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. The ownership model for every line item on the Bill of Materials (BOM) must be explicitly defined to assign risk, calculate margin, and determine liability.

The three ownership models

The model must be selected based on the component’s value, risk profile, and lead time.

Full turnkey (standard)

Definition: Factory sources, purchases, finances the inventory, 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

Consignment must not be used 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.

Model selection rules:

Component Values exceeding 20% of the total Bill of Materials (BOM) cost warrant consideration of a Consignment model to reduce margin stacking for the customer.
Generic components (e.g. a standard reel of resistors) must remain Full 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. It must be defined 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: The customer must supply an attrition overage along with the required volume.
- Rule: For example, if the build requires 1,000 units, the Customer must ship 1,000 + X%.
- Passives: Add +2% to 5% to account for Tape & Reel leader waste.
- High Value ICs: Add +0.5% or exactly 2 units (whichever is greater).

E&O (excess & obsolete)

Inventory that sits still is a liability. The “Aging Trigger” must be clearly defined.

Rule: Material aging beyond 90 days without forecast demand in the subsequent 90 days is deemed E&O.
Action: The factory issues an invoice. The Customer assumes financial responsibility by taking ownership (ship to customer) or authorizing scrap.

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:

Count Verification: The factory counts the receipt. If there is a mismatch, notify the Customer within 48 hours. Silence implies acceptance of the count.
Moisture Sensitivity Level (MSL) Status: If Moisture Sensitive Devices (MSDs) arrive with open vacuum bags, the factory must bake the parts immediately. The Customer is billed for this baking service to restore the components to a usable state.
Traceability: The Customer must provide Lot Codes/Date Codes on the packing list. If these are missing, the Factory cannot guarantee recall traceability.

Liability clauses kit (contract language)

These mechanisms must be inserted 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.”

Recap: Materials Ownership Model & Liability

Model	Primary Selection Criteria	Scrap Liability & Allowance	Mandatory Handling & Segregation
Full Turnkey	Part cost < $10; Commodity/standard components (e.g., passives, connectors).	Factory liable. Standard scrap allowance: 0.5% of material value per run.	Standard factory warehouse/ERP (e.g., Plant Code 001).
Consignment	Part cost > $50; Proprietary/high-value components (e.g., ASIC, FPGA); Customer-managed shortages.	Customer liable. Must supply attrition overage: +0.5% or 2 pcs (whichever greater) for ICs; +2-5% for passives.	Physically segregated. Distinct ERP warehouse (e.g., Plant Code 002) and orange labeling mandatory.
Free-Issue / Hybrid	High-cost custom items (e.g., enclosures, LCDs); Customer supplies specific parts.	Split liability per component. Scrap rules apply based on ownership model per line item.	Combined accounting; supplied parts must be clearly identified.