Is supplier ownership of raw materials good or bad?

Accountants like to see raw materials being shifted back to suppliers as consignment inventory, because this reduces the amount of working capital invested in inventory. Instead, suppliers shoulder the investment until the inventory is actually used.

The most common approach to consignment inventory management is for the supplier to maintain a sufficient quantity of inventory at the company to ensure a sufficient on-hand supply until their next replenishment visit. During each visit, they count the amount of inventory used since their last visit, replenish stock, and invoice the company for the amount used. Seems too good to be true? It is.

From a cost perspective, the company will still incur the cost of the storage space taken up by the consigned inventory. Also, the company may be held liable for any consignment inventory that becomes obsolete, especially if the supplier has custom-designed the goods for the company. Further, there is a significant cost associated with the initial consignment contract creation, as well as ongoing contract maintenance. And finally, suppliers may find ways to shift the financing cost of that inventory back onto the company, either through higher prices or lower product quality.

An additional problem is that many materials management systems are not designed to track consignment inventory, requiring painstaking manual procedures to coordinate activities with suppliers.

The bottom line is that working capital will decline somewhat, while material and administrative costs increase.

A better approach is to work with suppliers to mutually reduce the total amount of inventory in the supply chain. Since inventory is mostly a buffer to compensate for variations in the output of the supplier and the demand of the company, it is better to coordinate forecasts, thereby reducing the need for the buffer.

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