Consignment Sales in International Trade

In a consignment sale, the exporter sends the product to an importer on a deferred-payment basis; that is, the importer does not pay for the merchandise until it is sold to a third party. Title to the merchandise passes to the importer only when payment is made to the exporter (Shapiro, 2006). Consignment is rarely used between unrelated parties, for example, inde­pendent exporters and importers (Goldsmith, 1989). It is best used in cases involving an increasing demand for a product for which a proportioned stock is required to meet such need (Katzman, 2011; Tuller, 1994). It is also used when a seller wants to test-market new products or to test the market in a new country.

For the exporter, consignment is the least desirable form of selling and receiving payment. The problems associated with this method include the following:

• Delays in payment: Consignee bears little or no risk, and payment to seller is delayed until the goods are sold to a third party. This ties up limited credit facilities and often creates liquidity problems for many exporting firms.
• Risk of nonpayment: Even though title to the goods does not pass until payment is made, the seller has to acquire possession of merchandise (to sell in importer’s country or ship back to home country) in the event of nonpayment. This involves litigation in the importer’s country, which often is time consuming and expensive.
• Cost of returning merchandise: If there is limited success in selling the product, there is a need to ship it back to the exporter. It is costly to arrange for the return of merchandise that is unsold.
• Limited sales effort by importers: Consignees or importers may not be highly moti­vated to sell merchandise on consignment because their money is not tied up in in­ventory. They are likely to give priority to products in which they have some financial involvement.

In view of these risks, consignment sales should be used with overseas customers that have extremely good credit ratings and are well known to the exporter. They would also be satisfactory when the sale involves an affiliated firm or the seller’s own sales representative or dealer (Onkvisit and Shaw, 2008). This method is frequently used by multinational compa­nies to sell goods to their subsidiaries.

A number of issues should be considered before goods are sold on consignment between independent exporters and importers. First, it is important to verify the creditworthiness of foreign importers, including data on how long particular companies take to settle bills. Exporters can have instant access to information on overseas customers from credit agen­cies. No exporting company should consider itself too small to take advice on credit matters. Bad and overdue debts erode profit margins and can jeopardize the viability of an otherwise successful company.

Information on creditworthiness should also include analysis of commercial or country risk factors such as economic and political stability as well as availability of foreign currency to purchase imports. U.S. banks and their overseas correspondents and some government agencies have credit information on foreign customers.

It is also advisable to consider some form of credit insurance to protect against default by overseas customers. Outstanding debt often represents about 30 percent of an export company’s assets, and it is important to take credit insurance to protect these assets. Credit insurance also helps exporters obtain access to a wide range of banking services and an improved rate of borrowing (Kelley, 1995; Powell, 2010). Financial institutions tend to look more favorably on businesses that are covered and are often prepared to lend more money at better terms. The parties should also agree on who will be responsible for risk insurance on merchandise until it is sold and payment received by seller and on who pays for freight charges for returned merchandise.

Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.