Consignment Inventory: How It Works, Pros, and Cons
May 25, 2023
Inventory is an essential function in retail operations, but it has its fair share of risks. Retailers purchase and stock goods hoping to sell them at a profit before they expire. But this does not always happen. They may sometimes overstock merchandise, or it may remain on their store shelves for months collecting dust with no sales in sight.
In these cases, the investment made in the inventory becomes a loss for retailers. To avoid losing money, retailers can switch to consignment inventory. Different from traditional inventory, a consignment inventory model offers many benefits to consignors and consignees.
Here, we dive into this supply chain approach, how it works, its pros, and cons, and how to effectively manage it.
What Is Consignment Inventory?
Consignment inventory is a business model in which consignors supply merchandise that consignees sell to consumers. Consignors include manufacturers, wholesalers, or vendors while consignees are retailers or stockists.
Unlike the traditional inventory model where consignors sell goods to consignees, consignors own the goods in this model. Consignees pay for the goods only after they are sold.
What Is an Example of a Consignment Inventory?
To give you an example of consignment stock, a seller or a stockist may enter into a consignment inventory agreement with a soap brand and sell its soaps in-store. The seller will only have to pay for the products that are sold. Any unsold goods are returned to the soap manufacturer.
How Does Consignment Inventory Work?
Under the consignment inventory strategy, suppliers hand over their products to retailers but retain ownership of the goods. So, they do not earn any profit until retailers sell the stock to their customers.
Retailers pay suppliers only after selling the goods. They earn commissions based on percentages, say, about 20% to 60% of the sale price. If retailers have any unsold goods in stock that they cannot sell, they can return them to suppliers without incurring any risk.
This supply chain model is a cost-efficient way for consignees to stock products. It also allows manufacturers and brands to increase brand awareness and sales without having to increase their budgets.
Below, we go through the benefits and drawbacks of the consignment inventory model in detail.
What Are Its Advantages and Disadvantages for Consignors and Consignees?
Adopting the consignment inventory model the right way creates a win-win situation for consignors and consignees. But this business approach comes with a few disadvantages too. Let’s delve into its pros and cons for both parties:
Benefits for Consignors
Here are the advantages of the consignment inventory approach for consignors:
Higher Product Visibility
Adopting the consignment stock approach enables manufacturers and brands, especially start-ups, to get their merchandise into different retail stores. This allows them to sell through multiple retailers and increase their product visibility.
This boost in reach and exposure helps them make their goods available to a bigger audience while growing their businesses. Expanding the distribution of products without the need to establish retail locations is a huge plus for manufacturers and wholesalers.
Ability to Test New Offerings and Understand Market Demand
Consignors can use the consignment stock strategy to stock their newly launched products with retailers and gauge their customers’ reactions and demand. This market testing helps consignors get valuable customer feedback and insights on their products’ performance and success.
Ultimately, it enables them to launch more successful products and tweak their products to meet customers’ needs in case the test product failed.
Drawbacks for Consignors
Here are the disadvantages of the consignment inventory strategy for consignors:
Higher Upfront Costs
Consignment stock involves high initial costs that consignors need to pay toward packaging, shipping, distribution, and so on. If retailers can’t sell the goods, consignors cannot recover these costs and may lose their investment.
Potential Loss of Revenue
Consignors may not get paid in full for the inventory that they consign to retailers until after customers buy it. Depending on the payment terms of the consignment agreement, consignors will have to deal with risks in revenue. There is also no guarantee of timely payments from retailers.
This can lead to a short supply of money in the hands of consignors, especially those that are starting out in business. In such cases, this supply chain approach is a poor option.
Advantages for Consignees
Consignees also enjoy many benefits from the consignment stock approach such as:
Decreased Financial Risk
The consignment stock strategy greatly reduces retailers’ financial burden and risks. They do not need to buy goods upfront or pay for them before they make a sale. It lessens the financial risk of investing in unsold goods and creates a safety net for cash-strapped retailers.
Takes Up Less Space
The consignment stock strategy prevents retailers from having to make significant allowances for large quantities of inventory. This helps them save a lot of space, especially for retailers with limited inventory space.
