theirs.
After some deliberations with the store owner, you both agree to start off with 50 pieces of jackets to be sold over 3 months. By the time the sales period ends, the store has sold 35 pieces, handing the rest to you. Everybody gets their cut, you shake hands – end of business.
This is consignment inventory at play here. You consigned 50 units of stock to a third-party store that handled storage and order fulfillment. At the end of the agreed timeline, the store hands over the unsold stock back to you.
What is Consignment Agreement?
A consignment agreement is the foundation of any successful consignment arrangement, serving as a formal contract between the supplier (consignor) and the retailer (consignee). This agreement clearly outlines the terms and conditions for managing consignment inventory, ensuring both parties understand their roles and responsibilities.
Key elements of a consignment agreement include the ownership of the inventory, which remains with the supplier until a sale occurs, as well as payment terms, consignment period, pricing, commission rates, and shipping costs. The agreement should also specify how unsold products will be handled at the end of the consignment period.
Having a detailed consignment agreement is essential for effective consignment inventory management. It helps prevent misunderstandings, streamlines the process of managing consignment inventory, and supports a smooth supply chain strategy. Leveraging inventory management software can further enhance the process by tracking inventory movements, automating reporting, and ensuring both parties have real-time visibility into stock levels and sales. By establishing a comprehensive consignment agreement and utilizing the right tools, businesses can optimize their consignment arrangement and minimize potential risks associated with unsold products or unclear responsibilities.
The Pros And Cons of Consignment Inventory
Consignment sales can benefit both the retailer and supplier and at the same time be disadvantageous to them. Here are some of the known pros and cons:
Pros of Consignment Inventory for Suppliers
Increased Market Exposure: Consignment inventory allows suppliers to place their products in more retail outlets, increasing brand visibility and customer access.
Relationship Building: It opens doors to building relationships with a variety of retailers, including high-profile or niche stores that might have been inaccessible due to traditional purchasing risks.
Lower Entry Barriers: Consignment reduces the upfront financial commitment required from retailers, making it easier for new or smaller suppliers to enter the market and compete alongside established brands.
Real-Time Market Feedback: Suppliers can gain immediate insights into consumer preferences and product performance, enabling them to adjust production and marketing strategies more swiftly and effectively.
Inventory Flexibility: With consignment, suppliers maintain ownership of their inventory, allowing them to react to market changes by rotating stock between different retailers or pulling underperforming products for reallocation or enhancement.
Cons of Consignment Inventory for Suppliers
Delayed Payments: Unlike traditional wholesale transactions, payments in a consignment setup are deferred until after sales occur, which can strain cash flow, especially for suppliers dependent on quick payment cycles.
Risk of Unsold Inventory: Suppliers bear the brunt of unsold inventory risks. If products don’t sell, suppliers must either take back the stock, which can incur additional costs, or negotiate with retailers for discounted sell-offs, potentially eroding profit margins.
Complex Inventory Management: Managing consignment inventory requires meticulous tracking and coordination with multiple retailers to monitor stock levels, sales velocity, and replenishment needs, which can complicate logistics and inventory management.
Potential for Brand Dilution: Having products in too many outlets or in stores that don’t align with the brand’s image can dilute brand identity and value, especially if inventory management leads to stock buildup or frequent discounting.
Reliance on Retailer Performance: A product’s success becomes closely tied to the retailer’s ability to sell it. Ineffective marketing, poor store traffic, or competitive pressures at the retail level can adversely affect sales, over which suppliers have limited control.
Pros of Consignment Inventory for Retailers
- No Need to Purchase Inventory Upfront: One of the most significant benefits is the minimized financial risk. Retailers can stock a wide variety of goods without the hefty initial outlay typically required to purchase inventory outright. With consignment inventory, retailers avoid upfront supply costs, which further reduces their financial burden and helps with profit tracking. This can be particularly advantageous for small or emerging retailers with limited capital, as they don’t own the consigned inventory. In addition, this arrangement can help minimise shipping costs.
