Understanding Consignment Sales
Many business owners don’t realize that all sales are not created equal. Perhaps they are mesmerized by the idea of selling thousands of products in just a few minutes on QVC or Home Shopping Network or online at Woot.com. While this kind of success takes place every day with many products, it’s important to understand the downside risks of selling via these outlets.
When most of us think of a sale, we think of shipping a product to a buyer who has agreed to pay us within a specified number of days. This is a “true” sale. Goods or services are delivered and are paid for, as long as there is no dispute over quality of the goods. But with a consignment sale, or a guaranteed sale, the companies selling the product do not pay for it until the buying customer has paid. QVC, Home Shopping Network, Woot.com, and Overstock.com are all examples of these types of companies.
These merchants often require other strict conditions of doing business. For example, they might require you to provide them a very large inventory before they will sell your product. It often takes a great deal of cash to support large inventories sitting in warehouses until products are sold; and keep in mind, the seller probably won’t pay you for another 30 to 45 days after the sale of your merchandise.
The most critical aspect of doing consignment sales is to completely understand the terms and conditions of the sale; and make sure you have enough cash to support the long sales cycle. It is nearly impossible to obtain bank or commercial financing to support consignment sales because by their very nature, product that doesn’t sell can be returned to you without any questions asked.
Business owners must also completely understand sales in which retailers take allowances for marketing or other purposes. These types of sales are often found in large grocery store chains and big box retailers such as Wal-Mart, Sam’s Club, and Costco. Because these retailers are 800-pound gorillas, they can take discounts from the originally agreed upon price for expenses such as slotting fees, merchandising fees, and new-store stocking fees. The industry calls these fees “deduct from invoice” fees, or DFI. These fees are typically noted in the contract, but sometimes the fee amounts, as well as when the fees will be deducted, are left out. A small business’s cash flow can be dramatically disrupted depending on when the retailer decides to take the discount.
Although it’s easier to get financing to support large sales to these types of merchants than true consignment sales, your financing source will want to make sure you are completely aware of any DFI fees and will want you to be certain your anticipated profit margin is high enough to support the merchant-created discounts, as well as your normal cost of goods sold.
It is imperative that small business owners completely read and understand any master sales agreement they are asked to sign with large retailers, whether they use consignment purchases or not. If DFI discounts are mentioned in the master agreement but no dollar amount is specified, try to negotiate specific amounts for their programmed discounts. It’s equally important to read and understand every purchase order issued in conjunction with any master sales agreement in place.
Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.