Consignment items will still occupy some room on shelves and in the back of stores. But they won’t take up as much inventory space since sellers don’t need to order large numbers to take advantage of volume discounts. Also, unsold items can return to the consignors’ warehouses.
This helps retailers optimize the available space in their stores without having to shell out money to buy more space, resulting in significant cost savings.
Increased Sales Potential
Consignment stock has a positive impact on sales. It allows retailers to showcase new and exciting merchandise, keep up with trends, attract more customers, and boost revenue. Displaying interesting and trending products from different manufacturers and brands helps retailers offer more variety while increasing customer engagement and loyalty.
Disadvantages for Consignees
Here are a few drawbacks of the consignment stock model for consignees:
Greater Carrying Costs
Retailers often incur higher carrying costs under the consignment stock model. They are usually responsible for transporting stock from consignors’ warehouses to their stores. Also, the more the inventory, the more carrying costs retailers have to bear to keep the items on their shelves.
Moreover, retailers have to cover other costs like additional handling, storage, maintenance, and shipping. Retailers also need to set higher markups if they want to sell goods at higher prices than those suggested by consignors to earn better margins.
Potential Inventory Management Logistics Issues
Managing consignment stock involves tricky logistics, as selling under this model creates a few logistical challenges for retailers. Retailers and consignors may disagree over the stock quantity, or goods may not reach stores on time.
Retailers also have to track consignors’ stock, leading to a need for additional time and resources.
How To Manage Consignment Inventory
Here are our top five tips to help you successfully manage consignment inventory:
1. Build Strong Business Relationships
Under the consignment model, strong vendor or retailer relationships are fundamental for smooth inventory control. It’s thus important to enter into consignment agreements with reliable suppliers or retailers whose business values match yours.
If you don’t have a solid base of suppliers or retailers, you can easily find new and trustworthy suppliers and stockists at trade shows or actively look for partners. However, once you find them, make sure to vet them thoroughly before drawing up a contract.
2. Create Mutually Beneficial Agreements
Once you find reliable vendors for retailers, draw up and finalize a consignment agreement that benefits both parties. Here are a few details you must cover:
- Clearly stated shipping policy, including timeline and costs
- A mutually profitable sale commission rate
- A detailed return policy for unsold goods, including the deadline when goods must be sold to consumers or returned to consignors
- Location of goods
Incorporating the above information will help you avoid miscommunication and prevent business losses.
3. Leverage Robust Stock Management Software and Other Digital Tools
Digitizing your inventory and accounting systems is the best way to manage consignment stock. Use a cloud-based stock management software to streamline data entry, inventory tracking, accounting, reporting, and forecasting.
It will help you easily track your consignment goods and learn about their current and estimated sell-through rates. It will also help you boost sales and profit margins while staying on top of your inventory.
Also, if your business model uses a hybrid of consigned and non-consigned inventory, make sure to track them separately. Setting up different outlets for these inventory types eases tracking and management so you avoid logistical issues.
Additional Tips for Consignors
Avoid Oversupplying Stock to Consignees
If you’re a consignor, track and manage your supply of consignment stock to avoid excessive supply and unnecessary financial risks. Send merchandise to consignees only when they need it and in the quantities they need.
A detailed production plan will help you decide the optimal quantity of stocks and the frequency of restocking you need to follow.
Additional Tips for Consignees
Know Your Merchandise
As a retailer, you must know your products inside and out. Customers have different needs, tastes, and preferences so their choices may also differ vastly. Understanding market demand and trends will guide you in stocking the latest and most profitable products and styles.
Also, know your consignment stock’s quality, durability, and marketability before you start selling to avoid obsolescence and ensure greater success.
Unlike traditional inventory models, consignment inventory is a cost-efficient stock management solution for consignors and consignees. It helps them stay profitable and minimize business risks and losses.
But it’s important to have the right tools and practices in place to overcome the challenges that come with this model. Without adopting the necessary tools and practices, you may not be able to take full advantage of all the benefits that consignment inventory can provide.
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