4.2 Materials Ownership Model & Liability

Inventory is not an asset; it is cash trapped in a physical form that degrades over time. Ambiguity regarding who owns that cash—and who pays when it becomes worthless—is the primary cause of commercial disputes in manufacturing. We must explicitly define the ownership model for every line item on the Bill of Materials (BOM) to assign risk, calculate margin, and determine liability.

The Three Ownership Models

Select the model based on the component's value, risk profile, and lead time.

Full Turnkey (Standard)

• Definition: Factory sources, purchases, finances, and stores the material.
• Pricing: Component Price + Material Margin (Markup).
• Risk: Factory owns the liability until the unit is shipped, subject to NCNR agreements.
• Use Case: Passives (Resistors/Caps), standard ICs, connectors, cabling. (90% of the BOM count).

Consignment (Labor Only)

• Definition: Customer purchases the material and ships it to the Factory. Factory provides labor/machine time only.
• Pricing: Zero material markup. Handling/Admin fee applies.
• Risk: Customer owns the inventory 100% of the time. Factory is liable only for physical loss or negligence.
• Use Case: Proprietary silicon, high-value FPGAs, or parts where Customer has global buying power leverage.

Free-Issue / Hybrid

• Definition: Specific high-cost items (e.g., Enclosures, LCDs) are supplied by Customer; balance is Turnkey.
• Pricing: Blended.
• Risk: Split liability.
• Use Case: Custom mechanicals where Customer owns the tooling and manages the vendor directly.

Ownership Decision Logic

Do not use Consignment to save 5% markup on a $0.01 resistor. The administrative cost of tracking that resistor exceeds the savings.

Decision Matrix:

Criteria	Full Turnkey	Consignment / Free-Issue
Part Cost	Low / Medium (< $10)	High (> $50)
Availability	Commodity / Distribution	Allocation / Single Source
Financial Load	Factory uses their cash.	Customer uses their cash.
Responsibility	Factory manages shortages.	Customer manages shortages.
Scrap Liability	Factory pays for attrition.	Customer provides overage.

Logic:

• If Component Value > 20% of total BOM cost → Then Consider Consignment to reduce margin stacking.
• If Component is generic (Standard Reel) → Then Must be Turnkey.

Liability & Scrap Rules

Physics dictates that no manufacturing process is 100% efficient. Components will be lost to machine mis-picks, feeder loading, and setup waste. You must define who pays for this entropy.

The Attrition Factor (Scrap Allowance)

The factory is granted a standard allowance for waste.

• Turnkey: Factory absorbs cost of standard scrap (e.g., 0.5%).
• Consignment: Customer must supply attrition overage.
  • Rule: If the build requires 1,000 units, Customer must ship 1,000 + X%.
  • Passives: +2% to 5% (Tape & Reel leader waste).
  • High Value ICs: +0.5% or exactly 2 units (whichever is greater).

E&O (Excess & Obsolete)

Inventory that sits still is a liability. Define the "Aging Trigger."

• Rule: If material age > 90 days AND no forecast demand in next 90 days → Then Material is deemed E&O.
• Action: Factory issues invoice; Customer pays and takes ownership (ship to customer) or authorizes scrap.

Pro-Tip: Never allow "Consigned Inventory" to mix physically with "Turnkey Inventory." Consigned parts must be virtually segregated in the ERP (Plant Code 002 vs 001) and physically labeled with a distinct color sticker (e.g., Orange) to prevent accidental consumption by other projects.

Handling & Traceability

Consignment breaks the standard traceability chain because the factory did not perform the Incoming Quality Control (IQC) based on their own vendor selection.

Mandatory Intake Checks for Consigned Parts:

1. Count Verification: Factory counts receipt. If mismatch → Notify Customer within 48 hours. Silence = Acceptance of count.
2. MSD Status: If Moisture Sensitive Devices arrive with open vacuum bags → Factory must bake parts immediately. Customer billed for baking service.
3. Traceability: Customer must provide Lot Codes/Date Codes on the packing list. If missing, Factory cannot guarantee recall traceability.

Liability Clauses Kit (Contract Language)

Insert these mechanisms into the Supply Agreement.

Clause A: The "Production Scrap Cap"

"Supplier is liable for scrap exceeding 0.5% of total material value per production run. Scrap below this threshold is considered standard process variance. For Consigned materials, Customer shall provide 1.0% overage. Shortages caused by lack of overage result in incomplete shipments."

Clause B: The "90-Day Clock"

"Any unique material held in inventory for greater than 90 days without a consumption plan (Forecast Zone 1) shall be invoiced to the Customer. Storage fees of 1.5% per month apply thereafter until removed."

Clause C: The "Yield vs. Vendor" Distinction

"If a Consigned component fails during test (Functional Fail), it is not counted against Supplier's scrap allowance unless physical damage is evident. Customer bears the cost of the component; Supplier bears the cost of the diagnosis."

Final Checklist

Control Point	Passing Criteria	State
BOM Split	Every line item explicitly flagged as "Turnkey" or "Consigned."	Tagged
Overage Logic	Agreed % overage defined for consigned kits.	% Defined
System Separation	ERP allows distinct inventory codes for customer-owned stock.	Yes / No
Pricing Model	Markup % applied only to Turnkey lines; Handling fee applied to Consigned.	Verified
IQC Protocol	Defined responsibility for inspecting consigned parts (Pass-through vs. Full Inspect).	Defined