What is consigned inventory? Compare pros, cons, and understand best practices

When most people think of consignment, they think of consignment shops. These are stores where sellers offer their products through a third-party intermediary. In this case, it’s a store owner who will take a cut of the sale amount in return for storing and selling the item.

What most people don’t realize is that consignment can apply to larger inventories and companies as well. Could your business benefit from a consignment arrangement with a third-party seller?

We’ll break down the pros, cons, and best practices for this approach to selling in today’s article.

What is consigned inventory?

Consigned inventory is different than the traditional inventory in your business’s warehouse or stockroom.

When you take possession of traditional inventory, you’ve already paid for those items and make that cost back (hopefully) when you sell the items to customers.

With consigned inventory, this works differently.

In this scenario, the producer of the original product offers the consigned inventory to a retailer. The retailer houses the item and attempts to sell it to a customer (or, in some instances, uses the item as part of the manufacturing or some other process). The producer retains ownership of the item until the retailer uses or sells it. The retailer does not pay the producer of the item until it is sold or used.

The benefit of this scenario is that it shifts the carrying costs for the goods or materials away from the retailer.

The producer carries the cost of the inventory until it is sold. In return, they can store the inventory with the retailer and have access to a retailer’s customer base.

In a perfect world, this is a win-win scenario.

How does consignment work?

As you can see in the previous section, consignment inventory requires at least two party’s involvement to function. With multiple parties, businesses, or individuals involved, things can get complicated. However, the core idea of how consignment works is simple.

The producer makes a product they need a retailer to sell. They approach a retailer, who may not want or be able to take on a huge amount of the producer’s inventory.

They work out a consignment deal where they agree to terms. Cost, returns, and other fees should be negotiated upfront as part of the initial consignment deal.

Here’s an example.

A medical supply company carries some costly durable medical equipment.

Rather than pay for this inventory on delivery, they take it as consignment instead and only pay the purchase price to the medical equipment company when sold. The amount the retailer earns is dependent on what they sell the item for, but the price the consignees receive per product sold is usually set in the initial contract.

The benefit here works for both parties. The medical supply company couldn’t afford to spend tens or hundreds of thousands of dollars on expensive inventory that might sit in their warehouse for years.

With consignment inventory, they have inventory on-hand, pay only when they make a sale, and return items if they don’t sell.

The medical equipment company benefits by not having to store items in a warehouse (the retailer stores it for them) and doesn’t have to sell their products to a customer. This means they can save on sales and marketing.

Typical models for consignment inventory

Individual parties can structure their consignment deals in any way they choose. Still, two basic concepts provide the framework for these types of agreements: ownership models and tracking models. Let’s talk about them.

Ownership models

In this style of consignment selling, payment for the items breaks down in three different ways:

Real-Time

Here, the payment for the consigned inventory is made when the product is sold. Until that point, money does not change hands.

Periodic

In this set-up, payments are made at mutually agreed upon periodic intervals, regardless of whether the consigned inventory has sold or not.

Order to order

In this approach, inventory is taken on consignment, and no payments on that order are made until the next order is placed. This is particularly useful if you’re taking manufacturing materials on consignment. You won’t pay for those materials until you’ve used them and ordered the next batch.

Tracking models

This approach focuses on where and how consignment inventory is stored and tracked.

Transfer

In this first method, the consigned inventory moves into the seller’s warehouse, physical location, or distribution center.

Accounting

Here, the inventory stays in a set location and is only tracked when it’s sold to a customer.

Quantities

In this last method, consigned items are tracked as linked to the original consignment arrangement.

As mentioned earlier, it’s possible to create your own unique consignment approaches based on the parties’ needs.

The thing to remember is that consigner takes on the bulk of the risk in the consigned inventory set-up. As such, consigners need to lay out the rules and parameters of a consignment deal before any inventory changes hands.

When does using consignment inventory make sense?

At this point, you may be wondering if consigning inventory is the right approach for your business. There’s no one size fits all answer, but here are some things to consider.

For suppliers

If you’re a supplier, here are a few situations where using consigned inventory can benefit your business. 

If you want to increase product visibility

A consignment deal with a new or bigger partner could help you reach new markets if distributing your product through traditional channels isn’t getting you the kind of visibility you want.

If you want to build new partnerships

To expand your reach, consignment inventory can be a lucrative way to attract new business partners. The consignee can help market and promote your products with reduced risk while building new partnerships that can benefit your business in both the long and short term.

If you want to reduce inventory costs

One of the great things about consignment inventory is that it can offset your inventory costs. 

If you’re warehousing huge amounts of product, by consigning it to retail partners, you can let them handle the expense of storing these items until they sell. Consignment allows you to offload some of the cost of housing your inventory to your partners.

If you want insights into sales trends

Finally, consignment inventory could benefit you as a supplier if you’re interested in seeing how sales of your products trend.

By monitoring sales data from your consignment partners, you’ll gain a deeper understanding of how quickly your product moves, learn what kind of marketing helps your products sell, and have a better idea of what kinds of products to focus on for different market segments.

For retailers

If you’re a retailer looking to achieve the following, consignment inventory could be the solution for you.

Increase the size of your product line

There’s a fine line between having so many products that you lose your identity and too few products to appeal to a large enough customer base.

