Once upon a time
Once upon a time, many years ago there was a young, ambitious salesman selling flat rolled steel. This energetic young man called on one potentially large account for months and months with zero success. He was going nowhere fast. The only thing he got from the rather large, burly looking professional purchasing agent was frustration. The purchasing agent knew the young salesman was short on experience. The young salesman felt that the purchasing agent actually enjoyed watching him squirm month after month. This young salesman, being enthusiastic and energetic, tried every sales technique he had ever learned. Of course, the scruffy old purchasing agent was familiar with every one of them and had seen them many times before. Nothing seemed to work on this guy. The young man just couldn’t reach him. So, he went back to something very basic that most of us in sales (especially we Baby Boomers) learned from day one. The young salesman reflected on the words spoken by his most cherished mentor, “Build a relationship son. Get the man to like you and he’ll tell you how to do business with him.”
Well, the young man tried and tried, but even that didn’t seem to work. He was ready to give up. He was tired of repeatedly hearing that same pathetic purchasing agent’s theme song, “I’m happy with my current suppliers.”
The young salesman was not smart enough, did not have enough scar tissue and was not confident enough to reply, “Maybe that’s because you have set your expectations way too low.” Instead he resorted to his secret weapon, his rarely used prideful technique that only came out when all else failed – He begged. “Mr. Customer, is there anything I can do, anything at all that will convince you to give me a chance to do business with you?”
Have you ever been in the midst of a sales presentation and feel a knockout punch land on your chin? Well, that’s how the reply felt to the young salesman. “Look, we have a partnership with our current supplier. The only way you could ever do business with me is if you gave me our steel for free,” the purchasing agent barked.
The young salesman was devastated; He saw the thrill of victory vanish before his eyes, as he tasted the agony of final defeat. He walked away from that call with his tail between his legs.
The young salesman was down and depressed. He was in one of those typical valleys anybody who is or has ever been in sales recognizes. The best way to pull ourselves out is to make a buddy call – a call on one of our best customers, based not on revenue but on friendship; one of those frequent calls we make and get criticized for making because the sales volume doesn’t justify the number of times we visit.
“He was a friend,” the young salesman thought. So he told him the story. His friend and customer was sympathetic, understanding and even though he didn’t offer any advice, the young salesman recaptured his spirit. That night as he sat on his front porch reflecting on the day, he thought, “Why not? Why not give him our product for free?” Full of excitement, the next morning he went directly to his boss, the owner of the small privately held company. He convinced the owner of the integrity of his new plan.
A concept was born
The concept of consignment in steel distribution was born. That happened in the mid 1980’s. Consignment was already being used in the fastener industry but I do not recall anybody in the steel distribution industry using it. But, as we, the young salesman and me, his boss, found out, the concept of consignment can work in any industry. It was a tough sell, not so much to the customer, but to me as his boss. But, we did it and it was successful. The prospect this young salesman almost walked away from became our largest account, purchasing over $4 million by the end of the second year. It became a learning experience for both of us and we both profited from it. And the large burly looking purchasing agent actually did become one of the young salesman’s closest friends.
Consignment can become a very effective marketing tool if it is used correctly. The emphasis is on using it correctly. A consignment partnership should not be considered without establishing specific criteria for selecting appropriate accounts up front. This is extremely important to you, the supplier. We call this selection criteria the “Rules of Engagement.”
In contrast to the normal Rules of Engagement in selling, consignment Rules of Engagement are predetermined by the supplier, not the customer. Of course, the rules can be modified with proper approval to fit different situations. However, a consignment partnership must be a win-win relationship in order to be successful.
Rules of Engagement
The specific criteria that need to be determined before a consignment partnership is offered include:
o What is the minimum annual sales volume you are willing to accept?
o What are the minimum annual gross margin dollars you are willing to accept?
o Are financial statements available for your review?
o Is the customer financially secure?
o How much risk/investment are you willing to accept in off-site customer inventory?
Answers to these preliminary questions need to be established in addition to others that may pertain to your product and industry.
An Assessment of the Consignment Partnership
Even today in many industries, consignment is on the leading edge of custom designed cost reduction programs. Initiatives focus on total cost, not price, in order to move to the next level of partnering, surpassing expensive JIT programs that have high administrative costs and service risks.
The major objective of a consignment partnership is to reduce costs by eliminating inventory and duplicate effort, as well as reducing shrinkage and lowering transaction and handling costs. It is also effective in reducing scrap, rework, equipment downtime, lead-time and over production.
As consignment becomes recognized in the marketplace as the “way of the future,” caution should be exercised due to the lack of experience and misconceptions by the competition.
1: Consignment is a Supplier Program
Consignment does not start with a company/supplier seminar where you ask the customer how much he wants to stock on his floor. Consignment is complex, requiring supplier professional expertise, state of the art technological MIS and a true commitment of a joint partnership throughout both organizations.
2: Consignment is Just Another Program/Project
Because consignment is a total organizational philosophy on both the customer’s part and the supplier’s part, implementation extends beyond the purchasing department. Consignment requires organization, education and training, especially with front line supervision and labor on the shop floor.
3: Consignment is Easy and Can be Implemented Quickly
Consignment is not easy although consignment customers may think so. However, you can make it easy because of your years of experience, expertise and support from your IT department. Consignment requires organizational change and, in some cases, physical plant changes. Cultural transition barriers can extend the process. Sustaining the continuous improvement philosophy of consignment is critically dependent on organizational transition.
Implementation of consignment requires a plan, an implementation team, a commitment from both parties and staying power to build a partnership seeking continuous cost savings.
How do you know if consignment is right for a particular account?