- Enhanced Product Variety: Consigning inventory to retailers allows them to offer a broader range of products, appealing to a wider customer base without the risk of overinvesting in untested merchandise. Consigned inventory is managed separately from owned inventory, making it easier for retailers to track and refresh their product mix more frequently, keeping the store interesting and dynamic for repeat customers.
- Improved Cash Flow: Paying for products only after they sell improves cash flow, a critical aspect of retail management. This arrangement allows retailers to allocate resources more efficiently and invest in other areas of their business.
- Market Responsiveness: With the ability to test new products with minimal financial commitment, retailers can quickly respond to market trends and consumer preferences, staying ahead in the competitive retail landscape.
- Storage and Insurance Costs: Retailers are responsible for the costs of storing and insuring consigned goods while they are in their possession, which can add to their operational expenses.
Cons of Consignment Inventory for Retailers
Lower Profit Margins: While consignment reduces upfront costs, it often comes with higher costs per item compared to bulk purchasing, which can lead to lower profit margins on consigned goods.
Complex Inventory Management: Managing inventory in a consignment arrangement requires meticulous record-keeping and coordination with suppliers. Retailers must track which items are on consignment, monitor sales, and reconcile payments for sold goods, adding complexity to inventory management.
Dependence on Suppliers: Retailers might face challenges with stock replenishment and consistency, as they are somewhat at the mercy of suppliers’ inventory levels and delivery timelines. This can lead to stock shortages or delays, potentially impacting sales and customer satisfaction.
Contractual Obligations and Disputes: The consignment model requires clear, comprehensive agreements between retailers and suppliers to outline the terms of the consignment, including payment schedules, unsold inventory handling, and other logistics. Misunderstandings or disputes over these agreements can strain relationships and affect business operations.
Consignment Stock vs. Vendor Managed Inventory: Understanding the Key Differences
The line between consignment and vendor-managed inventory (VMI) can sometimes get blurry. For the former, the retailer sells stock from an inventory owned by the supplier. For the latter, the inventory is owned by the retailer, even though it is managed and maintained by the supplier.
Key Differences:
Ownership and Risk: Consignment stock keeps ownership (and risk) of the inventory with suppliers until items are sold. In contrast, VMI often involves retailers owning the inventory, but suppliers manage it, balancing inventory levels with demand.
Control: Consignment gives retailers more control over which products to stock and sell, while VMI places more control in the hands of suppliers to manage inventory levels based on agreed parameters.
Objective: Both models aim to optimize inventory levels and reduce costs, but consignment focuses on reducing retailer risk, and VMI emphasizes efficiency and responsiveness in the supply chain.
Relationship Dynamics: Consignment stock can be seen as more retailer-centric, with suppliers adapting to retailer needs. VMI, however, requires a deeper partnership, with shared access to sales data and more collaborative planning.
Carrying Costs in Consignment Inventory
Carrying costs represent the expenses associated with holding and managing inventory, such as storage, insurance, and handling fees.
In a consignment arrangement, the supplier typically absorbs the carrying costs for unsold inventory, since ownership remains with them until the retailer sells the goods. However, retailers may still face some carrying costs related to storing and displaying consigned inventory in their retail space.
To keep these expenses in check, both suppliers and retailers can adopt efficient inventory management practices, including the use of automatic replenishment tools, just-in-time delivery, and regular inventory audits. By minimizing carrying costs, businesses can improve profitability and maintain a competitive edge in their consignment inventory operations.
Common Challenges in Consignment Inventory
Managing consignment inventory comes with its own set of challenges, from tracking inventory across multiple sales channels to handling unsold inventory and maintaining strong business partnerships.
Accurate inventory management is crucial to avoid discrepancies and ensure that both suppliers and retailers have a clear view of consigned stock levels. Cash flow can also be a concern, especially if payments are delayed or unsold inventory accumulates.
Additionally, carrying costs and the complexity of managing consignment inventory across different locations can strain resources. To overcome these hurdles, businesses should implement best practices such as regular inventory audits, clear and consistent communication, and the use of advanced inventory management systems.
