Vendor Managed Inventory : A Step-by-Step Guide, Benefits and Risks

Vendor-Managed-Inventory
28 May

Given the disruptive nature of the supply chain dynamics, an important aspect of supply chain planning and control is the attempt by supply chain managers to improve supply chain performance. One way of avoiding this is to allow an upstream supplier to manage the inventories of its downstream customer. This is commonly known as vendor managed inventory (VMI).


Get Excess and Obsolete Inventory Policy

Vendor managed inventory (VMI) is a supply chain initiative where the supplier is authorized to manage inventories of agreed-upon stock-keeping units at customer locations. The benefits of VMI Programe are well recognised by successful retail businesses such as Wal-Mart.

In Vendor managed inventory, distortion of demand information (known as bullwhip effect) transferred from the downstream supply-chain member (e.g., retailer) to the upstream member (e.g., supplier) is minimized, stockout situations are less frequent, and inventory-carrying costs are reduced.

Furthermore, in VMI supply chain supplier has the liberty of controlling the downstream resupply decisions rather than filling orders as they are placed. Thus, the approach offers a framework for synchronizing inventory and transportation decisions. In this blog, I have presented a definition, typical  Vendor managed inventory (VMI) process, benefits and risk.

Definition of Vendor Managed Inventory

Vendor managed inventory (VMI) is defined as inventory which is managed by the supplier / vendor. Vendor Managed Inventory (VMI) involves another party, other than customer, taking responsibility for elements of inventory management, including setting and managing inventory levels, re-ordering, and replenishing.

Some Examples of Vendor managed inventory (VMI) are:

  • Vendor at the customer site, Vendor deciding when and how much inventory needs to be ordered, but the actual ordering and owning of the inventory is by customer (example Fastener VMI)
  • Vendor at the customer site, vendor in possession of the inventory, making the inventory decisions and placing the orders, with customer taking ownership of the inventory when customer takes the item of inventory for use (ex: Tool Crib/Items issued through supplier owned vending machines).
  • Vendor not at the customer site, vendor has inventory at the customer site and periodically reviews (either remotely or physically) the inventory on hand and restocks the inventory when the vendor deems it necessary. A form of consigned inventory.
  • Vendor not at the customer site, subcontracts the inventory management to a third party and has the inventory also held in a third party warehouse, from which it is shipped and replenished (example UPS VMI)

In summary Vendor-managed inventory (VMI) is a collaborative strategy between a buyer and supplier to optimize the availability of products at minimal cost. Overall, inventory management cost plays a significant
role in reducing supply chain cost. Specifically in the fast-moving consumer goods (FMCG) sector, inventory–turnover ratio needs to be very high to compete in the global market. Throughout the supply chain, VMI is used to cut inventory-related costs and keep inventory levels low.

VMI helps organizations to reduce the inventory-associated costs by shifting the responsibility of managing and replenishing inventory to vendors.

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Typical Vendor Managed Inventory (VMI)  Process:

 

When Customer needs product, they place an order against a supplier. Customer should be in total control of the timing and size of the order being placed, based on one of the examples above. Customer maintains the inventory plan.

The supplier receives electronic data (usually EDI or via the internet) that tells supplier customer’s sales and stock levels. The supplier can view every item that customer carries as well as true point of sale data in most cases. The supplier is responsible for creating and maintaining the inventory plan. Under VMI, the supplier generates the order for replenishment VMI inventory, not customer. Hence, the term Vendor Manage Inventory!

Important point to note here is VMI does not change the “ownership” of inventory. It remains as it did prior to VMI.

VMI

Benefits of Vendor Managed Inventory (VMI)

www.vendormanagedinventory.com has defined benefits of Vendor managed inventory (VMI) as follows:

DUAL BENEFITS for both supplier and Customer:

  • Data entry errors are reduced due to computer to computer communications. 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 supplier and the customer. They work closer together and strengthen their ties.
  • Stabilize the timing of Purchase Orders – PO’s are now generated on a predefined basis.

Customer BENEFITS:

  • Better visibility will make it possible to change from Air- to sea freight
  • The goal is to have an improvement in Fill Rates from the supplier and to the end customer. Also, a decrease in stockouts and a decrease in inventory levels.
  • Planning and ordering cost will decrease due to the responsibility being shifted to the supplier.
  • The overall service level is improved by having the right product at the right time.
  • The supplier is more focused than ever in providing great service.

Suppliers BENEFITS:

  • Visibility to the customers Point of Sale data makes forecasting easier.
  • Promotions can be more easily incorporated into the inventory plan.
  • A reduction in customer ordering errors (which in the past would probably lead to a return)
  • Visibility to Stock Levels helps to identify priorities (replenishing for stock or a stockout?). Before VMI, a supplier has no visibility to the quantity and the products that are ordered. With VMI, the supplier can see the potential need for an item before the item is ordered.

Information Considerations

From To What
Customer Supplier • Sales (actual & forecast)

•Minimum & maximum stock levels per part

•Actual stock levels per part

Supplier Supplier Production order (replenishment)
Supplier Customer Shipment plan (lead times)

 

Risk in Vendor Managed Inventory (VMI)

 

In my experience following risks needs to be managed in Vendor Managed Inventory (VMI) transaction:

  • Slow Moving items: It is not ideal to include slow moving items in VMI model. If the items has stock turn of 4 or less I would not recommend. Generally supplier asks customer to take inventory if not moved in 4 months max.
  • Physical Count of Inventory: suppliers and customer must make sure the ownership of physical stock count is defined from the outset of agreement.
  • New Product Introduction/Phase Out Items: I have found it is headache to manage to manage New Production Introduction and Phase Out plans for inventory on ramp down. This scenario needs special communication.
  • Monthly Exception: We all trust the data in the system, don’t we!! On serious note we like to trust data in our ERP or Inventory management system, but discrepancies are bound to occur over long period of time. Therefore, I strongly recommend to monthly exception reporting to align physical inventory between supplier and customer.

