What is Vendor Managed Inventory (VMI)?
What is Vendor Management Inventory?
It is a supply chain agreement where vendors or suppliers manage, maintain and optimize their inventory while it is in the possession of the buyer. It is a wholesale inventory management system where inventory is replaced for retailer or buyer without them having to initiate the purchase order. The inventory data is shared by buyer or retailer with the vendor and vendor determines order size, and frequency.
How a vendor management inventory system works?
Vendor owns the vendor management inventory but they are located at the premises of buyer or retailer. It is form of consignment inventory where a vendor consigns their inventory to care of another while maintaining ownership of it.
- The goals and metrics that define success are agreed upon by both vendor and buyer for their VMI relationship. These are in-stock performance, inventory turnover rate, and transaction cost. The agreement also includes whether or not buyer pays for inventory on acquisition or on sale to end user and also how the excess inventory will be returned.
- The vendor ships the inventory to retailer or buyer
- The vendor monitors sales patterns and inventory levels of their products at that of buyer or retailer.
- Vendor’s VMI specialist or planner reviews calculations and places the replenishment orders.
Successful replenishment is all about vendors knowing when to replenish their buyer’s inventories.
Vendor Owned Inventory management
It is based on friendly communication between vendors and buyers. A vendor has to know the demand trends of the buyers to know how much inventory to be delivered else it can lead to overstocking, under-stocking, wasted inventory and efforts.
- Be generous with data: Share on regular basis what you are sharing including inventory levels, seasonal spikes and seasonal lulls.
- Protect data: Successful vendor managed inventories are based on sharing sensitive sales information. Ensure a robust agreement before giving suppliers access to the inventory information
- Become experts on vendors: When giving another organization an access to data and control of inventory, it is important to ensure you are confident in their ability and trustworthiness. Do the research, read reviews and get references.
- Create VMI contract. The contract will specify in detail what inventory vendor will manage, minimum and maximum inventory levels and return policies.
- Small and medium sized vendors most reliable: Most national and large supply chains will not give best customer service as they deal with too many buyers.
- Upfront of any factor that affect the behavior: For instance planning to carry similar product line from competitor or starting to sell the product via another channel like wholesale marketplace.
- Set the minimum and maximum limits on how much inventory one is willing to hold or how much physical space one is willing to reserve for the inventory.
Vendor Managed Inventory Example
- A hypothetical home improvement store- Home World
Home World Sells refrigerators and has a VMI contract with X. Home World consistently sends X through EDI or online, data that details their refrigerator sales pattern and stock levels. Using this data, X considers their lead times and creates replenishment calculations. An inventory expert X reviews those calculations and places all the replenishment orders for Home World.The consistent sharing of accurate information paves way for a successful and profitable relationship between Home World and X.
- ABC Supermarket sells popular brand of wholesale popcorn from vendor Y snacks. The two parties agree for VMI arrangement.
- The supermarket ensures there is always Y snacks’ products in stock with no stock outs
- Y snacks want to optimize their inventory turnover ratio equation to minimize excess inventory and related costs.
- Both parties want to minimize transaction costs related with online ordering and managing inventory
- Under VMI agreement, Y snacks owns inventory but is located at ABC supermarket premises
- ABC supermarket shares the sales data and demand forecasting information with Y snacks
- On the basis of this information, Y snacks calculate the optimal order size and frequency required to maintain inventory levels and meet the demand.
- Y snacks ships the required inventory to ABC supermarket
- A VMI specialist or planner from Y snacks monitors ABC supermarket’s inventory levels and sales patterns to make sure optimal stock levels are maintained
- When it is time to reorder, VMI specialist or planner from Y snacks place the replenishment order with their own inventory that is then shipped to ABC supermarket.
By using VMI both ABC super market and Y snacks benefit from minimized inventory costs, optimized inventory levels and improved in-stock performance.
Vendor Managed Inventory Advantages and Disadvantage
VMI is a win-win for both vendors and buyers. A significant benefit of VMI is minimized cost of inventory management that benefits everyone.
Advantages of VMI to buyer
- Minimized risk: Buyers do not have to invest in the inventory they may not be able to sell
- No more cash flow restrictions: Money is not tied up with sitting inventory; as inventory is not paid for until it’s sold. Vendors bring in entire analytical ability to bear on replenishment ensuring inventory is optimized.
- Low inventory levels: With suppliers accepting risk of inventory not selling, one can rest assured they are cognizant of overstock and potentially obsolete or expired inventory. That means they exercise caution and opt for low inventory levels and more frequent shipments.
- Low carrying costs: Low inventory levels means low carrying costs as one minimize all excess stock and reduce the cost of storing and maintaining it.
- Less or no safety stock: Safety stock, buffer stock and safety stock tie-ups lots of money and effort. They also carry risk. When the suppliers take control of inventory management process they will be able to combine the data with their familiarity with the lead time to do away the need for extra stock.
- Reduce inventory shrinkage: Shrinkage is in unavoidable part of carrying inventory. The fewer inventories one will keep on hand, the less shrinkage one will experience.
- Less or no stock outs: It is in the vendor’s best interest to keep buyers happy or they will find another vendor. By establishing fluid, consistent replenishment with a VMI system, one will eliminate the uncertainty around random and periodic ordering. The vendor will always know exactly how to juggle lead time with demand as they are used to doing it.
- Planning, Ordering and inventory management costs minimize as they are shifted to vendor, supplier or manufacturer.
- Sales and brand loyalty increase because product knowledge among staff grows due to frequent contact with vendor representatives.
VMI benefits for vendors and suppliers
- More control over in-store product display, organization and branding
- Able to leverage the sales expertise of in-store staff, that will boost sales and brand loyalty
- Decrease the magnitude of bullwhip effect; a phenomenon that sees material orders increase in contrast to demand swings the further up the supply chain.
- Apt demand forecasting for products. With visibility to sales patterns, stock level, and demand forecasting, vendors can anticipate inventory needs and customer orders.
- Minimize carrying costs with more apt understanding of product’s demands.
Disadvantages of VMI
- Some suppliers are not data analytics organizations. They are not up to the data analysis that VMI needs. Ensure vendor you are dealing with is comfortable with numbers.
- It is more difficult to dissolve relationship that is not working out. A VMI relationship involves two organizations integrating with each other. It needs more efforts to disengage and walk away with amount of integration.
- It is vulnerable to share data with outside party. Make sure it is an airtight confidential agreement.
VMI are Symbiotic
Vendors have found the buyer that will protect one from predatory octopus of un-optimized in-store displays and disinterested sales people. Buyers have found a vendor who will freely transport one across raging sea of unreliable inventory management to tranquil shores of profitability.
- What Companies use VMI?
VMI is being used by more companies to benefit both supply and demand side. Some companies that use VMI are
- Pharmaceutical companies
- Ecommerce platforms
- Electronic companies
- Supermarkets and more
- What is the purpose of VMI?
VMI is a kind of inventory system where vendors use a buyer’s premise to store products, but still have control over their inventory. VMI is used by suppliers to outsource product storage to and by buyers to minimize amount of product receiving they are involved in. VMI creates a smooth flow of goods between supplier and buyer at low cost and with greater insight into demand changes.
- How do you analyze vendor performance?
Vendor performance is analyzed by establishing vendor key performance indicators or KPIs. It is business metric that can be measured across time with the intent to improve it. For instance VMI KPIs can be invoice accuracy, lead time, vendor availability, and defect rate.