Vendor Managed Inventory (VMI)

What is Vendor Managed Inventory (VMI)?

Vendor Managed Inventory (VMI) is a streamlined approach to inventory management and order fulfillment. VMI involves collaboration between suppliers and their customers (e.g., distributor, retailer, OEM, or product end-user) which changes the traditional ordering process.[1]

As a symbiotic relationship, VMI makes it less likely that a business will unintentionally become out of stock of a good and reduces inventory in the supply chain. Furthermore, vendor (supplier) representatives in a store benefit the vendor by ensuring the product is properly displayed and store staff is familiar with the features of the product line, all the while helping to clean and organize their product lines for the store. VMI can also decrease the magnitude of the bullwhip effect. One of the keys to making VMI work is shared risk. In some cases, if the inventory does not sell, the vendor (supplier) will repurchase the product from the buyer (retailer). In other cases, the product may be in the possession of the retailer but is not owned by the retailer until the sale takes place, meaning that the retailer simply houses (and assists with the sale of) the product in exchange for a predetermined commission or profit (sometimes referred to as consignment stock). A special form of this commission business is scan-based trading, where VMI is usually applied but its use is not mandatory.[2]

How to make VMI work[3]

  • Clarify expectations: There needs to be a thorough discussion about how the system will benefit both organizations in the long term or if one of the parties, particularly the supplier, is prone to disappointment with some of the short-term results. If these items are not addressed the program will likely be terminated quickly with neither side gaining any of the benefits expected from the program. The objective is clear and constant communication between the supplier and the customer. When the two parties work in conjunction they can be assured that the planning function, for both sides, will begin to smooth over time.
  • Agree on how to share information: If the supplier and customer can agree to share information vital to restocking in a timely manner, then the odds of a synchronized system will dramatically improve. Proprietary information would not have to be shared between the supplier and customer, but enough information to maintain a steady flow of goods is necessary. The customer should be willing to share production schedules and/or forecasts to provide some visibility for the supplier.
  • Keep communication channels open: When the two parties set out to implement a VMI program, they need to meet and discuss their goals and how they need to proceed in order to realize those goals. Once a VMI program has been activated, each side needs to understand that there are going to be some miscues. These miscues need to be studied as opportunities for learning and then used to avoid repetitive problems in the future.

Variations of VMI[4]

The term “vendor-managed inventory” covers a wide range of tasks related to managing inventory. A specific VMI program may cover a single task, all tasks, or any combination of tasks. Here are some examples.

  • Vendor shows up at customer’s facility, physically reviews inventory levels, and immediately replenishes with inventory he has with him (actually physically stocks the inventory on the customer’s shelves).
  • Vendor shows up at customer’s facility, physically reviews inventory levels, and places an order for replenishment inventory that will be delivered at a later date. Depending on the delivery method, the vendor may do the physical restocking or may leave it for the customer to do.
  • Customer periodically (daily, weekly, etc) provides the vendor with current inventory levels. The vendor reviews inventory levels and creates replenishment orders. Replenishment orders are shipped to customers. The customer performs all physical tasks related to the inventory at his facility.
  • Vendor has direct access to customer’s inventory system and can get real-time information related to on-hand levels, open orders, forecasts, production schedules, etc. The vendor makes replenishment decisions based on this data and ships orders to customers.
  • Vendor provides an on-site inventory planner that works full-time at the customer’s facility managing the inventory supplied by that vendor.
  • Vendor leases space within the customer’s facility and runs their own warehouse and inventory planning operation with their own employees from within the customer’s facility.

VMI - Vendor Managed Inventory as a business Enabler
Vendor Managed Inventory
source: Minh Le

VMI Benefits[5]

The Benefits of VMI are numerous for both Manufacturers & Distributors. Here is a partial Listing:

  • Dual Benefits:
    • Data entry errors are reduced due to computer-to-computer communications. The speed of the processing is also improved.
    • Both parties are interested in giving better service to the end customer. Having the correct item in stock when the end customer needs it, benefits all parties involved.
    • A true partnership is formed between the Manufacturer and the Distributor. They work closely together and strengthen their ties.
    • Stabilize the timing of Purchase Orders - POs are now generated on a predefined basis.
  • Distributer Benefits:
    • The goal is to have an improvement in Fill Rates from the manufacturer and to the end customer. Also, a decrease in stock-outs and a decrease in inventory levels.
    • Planning and ordering costs will decrease due to the responsibility being shifted to the Manufacturer.
    • The overall service level is improved by having the right product at the right time.
    • The manufacturer is more focused than ever on providing great service.
  • Manufacturers Benefits:
    • Visibility of the Distributor’s Point of Sale data makes forecasting easier.
    • Promotions can be more easily incorporated into the inventory plan.
    • A reduction in Distributor ordering errors (which in the past would probably lead to a return)
    • Visibility of Stock Levels helps to identify priorities (replenishing for stock or a stock-out?). Before VMI, a manufacturer has no visibility of the quantity and the products that are ordered. With VMI, the manufacturer can see the potential need for an item before the item is ordered.

Disadvantages of VMI[6]

  • Supplier That Can't Deliver: When a business relies on vendor-managed inventory, it's placing a big bet on that company's ability to deliver. The vendor has to be able to determine when to send new stock, what specific products to send and in what quantities. This can be beyond the means of a supplier that doesn't have the software, infrastructure, or expertise in place to make that work. If just-in-time inventory turns into way-too-late shipments thanks to poor demand forecasts or a supply-chain breakdown, VMI isn't going to work.
  • Unscrupulous Partners: Even with return policies in effect, a business risk being taken advantage of by a supplier looking to make its numbers. For example, a vendor might ship an excessive amount of product at the end of the quarter and book it as revenue to boost its sales figures regardless of the customer's needs. The customer may return the unneeded merchandise, but the vendor already has gotten what it wants out of the transaction. In addition, VMI may require a company to share sensitive information with the supplier, which can leave it in a delicate position should the relationship between the parties ever falter.
  • Limited Options: A vendor-managed inventory system can be bad for a business when it keeps the business from seeking better-suited or lower-cost options. Because VMI links the supply chain together so closely, it serves as a disincentive to make a change that necessitates changing the company's inventory management system. As a result, a business may find its inventory savings negated by settling for higher-priced or inferior goods.
  • Market Responsiveness: Customer preferences can change in a heartbeat, with favorites falling out of style and new items becoming more in demand. If your vendor doesn't supply a wide enough range of products and your contract prevents you from going to the competition, you may be stuck with items your customers don't want and have no way to fix the problem. Make sure your contract doesn't bind you so tightly to your vendor that you both sink together when the market changes.

See Also

Inventory Management


Further Reading