Vendor-Managed Inventory (VMI) is a means of optimizing supply chain performance in which the supplier (manufacturer/distributor) is responsible for maintaining the customer's inventory levels. The distributor has access to its customer's inventory data and is responsible for generating purchase orders.
Under the typical business mode, without VMI, when a customer needs product, he or she places an order with a supplier or distributor. The distributor is in total control of the timing and size of the order. The distributor maintains the inventory plan.
Vendor-Managed Inventory is a planning and management system that does not tie directly to inventory ownership. However, many of the information sharing requirements are the same as in consignment arrangements save that, in a VMI approach, ownership transfers to the stocking location. Under VMI, instead of the customer monitoring its sales and inventory for the purpose of triggering replenishment orders, the distributor assumes responsibility for these activities. Benefits include:
- Improved customer service
By receiving timely information directly from point-of-sale data, suppliers and distributors can better respond to customers' inventory needs in terms of both quantity and location.
- Reduced demand uncertainty
By constantly monitoring customers' inventory and demand stream, the number of large, unexpected customer orders will dwindle or disappear altogether.
- Reduced inventory requirements
By knowing exactly how much inventory the customer is carrying, a distributor's own inventory requirements are reduced because the need for excess stock to buffer against uncertainty is lessened or eliminated.
- Reduced costs
To mitigate the up-front costs that VMI demands, many suggest that manufacturers reduce costs by re-engineering and merging their order fulfillment and distribution center replenishment activities.
- Improved customer retention
Once a VMI system is developed and installed, it becomes extremely difficult and costly for a customer to change suppliers.
- Reduced reliance on forecasting
With customers for whom a supplier runs VMI programs, the need to forecast their demand is eliminated, thus sidestepping forecasting problems that, by definition, always contain errors.
The coupling of VMI often occurs with consignment, which is “the process of a supplier placing goods at a customer location without receiving payment until after the goods are used or sold.” When coupling VMI with consignment, the supplier must make sure that the consigned inventory moves rapidly through the customer's points of sale.
Among industry practitioners, there is generally no specific distinction made between who owns the inventory (the buyer or the seller) in application of the phrase “vendor-managed inventory.” Some distributors will manage inventory they still own until their customer sells it, and some will not.
In the VMI model, the distributor receives electronic data — usually Electronic Data Interchange (EDI) or via the Internet — that provides him with the customer's sales and stock levels. The distributor can view every item that the customer carries as well as true point-of-sale data. The distributor is responsible for creating and maintaining the inventory plan. Under VMI, the distributor, not the customer, generates the “order.”
VMI does not by necessity change the “ownership” of inventory. It can remain as it did before. VMI reduces stock-outs and reduces inventory in the supply chain. In summary, some VMI features include:
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Shortening the supply chain.
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Centralized forecasting.
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Frequent communication of inventory, stock-outs and planned promotions. EDI linkages facilitate this communication.
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No or less frequent manufacturer, distributor or supplier promotions.
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Filling trucks 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.
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Improved supplier relationship with downstream distribution channels.
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Result: Inventory reduction and stock-out reduction.
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VMI as a logistics process can work, but the problem is not just one of logistics. VMI often encounters resistance. At issue are roles and skills, trust and power shifts. Some of the organizational concerns are:
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Loss of control.
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Effect on compensation ? incentive bonuses may depend on how much product sells, but the sales force has less influence under VMI.
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Possible job loss.
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Skepticism that VMI will function well ? technical problems.
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Concern that reduced inventory will result in less shelf space and, therefore, loss of market share. You can address this concern by filling shelf space with other stock, keeping units from the same vendor.
There are two recurring obstacles to achieving a successful VMI program. One is strategic and the other is operational. At the strategic level, this requires a high-level decision from the company about how it wants to position itself. Are there benefits to stronger supply chain cooperation? If so, has a high- level decision been made to share the necessary information?
Operationally, job functions, processes and performance measurements will need to change in order to get the most benefit. Employees who fear change will feel resistant. Along with cultural change, issues will arise regarding the management of change and specific job changes. You will need to address concerns such as the role of buyers and salespeople in the new environment, as well as the new measurement systems. Roles and measurements will change, but with proper adoption of new cultural values, it will be obvious that job changes are needed. Nonetheless, anticipate confusion and resistance.
Other key points to consider
From the distributor's point of view:
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Consider VMI as a first step in forging a supply chain partnership.
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Aim at preferred trading relationships that can produce large increases in sales volume.
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Plan to negotiate practical alternatives to current forward-buying practices.
