Vendor Managed Inventory (VMI) is a supply chain practice where the inventory is monitored, planned and managed by the vendor on behalf of the consuming organization, based on the expected demand and on previously agreed minimum and maximum inventory levels. In its simplest form, Vendor Managed Inventory is the process where the vendor assumes the task of generating purchase orders to replenish a customer’s inventory. VMI is a term that is used to describe many types of supply chain initiatives. Traditionally, success in supply chain management derives from understanding and managing the trade off between inventory cost and the service level.
The Vendor Managed Inventory Approach
Vendor Managed Inventory reduces stock-outs and reduces inventory in the supply chain. Some features of VMI include:-
- Shortening of the supply chain
- Centralized forecasting
- Frequent communication of inventory, stock-outs, and planned promotions. Electronic Data Interchange (EDI) linkages facilitate this communication.
- No manufacturer promotions
- Trucks are filled in a prioritized order. For example, items that are expected to stock out have top priority, then items that are furthest below targeted stock levels, then advance shipments of promotional items (promotions allowed only in transition phase), and finally, items that are least above targeted stock levels.
- Relationship with downstream distribution channels
- Result: Inventory reduction and stock-out reduction
Vendor Managed Inventory is based on the belief that supplying parties are in a better position to manage inventory as they have better knowledge of the goods production capacities and lead times. Also it is based on the belief that allowing vendors to manage inventory reduces the number of layers in the supply chain, increasing stock visibility and reducing overall inventory levels. To enable VMI, sales data must be provided to the vendor via Electronic Data Interchange (EDI), other electronic means, or via traditional human agents at outlets.
Origin of Vendor Managed Inventory
Vendor Managed Inventory started in the retail business and grew out of Efficient Consumer Response (ECR), where consumer satisfaction or rather consumer expectation of stock availability is an important way to have a competitive edge over others. Wal-Mart is one of the successful pioneers of this supply chain strategy.
Vendor Managed Inventory is now gradually progressing towards strategic-partnership based forms. These influences the way companies plan their inventory, evolving to Collaborative Planning, Forecasting and Replenishment (CPFR).
Usage of Vendor Managed Inventory
- Error sensitive industries. Example: Pharmaceutical Sector.
- Multiple outlets, fast-moving consumer goods. Example: Wal-Mart.
- Perishable goods. Example: K Mart.
- Valuable and unpredictable components. Example: PC manufacturing.
- Strong competition (small margins). Example: Automotive.
Steps in Vendor Managed Inventory
Vendor Managed Inventory should be achieved in a number of phases:-
- Communicate expectations of all parties.
- Retailer/distributor must commit to sharing precise information.
- Vendor must ensure reliable transmission, receipt, and use of information.
- Agreement on ordering policy, risk and reward sharing.
- Commit time and resources.
- Extensive testing.
- Implementation and evaluation.
- Adjust appreciate vendors that manage the inventory well. Example: promotion to Category Captain, profit sharing schemes, etc.
Strengths of Vendor Managed Inventory
- Supply Chain level
- Lower inventory levels at total supply chain level.
- Less overhead.
- Increased sales.
- Reduces human data entry errors.
- Better insight in customer demand (better resource usage, reduced raw and finished goods inventories).
- Improved, more direct communication with customers.
- Improved market analysis.
- Increased sales via lower out of stock rates.
- Opportunity to provide category management and other value-added services.
- Reduced replenishment times and lower inventory costs.
- Increased sales through reduced stock outs.
- Less redundancy.
- Build strategic strengths through establishing strong supply chain relationships.
- Vendor assistance with category management.
- Increased service level.
- Reduced stock outs
Limitations of Vendor Managed Inventory
- Success of VMI initiative depends on the strength of relationship between the vendors and retailers.
- Increased dependency between the parties and increased switching costs.
- Lack of trust to exchange data can result in the ineffective implementation in one or more of the following forms:
- Inventory invisibility.
- Inventory imbalance.
- Costs of technology and changing organization.
- Extensive data- and EDI testing is needed.
- Loss of necessary shelf space at the selling party may result in less attention by buyers, compared to competitors that are not into VMI yet.
- Special promotions or events need to be communicated beforehand to avoid replenishment planning mistakes (loss of flexibility).
- Increased vulnerability for non-foreseeable risks such as employee strikes, hurricanes, etc. due to lower inventory levels.
- Most of the benefits are for the end client and for the selling party, while the vendor does much of the work.
Assumptions of Vendor Managed Inventory
Vendor Managed Inventory is usually successful for industries and organizations with the following characteristics:
- Multiple outlets, because this increases the benefits compared to traditional inventory management.
- Severe consequences in case of human errors (Pharmaceutical).
- Industries with steady and high volumes (Retail, Consumer Products).
- Industries with high-value inventory and a high level of demand unpredictability (High Tech).
- Management with strong leadership capability to form strategic long term partnerships (Automotive).
Vendor Managed Inventory Implementation Challenges
Vendor Managed Inventory can be made to work, but the problem is not just one of logistics. VMI often encounters resistance from the sales force and distributors. At issue are roles and skills, trust, and power shifts. Some of the sales force concerns are:
- Loss of control
- Effect on compensation – incentive bonuses may depend on how much is sold, but sales force has less influence under VMI.
- Possible loss of job
- Scepticism that it will function well – technical problems
- Concern that reduced inventory will result in less shelf space and therefore loss of market share. This concern can be addressed by filling the shelf space with other stock keeping units from the same vendor.
- Understanding Vendor Managed Inventory (Oracle)
- Vendor Managed Inventory (VMI): Three Steps in Making It Work (NC State University)