With consignment inventory, you can experiment with product lines without the financial entanglement of spending lots of money to test them out.

You’ll be able to offer your customers more products with consignment inventory, with significantly less risk for your business.

If you only want to pay for sold goods

Building on the previous point, consignment inventory allows retailers to take on products and only pay for them when they sell.

This can be a huge boon to businesses with tight margins, as it eliminates a large amount of financial risk.

If you don’t want to manage restocks

Finally, if you’d like to put your inventory management into someone else’s hands, consignment inventory can help you do that.

In most instances, the consigner will be responsible for knowing your stock levels and managing the restocks of products when you run low. This frees you up to focus on other aspects of your business.

Pros and cons of consignment inventory

In this section, we’ll break down the pros and cons of consignment inventory so you can make an informed decision about whether or not this approach is right for your business. 

Pros for consigners

As with the previous section, the pros and cons vary depending on whether you’re the consigner or the consignee. First, we’ll tackle the consigners.

New markets

If you’re looking to break into new markets, consigning inventory is a great way to do it without building new retail infrastructure or expanding your current business.

By consigning inventory, you can get your products into the hands of businesses that already have the customers you covet. 

Reduced carrying costs

By allowing retailers to warehouse your products on consignment, you can reduce the cost of your warehousing operations significantly.

Direct shipping to retailers

By having inventory shipped directly to retailers, consigners can simplify their supply chain, reduce labor expenses, and get their products onto store shelves faster.

Cons for consigners 

Cashflow fluctuations

Depending on the payment arrangement, vendors may be waiting to receive payment for their goods or receive less money than expected in each accounting period, depending on the consignee’s sales.

Increased costs on unsold items

Since the consigner still owns the inventory until sold, it still figures into their accounting and costs. The longer items sit unsold, the more dramatic the impact on the bottom line can be.

Pros for consignees

Minimal risk

Since you’re only responsible for paying for products you sell and can potentially return unsold consignment inventory, consignment can be a great way to test new products and try to reach new markets with minimal risk for your business.

Reduced cost of ownership

Because you don’t own the actual inventory, the consignee can lower holding costs significantly.

Better cashflow

Because the retailer isn’t paying carrying costs, their cash flow situation is often better than if they owned the inventory outright. This improved cash flow can open up other opportunities companies might have otherwise missed.

Cons for consignees

Risk of damaged inventory

Remember the old saying, “if you break it, you buy it?”

Well, that applies with consignment inventory. The longer your business holds consignment products, the more likely it is to get damaged. Damaged inventory has to be paid for, usually out of your pocket.

Higher risk of inventory errors

While your consignment products don’t appear to be any different than your traditional merchandise, the way they’re managed in your inventory counts isn’t the same.

This can create confusion when conducting inventories and is something you’ll need to plan for if you get into the consignment inventory game.

Best practices for consignment inventory

The easiest way to avoid the cons of consignment inventory is by utilizing best practices.

Create a solid contract

This point cannot be stressed enough. You must build a solid contract for your consignment inventory before shipping off or receiving product.

Both parties should agree to terms. Cover payment schedules, supply replenishment, terms for damaged inventory, reporting, and all the other key components.

You’re entering into a collaborative relationship, so clarity matters. Cover all the details in the contract before you start. You’ll save yourself headaches down the road.

Use the right technology

In the last section, we touched upon the fact that managing consignment inventory is different than managing your traditional stock. Many companies fail to recognize this and create problems for themselves.

Avoid this issue by choosing inventory management software that can help you manage your consignment inventory. Trust us; this software will make your consignment inventory project much more manageable.

Collaboration

Remember that consignment inventory is a collaborative process. Both companies should work together because it’s in everyone’s best interest that the products on consignment sell.

Consigners, this means helping retailers better understand your products so they can sell them more effectively.

Consignees should also make sure they’re reaching out to the suppliers whenever questions or issues arise. Part of the beauty of consignment inventory is that you’re not shouldering the burden alone.

Share information and strategy with your partner.

Sales channels

The simple point here is that you should always have more than one sales channel option no matter which side of the consignment inventory equation you’re on.

Multiple sales channels minimize risk if any one consignment deal doesn’t work out.

As the old saying goes, don’t put all of your eggs in one basket.

Benefits of using Inventory Management Software for consignment inventory

Finally, here are a few words about how inventory management software like Linnworks or SkuVault Core can make your consignment inventory initiative easier to manage.

Choosing the right IMS can make a world of difference when it comes to tracking consignment inventory. The old pen and paper approach or the Excel spreadsheet can work, but it’s cumbersome, slow, and prone to errors.

Instead, modern inventory management software can make consignment inventory much easier to track.

Here are a few key features to look for when shopping for an IMS for consignment inventory:

• Track inventory sent to consignees (or received from consigner)
• Track replenishment needs, so stock-outs don’t occur
• Track consignor inventory levels so they can supply consignees
• Track location and sales of consigned stock

Not all inventory software can handle these tasks, so it’s important to schedule demos, ask questions, and understand the unique challenges you’ll face with this type of inventory management.

The good news is, we’re here to help.

Final thoughts

Consignment inventory provides many benefits for companies looking to expand their markets, grow product lines, and lower their carrying costs.

It’s not without challenges, but with an understanding of the basics, implementation of best practices, and good inventory management software, your business can seamlessly transition into this area.

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