What is Consignment Inventory: Pros, Cons & Management Tips

One of the biggest challenges for retailers is the price associated with inventory. Merchandise can sometimes be overstocked or languish on the retailer’s shelves for weeks without a single sale being made. This is when the stock investment becomes a financial loss, and the retailer must do something about it.

Nonetheless, the retailer has an alternative to minimize the risk of financial loss: consignment. Consignment is an arrangement in which goods are left in the possession of a third party authorized to sell them. The products or items in question are called consignment inventory.

1. What Is Consignment Inventory?

Simply put, consignment inventory is stock on hand with the retailer, also called consignee, but still owned by the supplier or consignor. Consignment inventory is held in warehouses solely for inventory owned by the supplier and intended to be sold by the retailer.

Let’s say a company has just launched a new line of beauty care products. As a retailer, you may negotiate with this company/supplier to increase the products’ exposure to your customers.

In other words, you will take the company’s beauty care products to sell in your store. Once in your store, you will increase the price of the items by 25- 40%, a suggested cost from the consignor. This extra margin is the profit you will make on each sale. If the products do not sell as expected, you must return the products to the company after a certain period agreed upon with the supplier. Depending on the contract negotiated with the supplier, the products’ shipping costs can be charged to the retailer or shared by both parties.

2. How Does Consignment Inventory Work?

A consignment inventory works similarly to how a traditional retail business operates. But instead of the retailer buying the stock from a supplier and then selling it at a price they choose, the retailer sells the stock at a higher price and pays the supplier a portion of the profits.

In this way, the retailer sells the products without fear that they will deteriorate or be rendered ineffective by a competitor. After all, they didn’t have to invest capital in purchasing the products. However, holding even consigned stock is not without costs. We will touch on this more in the following sections.

3. Who Uses Consignment Inventory and Why?

Consignment inventory is a business arrangement used by two leading players:

1. Consignors: These are manufacturers, wholesalers, or artists supplying the merchandise. They retain ownership of the goods until the retailer sells them.
2. Consignees: These are the retailers who sell the consigned goods to customers. They pay the consignor only for the items that are sold.

There are several reasons why both consignors and consignees might choose to use consignment inventory:

Benefits for Consignors (Suppliers):

• Reduced upfront costs: Consignors don’t have to pay for manufacturing, storage, or transportation of unsold items.
• Testing new markets or products: Consignment allows them to get their products in front of new customers without a significant investment. They can see how well the items sell before committing to a larger production run.
• Increased brand awareness: Consignors can gain greater brand recognition by having their products in more stores.

Benefits for Consignees (Retailers):

• Lower financial risk: Retailers don’t have to pay for inventory upfront to offer a wider variety of products without a huge investment. This is especially helpful for new or smaller retailers.
• Reduced storage needs: They only need to store the inventory that is selling.
• Potentially higher profit margins: The commission they charge on the consigned goods can be higher than the markup on traditionally purchased inventory.

Here are some specific examples of businesses that commonly use consignment inventory:

• Art galleries: Artists can consign their artwork to galleries to get exposure and potentially sell their work.
• Antique stores: Dealers may consign items to antique stores to reach a wider audience of collectors.
• Clothing boutiques: Boutiques might use consignment to offer a more comprehensive selection of designer apparel or seasonal trends without committing to buying a large stock of clothing merchandise.
• Event venues: Caterers or event planners may consign food and beverages to event venues.

Consignment inventory can be a win-win situation for suppliers and retailers when used strategically.

4. Vendor-Managed Inventory vs. Consignment Inventory

Vendor-managed inventory (VMI) and consignment inventory are closely related terms, but they differ.

Vendor-Managed Inventory

With VMI, the supplier manages and controls the inventory, determines how much stock the customer needs, and ensures that the supplier has the required items when depleted. This proactive approach allows for streamlined supply chains, often leading to reduced stockouts and improved efficiency.

Consignment Inventory

Conversely, consignment inventory involves the supplier delivering goods to the retailer’s location but retaining ownership until sold. This setup offers the retailer more flexibility in managing cash flow, reducing slow-moving inventory, and avoiding overstocking. This arrangement can foster more robust partnerships between suppliers and retailers, as both parties share the responsibility and benefits of inventory management.

5. The Advantages & Disadvantages Of Consignment Inventory For Retailers?

Pros of consignment stock for consignees

Consignees are retailers or companies that take on the responsibility of selling inventory on consignment on behalf of a manufacturer or supplier. This means that individuals, corporations, and businesses can be consignees. The consignment inventory model can benefit them in several ways:

• Broader selection of products 

In taking consignment stock, a retailer typically requests the product in bulk and places it in their store. This allows the retailer to choose from a wide variety of consignment products from their suppliers and select them based on their customer base, location, and market.

• Minimal financial risk

The main benefit of consignment inventory is that it reduces retailers’ financial risk. Since retailers don’t have to pay for products until sold, they don’t have to worry about tying up or losing capital on inventory costs. Plus, you don’t have to worry about disposing of excess inventory. If the retailer does not sell any products, they can return them to the supplier. 