By addressing these challenges head-on, companies can optimize their consignment inventory management, reduce risk, and achieve a sustainable competitive advantage.
Best Practices for Managing Consignment Inventory
1. Forge Strong Agreements
Ensure the consignment stock agreement is comprehensive, covering all possible scenarios, including handling of unsold inventory, payment terms, and responsibilities of each party. This will go a long way in helping the retailer manage consignment inventory effectively.
2. Implement Robust Inventory Management
Utilize inventory management systems that can segregate consignment stock from purchased inventory, ensuring accurate tracking and reporting. Also, Schedule frequent physical counts and reconciliations to ensure inventory accuracy, identify discrepancies early, and adjust records accordingly.
3. Establish Transparent Communication
Adopt tools and platforms that facilitate real-time sharing of sales data, inventory levels, and consumer feedback between suppliers and retailers.
Hold periodic meetings to discuss inventory performance, trends, and adjustments needed to optimize sales and reduce stock holding.
4. Optimize Product Selection
Select consignment products based on current market trends, consumer preferences, and sales data to ensure the inventory remains relevant and attractive to customers.
Maintain a diverse product mix to cater to various customer segments while monitoring performance to identify and focus on high-demand items.
5. Strategize Pricing and Promotions
Work collaboratively to set competitive prices that attract customers while ensuring profitability for both parties.
Plan and execute joint marketing and promotional strategies to boost product visibility and sales, leveraging both parties’ networks and platforms.
6. Manage the Retail Space Effectively
Give consignment products prominent display space to maximize visibility and sales potential. Regularly refresh product displays based on sales performance, seasonal changes, and marketing campaigns to keep the retail environment engaging.
7. Build a Partnership Mindset
Approach the consignment relationship with a partnership mindset, understanding that the success of one party benefits the other. Encourage open dialogue for feedback on product quality, customer preferences, and potential improvements to foster continuous improvement and adaptation.
Common Challenges in Consignment Inventory
Managing consigned inventory comes with its own set of challenges, from tracking inventory across multiple locations to handling unsold inventory and returns. Businesses often struggle with maintaining accurate records, especially when managing consignment inventory at scale or across different sales channels. Other common issues include reconciling sales data, managing the return of unsold inventory, and ensuring timely payments.
To overcome these challenges, it’s important to implement best practices such as using advanced inventory management software, establishing clear and detailed consignment agreements, and conducting regular inventory audits. Monitoring inventory levels closely and maintaining open communication between all parties involved can help prevent discrepancies and streamline the consignment inventory management process. By addressing these common challenges proactively, businesses can optimize their supply chain, reduce the risk of unsold inventory, and ensure the success of their consignment inventory program.
Conclusion
Consignment inventory is a flexible approach that can help apparel retailers and suppliers mitigate risks, test the market, and manage cash flow more effectively. By understanding the benefits and challenges, and implementing best practices, businesses can leverage consignment inventory to navigate the ever-changing apparel landscape successfully.
Consignment Inventory FAQs
Consignment stock refers to goods that are stored at a buyer’s location but remain the property of the supplier until they are sold. This arrangement benefits both parties: the supplier maintains ownership and reduces the risk of unsold inventory, while the buyer has the convenience of readily available stock without the upfront cost.
The easiest way to track consignment inventory is to use an inventory management software.
Selling on consignment offers numerous advantages for both suppliers and retailers, making it an attractive business model in various industries. Here are some key benefits:
Reduced Risk for Retailers: Retailers can stock a variety of products without the upfront cost, reducing financial risk. They only pay for the items once they are sold, which helps manage cash flow more effectively.
Increased Product Variety: Consignment allows retailers to offer a broader range of products to their customers. This variety can attract more customers and boost sales without the need for large investments in inventory.
Better Inventory Management: With consignment, unsold products can be returned to the supplier, minimizing overstock and reducing storage costs. Retailers can maintain optimal stock levels without worrying about excess inventory.
- Implement Robust Inventory Management Software
- Set Clear Terms and Agreements
- Regular Audits and Reconciliation
