The money factories save through consignment ends up back in the purchase price

I once read an annual inventory plan that set a clear target for consignment: 60% coverage.

The KPIs attached to it were inventory turnover and consignment coverage. None of them measured supplier delivery performance, and none looked at the total cost of the chain.

What got measured was how much inventory moved off the factory’s books, not where that money went.

1. First, the distinction: what material consignment actually is

An example: a supplier delivers a box of bolts into the factory warehouse. Under normal purchasing, the factory owns it on receipt, and the supplier can invoice.

Under consignment, the bolts sit in the factory but stay on the supplier’s books. When the sale happens depends on which moment the contract names:

• Goods issue: the line withdraws it and it counts as bought. This is SAP’s standard approach.
• Assembly confirmation: it counts as bought only once it is built into a product and the work is confirmed. This is the latest possible point.

The later the settlement point, the longer the supplier carries the cash. Scrap and BOM errors between withdrawal and completion also fall on the supplier, who cannot see that data.

2. The premise behind consignment’s savings is the opposite of an OEM’s reality

The founding paper on consignment is Valentini and Zavanella (2003). It shows consignment can lower the total cost of the chain, and it states the premise plainly: the buyer’s cost of capital is higher than the supplier’s.

OEMs are mostly large companies with cheap capital. Many suppliers are small and mid-sized firms for whom financing is harder and more expensive. Moving inventory from the cheap side to the expensive side raises the chain’s total cost of capital.

That money does not disappear. It comes back. A 2024 BCG supplier survey found that when payment terms run 15–30 days longer than usual, suppliers raise prices by 5–8%, openly or quietly. Another study found that the slower large buyers pay, the less small suppliers invest. The Hackett Group’s working capital research is blunter: this pushes the working capital burden onto suppliers and can even destabilize the whole supply base.

3. How the vicious circle gets going

The same paper describes a conflict of interest. Suppliers want the consignment minimum stock as low as possible, because it is their frozen cash. Factories want it as high as possible, because it is free safety stock.

So suppliers stock to the minimum. The plan changes, parts run short; parts run short, the plan changes again; the more the plan changes, the less suppliers dare to stock.

An auto parts business owner put it concretely in an interview: the transaction is only triggered when parts reach the line, OEMs often change call-off quantities at short notice, and suppliers have to fund one to two months in advance.

My earlier piece on the 8 systems did the arithmetic: with 300 part numbers each 99% on time, the chance they all arrive together is only about 5%. My judgment: consignment pulls every part’s on-time rate down a little, and kit completeness falls multiplicatively.

4. What to do: write six clauses into the contract

① Classify first. Consign only parts that are high in unit price, steady in usage, common, and supplied from nearby. Custom and long-lead parts go through normal purchasing.

② Settle on goods issue. Generate the settlement statement automatically on a fixed day each month; if no objection is raised within 10 days, it is deemed confirmed, and the payment term runs from the confirmation date.

③ Set upper and lower limits; convert aged stock to a purchase. Anything above the upper limit, or not withdrawn within 60 days of receipt, automatically becomes a factory purchase. The number of days is an example; set it by your own turnover cycle.

④ Mutual buy-back of obsolete stock. Issue an aging report every month and verify it within 15 days. Obsolete stock caused by engineering changes or discontinuation is bought by the factory at cost. Large electronics manufacturing contracts include clauses like this.

⑤ Tiered authorization on forecasts. Forecasts are not commitments, but stock within the scope the factory authorizes in writing is the factory’s responsibility.

⑥ If you really want to save capital, use reverse factoring. Materials settle normally, and the supplier discounts the receivable at low cost on the strength of the factory’s credit. Under the rules from the People’s Bank of China and other regulators, the instruments should in principle run six months or less.

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Clause ④ is the hardest to negotiate: for obsolete stock caused by engineering changes, what split did your side end up with?