 

Conclusion

 

Vendor-managed inventory (VMI) is a collaborative strategy between a buyer and supplier to optimize the availability of products at minimal cost. Overall, inventory management cost plays a significant role in reducing supply chain cost.

VMI is a logistics distribution strategy through which the supplier manages inventory at customers’ sites and decides on replenishment policies, subject to stipulated levels of availability and service. The supplier benefits by reducing its inventory levels, reducing customers’ demand variability, and improving routing strategies; customers benefit by reducing resources dedicated to manage inventories and by decreasing their stock-outs, thus increasing their revenues.

VMI is made possible by installing technological equipment at participating sites to allow the supplier to keep track of customer demand and inventory. The decrease in the cost of applicable technologies, such as EDI and the Internet, has accelerated the adoption of this strategy across several industries. The objective of the supplier in VMI is to decide on distribution tactics that will minimize the inventory and transportation costs across the supply chain.

Whilst there are many benefits of Vendor-managed inventory (VMI) , there are few risk as well, which needs to be considered.

I hope this guide helped you realize that in given day and age, Vendor Managed Inventory (VMI) isn’t optional anymore. While it doesn’t take a lot of effort to get a few basics right, but it is all worth it for buyer and supplier.

After reading this guide, how will you change your attitude towards Vendor Managed Inventory? Please share your comments .

MRPeasy – Fast and easy production planning

Recommended Reading

Vendor Managed Inventory: Exploring objectives, benefits and shortcomings of the business concept

20 Comments

  • Nestor N. de Albuquerque

    Dear Dr. Ahmed,
    Thanks for the excellent text. Really enlightening one.
    Would you have a higher resolution of that picture?

    • muddassirism

      Hi Nestor N. de Albuquerque, I have send you the image by email. Hope this helps, Muddassir

  • Alpha

    Hi Dr Ahmed, I am a supply chain specialist and I would like to share my experiences and insights on your platform. Hoping to hear from you

  • Prakash

    Dear Mr Ahmed
    Thanks for VMI Insight.
    How suppliers deal or cope up with Forecast Increase during Lead Time period. Who will be accountable for Premium Freight shipments? It will be of great help if you can share few Thumb Rules for Different scenarios after VMI implementation.

    • muddassirism

      Roles for demand forecast variation impact and who will take care of premium freight mostly stays the same as in without VMI system.

  • JUAN CARLOS

    Nice article! Really did a good job pin-pointing the important information.

    • Muddassir Ahmed

      Thanks very much for your comments Juan Carlos.

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  • Theophilus B . Wesseh

    Dear Dr. Ahmed,
    I am so glad to received this email from it has help me to understand something about Inventory.
    Best,
    Theophilus B. Wesseh

    • Muddassir Ahmed

      You are welcome Theophilus.

  • Jaakko Ristaniemi

    Hi,

    Nice summary of VMI! 15years ago when I did my master’s thesis there wasn’t any as good academic material about VMI as this.

    Few points related to this summary:
    – “Better visibility will make it possible to change from Air- to sea freight” in my mind this is quite strong expression without knowing air and sea transportation LTs, demand dynamics and inventory carrying costs for the material.
    – Like mentioned in few earlier comments, in VMI logistics inbound model there are many things to be agreed between Customer and Supplier. This is in line with the conclusion of my “already dust covered” master’s thesis related to implementation of VMI (with consignment): The hardest and most time consuming part of the implementation project is the legal agreement. Setting up transportation and system-to-system connections with developed messages and related functionalities in legacy systems with SOX requirements are the easiest part of the implementation.

    • Muddassir Ahmed

      Dear Jaakko for your comments.

  • Vikaynash

    Good day Sir.
    Can you kindluy inform me the detailed process numbered #1 till #9 in the above graphic?
    I would love to know the process / execution that takes place at each step. TQ so much and may we get more insightful information from yourself. TC

    Vikay

  • Oenga

    Very useful information and well understood…

  • CHANDRA GANGADHARAN

    One of the important benefits of VMI is reduction of waste in consumption .
    When we are going in for VMI in manufacturing it is not enough to just fix the quantities based on the forecast but agreed production norms
    I have done this exercise in a Float Glass mfg company Metal packing straps.Fixing the consumption norms fr issue of VMI is very important.This will help in reducing waste and excess usage

  • Sandeep

    Above VMI management concept explained beautifully. If 1 or 2 case study examples can be explored, it would give deep insight on VMI.

  • Yayra Avemegah

    Good morning Sir, I have read through the article but I dont see how VMI is going to reduce cost. If products are moved from supplier to the vendor there will definitely be a transportation cost which will be paid by one of the parties depending on the terms of engagement and will eventually be added to the cost of the product. Please I need more clarification? Thank you

  • CHANDRA GANGADHARAN

    Another Big advantage of VMI is reduction of Waste leading to overall reduction in Materials Consumption.
    I have done a VMI exercise with a Global Float Glass Mfg for packing materals in close coordination with SIGNODE of USA

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