How to Implement and Manage Consignment Inventory to Boost Your Rig’s Efficiency and Operational Effectiveness
In many cases, having a consignment inventory is a practical solution to any challenges you might have with an inventory.
Let’s explore the benefits of consignment inventory, some things that prevent the oil and gas industry from implementing it on a larger scale, and how to manage the agreement properly.
Consignment inventory is inventory owned by the supplier or wholesaler but is stored at the consignee’s premises. The consignee holds the inventory on behalf of the supplier and pays the supplier when it is consumed.
The typical arrangement for consignment inventory allows the end user to keep the inventory at their facility and receive a monthly invoice for the items used during that period. The supplier usually replenishes the used inventory at the same time.
It’s all about risk sharing. The vendors would still have the same investment except for storage costs, as the consignee would be responsible for storage.
Vendor-managed inventory (VMI) and consignment stock are two inventory models that oil and gas businesses can use to streamline their inventory management. In a VMI model, the supplier manages the inventory at their warehouse. While in a consignment model, the stock is consigned to the management of the vendor.
The main difference between these two models is who is responsible for managing the inventory. There are pros and cons to both models. One advantage of VMI is that it can help to reduce inventory costs for the company. However, one downside is that it can be challenging to manage and control the inventory if it is located at the supplier’s warehouse.
Here are some key reasons you’d want to implement a consigned inventory plan for your rig.
We call it a plan because there are hundreds of suppliers for each rig, and you won’t have it all on consignment.
- Capital savings. When you purchase items on consignment, you only pay for them once they have sold, which means you don’t have to tie up a lot of capital in inventory.
- Safety net. A buffer against unexpected maintenance while preserving cash
- Reduced risk. By using parts on consignment, the rig lowers the risk of stocking items that you will never use, overstocking inventory, or ordering the wrong items.
- Provides service. Offering consignment inventory options allows the vendor to provide additional value without necessarily reducing the price.
- User demand data. Consignment inventory that is invoiced when used instead of when ordered lets the supplier have actual user demand data instead of orders based on replenishment (which we know may never be used).
- Lower freight costs. Freight costs are a major factor in oil rig inventory control. Consignment inventory at the rig helps reduce freight costs incurred when constantly shipping smaller quantities to maintain service.
Here are some of the issues that stand in the way of consignment inventory arrangements at many drilling companies:
1. Lack of control.
Rig personnel are concerned that they will lose control over inventory if it is consigned. However, this should not be a problem because consigned inventory is typically stored at the driller’s facilities. VMI is a different story because you trust the vendor to keep stock for your company instead of selling it when they get the first RFQ request.
2. Additional risk.
Some companies believe that having inventory that is consigned (owned by someone else) brings an additional risk that is not present with a company-owned inventory. In reality, the risk is more or less equal if there’s a formal consignment inventory agreement (more on that below).
3. Supplier resistance.
Some suppliers in the oil and gas industry never agree to consignment setups. If they did agree, it would add to the cost of spare parts. We should ask ourselves: who should invest in inventory before stocking any item.
With the current state of the industry, our most prominent vendors are more open to contracts that they would not have been interested in the past. For example, you could save millions if your rig has all BOP rubber goods on consignment.
Consignment inventory only works with constant communication between the rig and suppliers. Both parties need to be able to see what is happening. The conversation between vendors and rig leadership should address several questions to create an optimal consignment agreement:
- When does a vendor’s ownership of stock officially transfer to a driller?
- Are there any customs or legalities to take into account?
- Who is responsible for insuring and taking risks on stock items?
- If there is loss or damage to stock, who incurs these costs?
- What are the notification policies for stock releases?
- What are the credit and payment terms, and what steps will be taken if payments are not made on time?
- What are the rules for stock control and stock-take responsibilities?
- What are the tax implications?
A sound inventory management system is key to simplifying consignment inventory management.
Do a statistical analysis of inventory items and look at various lead and demand times. Examine the supply chain from product manufacturers through regional and country hubs to rig storage. Implement dynamic inventory optimization programs so that supply chain managers are told when it would be optimal to procure the product.
You can save money and reduce the amount of working capital you need by taking a closer look at your inventory levels. In many cases, consignment inventory can be a helpful way to increase your rig’s efficiency and effectiveness.
Not sure if consignment inventory is right for your ops? We’re happy to talk to you about it!
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