First, determine which accounts may or may not be eligible for consignment. At a minimum, you should consider the following:
o Financial stability. Since consignment involves the physical transfer of inventory to your customer’s location before he has paid, you should be sure that he will remain solvent throughout the program. Financial reports are the preferred method of validating stability.
o Minimum level of revenue desired. This needs to be determined to justify the investment not only of inventory, but of other resources to manage the program.
o Minimum volume level on items. The consignment program involves a level of overhead that may not be supportable on low turnover items.
o Integrity of customer. No matter how thorough your consignment agreement, all such programs involve a high level of trust between parties. How easy are they to do business with?
It is very important, then, to complete a diagnostic review. The diagnostic review, initiated by your sales support team, is the first step in preparing for consignment. The review involves your entire organization and represents a complete and thorough assessment of the customer’s current operating environment. It provides the base of reference for all future consignment activities. It is primarily a data collection and operational analysis effort which defines the consignment opportunities and the challenges that must be met for implementation. It includes an assessment of:
o Material Flow
o Material Storage
o Market Requirements
The diagnostic review results in a thorough understanding of the barriers, constraints and opportunities to implementing the consignment partnership. It provides the baseline for assessing improvement opportunities and for developing the consignment strategy. Failure to perform the diagnostic review significantly reduces the probability of success for consignment implementation. This can often negate any cost savings generated by the concept itself.
Once an account is determined eligible and the diagnostic review has been completed, further development of the rules of engagement include:
o Minimum turn rate
o Number of items to be consigned
o Stocking location
o Who will do the count
o How damaged goods will be handled
o What the replenishment cycle will be
o What the billing procedure will be
o What the billing cycle will be
Other criteria that is specific to the customer in question should be added to this list.
JIT on Steroids
Consignment partnerships act like Just-in-Time programs on steroids. They provide all the benefits of Just-in-Time without the high transaction cost, purchasing management stress and risk of stock outs.
It is extremely important to get as much specific information as possible directly from the customer. When you do your “cost savings analysis” and your “price is not the same as cost demonstration,” you will face less of a challenge if the bulk of your information comes from the customer, thereby increasing their perceived accuracy of your assumptions.
The following information is critical to the success of your sales presentation. Your objective is to get as much accurate information as possible from the customer. That information should include:
o Average volume of purchases on items being considered for consignment
o Average inventory of purchases on items being considered for consignment
o Average number of turns on items being considered for consignment
o Average cost per transaction (Customer generally doesn’t know the answer to this one, but use whatever number he guesses. Industries average between $30 per transaction to as high as $85 per transaction.)
o Annual average inventory write-offs
o Cost of cycle counting
o Cost of annual physical inventory including reconciliation
o Number of stock outs per year and cost of a stock out
If your customer can’t answer these questions, try to help them come up with their best guesstimate before you resort to using industry estimates. The idea is that it is difficult for the customer to challenge a number that they created.
Consignment benefits, pure and simple, equate to cost reductions. These cost reductions include:
o Reduction or redeployment of personnel
o Reduction of transaction costs
o Reduction of handling costs
o Reduction of insurance costs
o Reduction of inventory taxes
o Vendor consolidations
o Reduction of interest costs
o Elimination of opportunity costs
o Elimination of stockouts
A primary objective of consignment is to reduce the customer’s cost of carrying inventory. This includes the cost of money, shrinkage, taxes, handling and storage. Typically, these handling costs range from 18-30% of the average inventory value.
Additional benefits to the customer include:
o Material is always in stock at no cost until the material is released for production. Quantities available can be altered to meet peak demands as well as downturns.
o Reduction of dollar investment in inventory
o Consignment partnership provides an alternate use of capital and customers will not be invoiced for material until released for production. It also provides emergency safety stock for production with no inventory investment cost.
o Shorter lead times
o Normal lead times would be approximately 1-2 days, however, the consignment partnership eliminates lead time as material is always in stock and available at the customer’s plant.
o Assures growth opportunity
o Consignment partnerships provide the availability of consistent quality. Quantities and pricing are not subject to restrictions based on changing market conditions. Consignment partnerships enable us to effectively manage the supply chain, thus ensuring the lowest total cost.
o Pricing will be consistent regardless of quantity used. (No Extras) The price for one item is the same as the price for 100 items.
o Vendor reduction
o Reducing the number of vendors, consolidating sizes, parts, communication and administration can contribute to overall cost reductions – substantial reduction in debits and credits.
o The intent of this program is designed to offer overall cost reductions, flexibility in scheduling, improved cash flow, reduction in inventory and investment, assured growth opportunities and to enhance long-term vendor relationships.
This results in the true meaning of partnership, a win-win relationship. A customer may ask the question, “How can you provide all these services without charging a substantial premium on pricing?” The answer is simple. Consignment is a partnership that provides benefits to both parties. Your benefits as a supplier include:
o Locking out competition
o Better control of inventory
o No warehouse space required for growth
o Regularly involved at customer location
o First chance at new opportunities
o Hard to cancel – hard to duplicate
o Customer becomes supplier dependent
o Free storage space at the customer’s facility
We started this article in storybook fashion. Consignment may sound like the “Knight in Shining Armor,” the “Magic Bullet,” or the answer to cracking your toughest challenge. Be cautious. Not every story has a happy ending. You can hurt yourself with consignment. Consignment is a serious program that requires serious investment of assets and resources. Make sure you do your homework in the beginning. Consignment is not right for every account. It should be the exception, not the rule. But, if it’s done right, it can be the “Knight in Shining Armor.” So, if you’ve done your homework and all the pieces fall into place, go for it. And, when that purchasing agent says to you that he’s happy with his current suppliers, don’t be afraid to look him in the eye and, without cracking a smile, reply very slowly…”Maybe that’s because you have set your expectations way – too – low!”