A vendor rep presents you with some good looking merchandise. You are somewhat apprehensive about adding his products, but you sign on when the salesman suggests, “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.”
Sounds like a good deal. You have no investment in the inventory and pay only if and when it’s sold, so it appears there’s no danger, all upside.
What’s wrong with this deal? Everything! Consignment inventory offers are loaded with risk and hidden costs. Let’s take a look at these pitfalls.
Whenever you purchase inventory, paid for or not, this inventory, from the moment it arrives, 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, whether it’s consignment or otherwise, will lower turns, lower margins and increase costs.
All merchandise is in competition with all other inventory in your store. It competes for shelf space, consumer spendable dollars and sales staff time and attention. It also reduces purchasing opportunities: If you already own this, you can’t buy that. The issue of when inventory is paid for is not a part of evaluating the margin return on inventory.
Consignments Are Easy to Ignore
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 in the inventory. There is an automatic lack of urgency attached to consignment inventory, so often the store 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 the consumers get bored with the same old items. This is something they don’t experience with the paid inventory because you as the retailer are paying attention, it’s moving and there’s a constant stream of new inventory.
Better Buying Decisions
A better course of action to taking the “easy” way with consignment offers is to make purchasing decisions on the merits of the inventory, the vendor and the buying terms. Your first questions should always be, will it sell, in what quantity, over what period of time and will the consumers find the products attractive offerings. 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 in inventory. 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 — and for that matter inventory bought on extended dating terms — 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. So, even if you elect to make a consignment purchase and if the products do not sell well after six months of consuming your shelf space, you still face the inconvenience of packing up the inventory and shipping it back to the vendor (and perhaps incurring return shipping costs in the process, another dollar figure you’ll have to figure into the cost of these offers). Now add to that the fact that what invariably follows with consignment inventory returns are the hassles of inventory discrepancies, charges for missing or damaged items, a slew of back-and-forth correspondence that takes up your time and, yes, arguments between you and the vendor.
Try Before You Buy?
You might ask if there any circumstance 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 simply should not make the purchase. When you pay for the goods is irrelevant to that decision. It is far more profitable to make a purchase decision based upon sound buying principles versus a decision based upon when product payment occurs. If, however, you feel strongly about a vendor offering involving consignment arrangements, then minimally 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.
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Robbie Brown has an extensive background in retailing, wholesaling, distribution service industries and consulting. He has been CEO of numerous companies in the shooting sports industry, including several retail chains and distribution companies. Brown consults for businesses of all sizes in both the merchandise and service industries, as well as for a variety of corporations, industry groups and trade associations. He is a frequent round-table moderator and speaker before industry trade shows, conventions and other corporate groups, and he has published more than 300 business-related articles in various trade magazines, delivered hundreds of speeches and served as a business advisor to many CEOs both inside and outside of the firearms industry.