Consignment inventory offers are loaded with risks
A vendor rep presents you with some good-looking merchandise. You are somewhat apprehensive about adding his products to your line, but you sign on when the salesman says, “We’ll put the goods in on consignment. You won’t have to pay for them until they’re sold, and if they don’t sell, we’ll take back the inventory.”
What’s wrong with this deal? Everything! Consignment inventory offers are loaded with risks and hidden costs. Let’s take a look at these pitfalls.
Inventory, paid for or not, has carrying costs such as opportunity costs, insurance, shrinkage, obsolescence, handling, and income taxes on paper profits not yet realized. Moreover, excess or slow-moving inventory, consignment or otherwise, lowers turns, lowers margins, and increases costs.
All merchandise is in competition with other inventory in your store. It competes for shelf space, consumer spendable dollars, and sales staff attention. It also reduces purchasing opportunities: If you already own this, you can’t buy that.
Lack of Urgency
When buyers purchase inventory on a net 30-day basis, they tend to pay close attention to rates of sale and weeks of supply. Consignment purchases, though, tend to get far less attention because there hasn’t been a dollar investment made, so often the merchandising may be sub-par and markdowns don’t get taken on a timely basis. As a result, sale rates decrease, the inventory gets shopworn, and consumers get bored with the same old items.
Better Buying Decisions
A better course of action is to make purchasing decisions based on the merits of the inventory, the vendor, and the buying terms. Ask yourself if it will sell, in what quantity, over what period of time, and will consumers find it attractive. In other words, does this inventory make sense in the context of the total merchandise mix?
The prudent buyer makes his purchase decision in the context of return on invested inventory—gross margin return on inventory, or GMROI. How many gross margin dollars will be generated for every dollar invested? When this number is more than $1.50 and moving closer to $2.00, then the inventory is producing sales, margins, and turn rates worthy of the invested time, space, and dollars.
Let’s look at another facet of this. As I just explained, consignment purchases dilute the attention that should be given to that inventory. In turn, such purchases lessen the retailer’s ability to make vendor or product changes quickly in response to changing market conditions or purchase opportunities. Then, if products do not sell well after six months of consuming shelf space, you face the inconvenience of packing up the inventory and shipping it back to the vendor (and perhaps incurring return shipping costs in the process). Now add to that what invariably follows with consignment inventory returns: the hassles of inventory discrepancies, charges for missing or damaged items, and a slew of back-and-forth vendor correspondence taking up your time.
Try Before You Buy?
Are there any circumstances under which a consignment purchase is warranted? As a general rule, I would say no. If you lack belief in the sales potential of the products in question, then you should not make the purchase. When you pay for the goods is irrelevant. It is far more profitable to make a purchase decision based on sound buying principles versus a decision based upon when product payment occurs.
If, however, you feel strongly about a vendor offer involving consignment arrangements, then at a minimum insist on a trial period not to exceed 90 days and a sell-through percentage of 70 percent. This type of stress test keeps the focus appropriately on sales.