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Install the necessary support systems to ensure you actually improve supply chain forecasting and planning.
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Plan to make use of the information that you will receive in order to reduce your own stock levels and operating costs.
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As a manufacturer, be prepared for a one-time volume hit as excess stock is withdrawn from the supply chain.
From the customer's point of view:
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Recognize that VMI can be a fast way to set supply chain improvements in place while you are working to improve your own systems.
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Be prepared to share sales and inventory information with the supplier. This is a cornerstone of the arrangement. Handle promotions as special cases.
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Only move to VMI if the vendor can actually make better decisions than you, and only stay with VMI if that continues to be the case.
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Finally, you will need to deal with several management issues that arise for the changes you are making. In particular, you may need to review and revise staffing and organizational arrangements and alter pricing practices.
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Although VMI does have many benefits, it may have its pitfalls.
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EDI Problems: Extensive EDI testing should be done to validate the data being sent. Is the distributor sending all the data that should be sent? Is each field populated with the correct data?
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Acceptance: Make sure that all employees involved in the process fully understand and accept this new way of doing business. It's not enough to just sell the concept to senior management; all employees who are involved must be willing participants.
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Promotions/Events: Anything that adds or takes away from the normal ordering pattern must be properly communicated.
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Customer Base: Any large customers gained or lost must be communicated to the manufacturer. The distributor must guide the manufacturer on how this will affect sales.
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Over/Obsolete Stock: An agreement must exist between the manufacturer and distributor on what to do if an overstock does occur (or in case of an ordering error). Also, both parties must agree on how to handle obsolete stock.
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Time: Both parties must understand that this is a learning process. Errors will occur. You will probably not have a perfect process in place from day one.
VMI can be a quantum shift in the way a supply chain is managed. And with such a large shift in method, there can be large hurdles to clear; however, the potential benefit, to both supplier and customer, is indeed attainable and more than worth the effort.
Paul Evanko is a vice president and principal with St. Onge Co. He has more than 30 years of experience in line distribution management and related operations research for the control and design of warehousing, transportation, traffic and distribution support functions. St. Onge Co. (www.stonge.com) is an international supply chain strategy and logistics consulting firm. Its discovery-driven approach brings together the elements of supply chain logistics, engineering and operations. Contact Paul at 717/840-8181 or by e-mail at [email protected].
Pros and Cons of VMI
Pros of VMI
- Fosters cooperation in the supply chain — forms partnerships and cross-functional lines of communication that can help to improve the pipeline process and relationships
- Fast way to improve results — can be implemented in a short amount of time and provide considerable benefits over existing performance
- Maximizes in-stock position — can increase customer service levels and reduce stock-outs through better understanding of demand and more sophisticated inventory policies
- Reduces overall supply chain costs — a fresh look at supply chain processes will identify shortcomings and better information helps smooth demand and reduce inventory
- Sales are higher for vendor and customer — increased service levels will maximize in-stock positions and notch up sales levels
Cons of VMI
- Vendor's administrative costs increase — vendor's responsibilities increase and more work needs to be done
- Hard to use with volume discounts and special pricing — alternate pricing strategies will have to be worked out to the agreement of both parties
- Complicates the system in the short run — new systems can start immediately but roles of employee, vendor and customer may not be clear at first
- Retailer risks loss of control/flexibility — especially when procedures are new; understanding and ability to control procedures is low
- Manufacturer takes one-time volume reduction — inventory is withdrawn from the supply chain, which reduces production requirements
- Minimal benefits for manufacturer until critical mass — manufacturers do not integrate DRP into MPS or MRP until 50% of overall sales volume is through VMI
Performance Metrics for VMI Relationships
Possible Dimensions of Performance
Turns
- Distribution Center Turns
- Retail Level Turns
Inventory Levels
- Customer Inventory Levels (40-60% reduction feasible)
- Manufacturer Wholesaler Inventory (30-60% reduction feasible)
- Average Carrying Cost
Sales
- Change in Sales
Productivity
- % Time Negotiating Price, Deals and Following up on Invoice Deductions
- % of Salespeople's Time Dealing with Replenishment
- % Inventory Manager's Time Spent Operating VMI Program
Distribution/Operations Cost
- Truck Utilization
- Number of shipments
- Reduction in Paper Work
- Reduction in Returns
- Personnel Costs
- Depreciation
Consumer Satisfaction
- Service Levels (98% feasible)
- Product Freshness
Other supply chain metrics that should be included in any VMI agreement include: backorder performance; customer-order actual cycle time; line item fill rate; inventory record accuracy; inventory turns; on-time delivery and perfect orders.