• Reinforced relationships with suppliers

By agreeing to take on most of a product’s inventory, the retailer is taking on a relatively large financial risk. The more they market and promote consignment products, the more they build a relationship with their suppliers with the same goal. This is important because they are more likely to be loyal to their supplier.

Cons of consignment stock for consignees

• Higher carrying costs

Retailers may incur higher carrying costs for consigned inventory. This is because the consignor generally sets its own prices. The retailer must cover their own expenses, including labor and additional shipping or handling costs. Retailers may also charge a higher margin to sell the items at a higher price than the consignor suggests.

• More complex inventory management

One problem that consignment stores may need help with is inventory management. Consigned merchandise must be tracked separately from non-consigned items. Since consignment stores don’t incur upfront supply costs, tracking their margins and profits can be trickier. Not to mention that keeping goods in your store or warehouse carries risk, and you’ll have to pay for damaged items.

Retailers may also need to keep track of the consignor’s inventory and make timely payments. All of this can require additional time and resources. Speaking of resources, using a retail inventory management system is essential for better consignment inventory management. The point of sale software must have robust inventory management features. So, be mindful of the type of point of sale system you choose.

6. The Advantages & Disadvantages of Consignment Inventory for Consignors?

As mentioned earlier, consignors are manufacturers, wholesalers, or suppliers of goods. Like the consignee, the consignor also enjoys certain benefits of consignment inventory. These benefits include the following:

Pros of consignment stock for consignors

• Eliminating inventory holding costs

Carrying costs are the money and inventory costs a company spends when holding a certain amount. In short, it is the cost of storing, owning, or maintaining an inventory of goods. Since shippers/suppliers transfer ownership and do not have to hold the inventory on consignment, they can incur minimal or no holding costs. This gives them more money to spend on other business expenses.

• Product visibility

Consignment stocks allow suppliers to introduce their products to new audiences. Consignors can also use consignment inventory to gauge interest in their products before committing to stocking a large quantity.

When a retailer accepts consignment stock, they typically hold a large percentage of that stock. The consignor can use this opportunity to showcase smaller-scale products to the public while testing the demand for any product on consignment.

• Streamlined supply chain

A consignment inventory model’s essential benefits include reducing costs and eliminating inventory. However, it also means streamlining the supply chain. Consignment inventory can help manufacturers and distributors avoid the costs associated with storage. Creating a supply chain without excessive costs and space makes the consignment process more efficient.

• Strong relationships with retailers

As long as a retailer is willing to take on most of the inventory for a product, the consignor is taking on a relatively large risk. This means they are more likely to be loyal to their consignor. Knowing that a retailer’s success may depend on their supplier, a consignor must satisfy their retailer to ensure they do not intend to change consignors.

Cons of consignment stock for consignors

• High initial investment with no guarantee of sale

Consignment inventory can involve an upfront cost for packaging, shipping, and other costs associated with placing the inventory in the store. If the inventory does not sell, these costs will not be recouped and may prevent consignors from seeing a return on their investment.

• Revenue at risk

When consigning inventory to a retailer, the consignor may not receive full payment until after purchasing the inventory. Depending on the agreement’s payment terms, this can jeopardize the consignor’s revenue. Consignors may face a cash flow problem (especially those who are smaller or just starting out), so consigning inventory may not be the best option.

7. What Should a Consignment Stock Agreement Contain?

A consignment contract, or consignment agreement, is a legal document defining the terms of the agreement between the consignee and the consignor concerning the consigned goods. The details of your agreement will depend on your situation, but you generally want to cover the following items in the contract:

• Right to sell – The “right to sell” section formalizes the agreement. It should state that the consignor formally authorizes the consignee to display and sell items in their retail store.
• Time Limit—The time limit indicates the duration the items must be sold. They must be returned to the consignor if they are not sold by the specified date.
• Insurance – Describe the implications of purchasing insurance for the products. 
• Policies – Define the shipping and return policy
• Transactions – How will the transactions be processed?

8. How To Manage Consignment Inventory

Once you have signed your agreement and are ready to sell consigned products in your retail store, it is vital to have an inventory control strategy in place when selling consigned products. Below are some best practices for managing consignment inventory. 

• Learn more about your product

First and foremost, you must know what your product is as a retailer. Different customers prefer many different types of products. Knowing this will help you understand what styles and items are currently in demand and merchandize accordingly.

Knowing the type of products your customers want will depend on your available data. Therefore, having the right point of sale software is crucial. It’s also essential in a consignment model to know your product’s durability, quality, and market value before you make any sales.

• Do not consign too many products as a consignor

As a consignor/supplier, it is imperative to monitor and manage the supply of your consignment inventory. You must supply only what is needed and in the correct quantity.

It is best to have a comprehensive production plan to help you determine how much supply is needed to achieve this. This will help you avoid overstocking your warehouse and save you unnecessary financial burdens.

• Leverage inventory management software

The best solution to maintaining control over consignment inventory is to automate your accounting and inventory systems. Instead of using spreadsheets or pen and paper to track and manage your inventory, adopt cloud-based POS software that streamlines data entry, tracking, and reporting.

Regarding managing your sales and inventory, KORONA POS offers robust tools to help you sell and manage your products. KORONA POS retail system lets you know which items are selling best, how profitable they are, and which products are underperforming. Click below to get started with KORONA POS.