SMU Data and Models

Steel Buyers Basics: Consignment Inventory Deals

March 2, 2014

In order to keep their operations running smoothly, steel buyers have to manage the difference between their company’s predicted use of steel and the actual demand. Since flat rolled steel lead times from Steel Mills can be many weeks, buyers have to maintain large safety stock inventories to handle this discrepancy. That does not mean, though, that the buyers have to maintain this stock themselves.

As discussed in a previous article, part of the value Steel Service Centers provide is to hold inventory for their customers. Service centers can average the variation in supply across a wide range of customers and therefore are more efficient at planning inventory levels than any single user of steel can be. However service centers charge for this service — a large steel buyer has another option, they can negotiate with their suppliers to establish consignment inventory.

Consignment inventory is owned by the supplier (typically a steel mill or an overseas broker) until the buyer uses it in their operation. In the steel business a consignment deal will work in the following way: The buyer places an order for steel and, (after the supplier’s lead time) the supplier makes and ships the steel. However, instead of billing the customer for this steel, the supplier keeps ownership and holds it in consignment inventory for the buyer. The buyer controls the inventory but the supplier does not bill for the steel until it is actually consumed in the buyer’s operation.

In today’s low interest rate environment the cash cost of holding steel is historically inexpensive. With interest rates as low as 3%, the financial cost of $1000 per ton coil of steel ($50.00/cwt) is only $2.50/ton each month. This cost is small enough that consignment programs, both domestic and foreign, are financially easier for mills and large brokers of overseas steel to offer.

For a buyer looking to shrink his inventory or who has limited cash, a consignment program is a very good deal – it’s like having your cake and eating it too. However like most things that seem to be free, there can be some hidden problems. Buyers should remember that nothing of value is really free.

Fifteen years ago Steel Mills were very accommodating to buyer requests to hold inventory. However, from 2001 through 2004 a number of large Steel Mills went into bankruptcy and one of the prime reasons is that they had bloated inventories in a time when steel prices were falling. Many of their customers who had signed up to take consignment inventory simply didn’t. After that experience and as the remaining mills got stronger, they became much more particular about the rules for such deals.

In a typical consignment deal, each coil of steel has a unique serial number and a born-on-date. As part of the deal the buyer has a specified period of time in which to buy each coil. If the buyer does not consume the coil by the appointed date (typically one to two months of age) then the Mill will invoice the buyer for the steel even if the buyer does not want it.

Since consignment inventory is off the books (and perhaps not being accounted for in the buyer’s material planning system) it often doesn’t get the attention that inventory deserves. Also, buyers are tempted to think of consignment inventory as somebody else’s problem and so don’t manage it as carefully as they should. This lack of visibility can cause bloated inventory levels and buyers are surprised with large invoices when the holding period is up.

A further problem with this type of inventory is its price. Many consignment deals are priced at time of consumption and not time of order. In other words, the buyer places an order before he actually knows what the price of the material will be. In that situation, the buyer can be at the mercy of the pricing of the supplier.

In my view it is always better to have a supplier with a short, reliable, lead-time than to have a supplier who tries to make up for that with a consignment program. However, so long as a buyer carefully tracks and manages his consignment inventory these types of deals can work for both suppliers (since the cash cost is low) and for buyers who are trying to reduce their inventories.