Vendor Managed Inventory

A supply chain practice where the vendor manages the inventory on behalf of the consuming organization. Explanation of Vendor Managed Inventory. ('88)

What is Vendor Managed Inventory? Description

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. Traditionally, success in supply chain management derives from understanding and managing the tradeoff between inventory cost and the service level. VMI projects can result in improvements along both dimensions. At least 2 forms can be distinguished:

A wholesaler (distributor) manages inventory levels for a retailer. VMI in this context is also called Efficient Consumer Response (ECR). Note that the retailer still owns the inventory, even though the replenishment order is triggered by the wholesaler.
A manufacturer manages inventory levels for a distributor. Note that the distributor still owns the inventory, even though the replenishment order is triggered by the manufacturer.

VMI 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. Compare also: RFID Technology.

Other terms for VMI are Continuous Replenishment and Supplier Managed Inventory.

Origin of Vendor Managed Inventory. History

VMI 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.

VMI is now gradually progressing towards strategic-partnership based forms. This influences the way companies plan their inventory, evolving to Collaborative Planning, Forecasting and Replenishment (CPFR).

Usage of Vendor Managed Inventory. Applications

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. Compare: Kraljic Model.
Strong competition (small margins). Example: Automotive.

Steps in Vendor Managed Inventory. Process

VMI 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. Benefits

Supply Chain level:
- Lower inventory levels at total supply chain level.
- Less overhead.
- Increased sales.
- Reduces human data entry errors.
Vendors:
- 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.
Suppliers:
- 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.
End-users:
- Increased service level.
- Reduced stock outs.

Limitations of Vendor Managed Inventory. Disadvantages

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. Conditions

VMI 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).

Book: Edward, A Silver - Inventory Management and Production Planning and Scheduling -

Book: David Simchi-Levi - Designing and Managing the Supply Chain -