6 Steps for Successful Consignment Selling to High-Risk Customers

"A well-managed inventory consignment program works for us," Jerry Wehr, formerly director of financial services for global industrial manufacturer Ryobi America. Like any other consignment arrangement, Ryobi delivers products to a customer's place of business and maintains ownership until the customer sells them. These arrangements work very well when they involve just a limited number of items and the customer has computer capabilities to gather point-of-sale information. But Wehr cautions that there are two other issues you must resolve before you consider offering a customer a consignment program:

1. Tax considerations. If you have a sales office in the same state that you have a consignment program with a customer, you may have state tax responsibilities. Investigate this before beginning any consignment program.

2. The customer's ethics. "Management integrity is vital to the success of a consignment program," he emphasizes. "If there's any questionable integrity, your products could disappear out the door before you even bill the customer." He recommends engaging in thorough credit checking and meeting with the prospect or customer in person to make sure you are comfortable with management integrity.

If the "green light" is still on for such a program, he recommends six steps:

1. Conduct a UCC search at the state and county level where your product will be located. "This will tell you which creditors have liens against your customer's products," he notes. "If you decide to go ahead with the consignment program, you must notify these creditors that you're placing consignment inventory in the customer's location so that it doesn't become part of their security agreements with the customer." (See #4 below.)

2. Create a consignment agreement between you and your customer. The agreement should cover --

• • • • Pricing.
      • Terms of sale. While you may offer 30-day terms with traditional customers, consignment program terms should be very short, usually under 10 days, because the customer has already been paid for your products by its customer, and has the cash available to pay you.
      • Insurance for the product.
      • Returns policy.
      • Delivery shortage resolution. For example, if shrinkage occurs between the time you ship and when the customer receives your product, the contract should specify who is responsible for contacting the trucking company and/or for the shortage if a third-party cause cannot be identified.
      • Store-level shrinkage resolution. This should be relatively simple: The customer should assume all responsibility for any of your inventory shrinkage within its store(s).
      • Final settlement arrangements if and when the consignment agreement is terminated.

3. File a UCC1 with the secretary of state's office and the county recorder's office for each customer location where your inventory will be available.

4. Notify all secured parties that you are placing your inventory in the customer's location, and that the inventory is on a consignment basis. (See #1 above.)

5. Make sure that your products are clearly identified and, if possible, separated from other inventory.

6. Guarantee your right to verify inventory levels on a specified frequency.

Inventory Management
Ideally, you and your customer should have computerized technology for scanning the SKUs and reporting the sale of your product to you on a real-time basis if possible. Opportunities include POS (point of sale) technology, EDI (electronic data interchange), ASN (advance ship notices), and so on. "If the customer must collect and report the data manually, it will be difficult to monitor," Wehr cautions.

If you are setting up a consignment program with a new customer, agree to a beginning inventory level for each SKU you provide. Do the same with existing customers who are shifting from traditional terms to a consignment program, but don't forget to also consider their existing inventory levels. If, for example, you already have 500 units of your product in the customer's store that has been paid for on traditional terms, you won't begin billing under the consignment program for new shipments until the original 500 units have been sold. Under those circumstances, he recommends using FIFO (first in--first out) inventory control.

Collections
Once you set up a program, bill the customer weekly, and monitor the account closely to make sure you're paid within your pre-established terms. (As with traditional credit, issue credit memos, as appropriate, that allow customers to deduct appropriate amounts from their remittances.)

If a customer becomes delinquent, take action immediately. Place a call or make a visit, and identify the source of the delinquency. "If you cannot get payment, the agreement will automatically be null and void, and you'll be free to pick up your inventory," says Wehr.

Reconcile inventory levels at least quarterly. Then, invoice customers immediately for any and all shrinkage (as per the original agreement).

Reflections
Consignment agreements allow you to continue to do business with customers who are experiencing temporary hardships or to begin doing business with potentially risky customers who can become strong players in the future. Just as important, these agreements can increase your sales by making it possible to do business with customers who are high risk or purchasing from other suppliers on traditional credit terms. "Your only exposure is for the product that has been sold by the customer, but not yet paid for," notes Wehr. "If you have tight terms, this should only amount to about a week's worth of product sales."

Reflecting back over the consignment arrangements he's made with customers during his 30 years in credit management, Wehr says, "If we'd walked away from them at that time, we probably never would have gotten back in once they turned themselves around. But by offering consignment programs, we were able to protect ourselves, and the customers were very happy with the arrangements."