What Is Vendor-Managed Inventory (VMI) and How to Use It?

Vendor-managed inventory is a supply chain management method wherein a supplier is responsible for replenishing the inventory of the buying company. This approach can lead to better inventory optimization, reduced costs, and stronger relationships between companies.

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What is Vendor-Managed Inventory?

Vendor-managed inventory (VMI, also known as continuous replenishment or supplier-managed inventory), is a supply chain management method where a company shares inventory data with their suppliers in order for the vendors to ensure that sufficient quantities of stock are consistently available at the buyer’s facility.

In traditional inventory management, the buying company makes decisions regarding when and how much stock to order. In the case of vendor-managed inventory, however, the responsibility of replenishing and optimizing a company’s stock is passed on to the suppliers. By using this method, purchasing and inventory management are simplified and supplier relationships strengthened.

This approach does demand a large degree of collaboration between the buying company and the suppliers so a certain level of trust needs to be established before deciding to operate in this fashion.

Benefits of Vendor-Managed Inventory

There are plenty of advantages that come with vendor-managed inventory, both for the buying company and for the suppliers.

Benefits for the buying company

1. Easier management of purchases and inventory

Automatically sharing inventory data with a supplier allows a company to spend much less time on demand forecasting, purchasing, and inventory optimization. Instead, these tasks are left to the supplier who has to make sure that neither overstocking nor stock-outs would happen.

2. Reduced inventory space requirements

With vendor-managed inventory, a company can forego holding safety stock, keeping only quantities of stock that are required in a certain time period. Inventory levels are monitored by the supplier and when a reorder point is reached, stock will be replenished.

3. Reduced costs

Needing less space for holding stock and spending less time on supplier communication, inventory optimization, forecasting, etc. also means spending less labor and money, giving the company a chance to divert resources into other areas of the business.

4. Better communication with suppliers

With the shared and readily available inventory data, there is no need for many purchasing account managers in a buying company as communication is largely automated. In case there is a sudden spike in demand, suppliers will be instantly informed. And when a disruption occurs on the supplier’s side, i.e. they would not be able to replenish their customer’s inventory in the desired quantities, they can notify the client much sooner.

5. Improved customer satisfaction

When running smoothly, vendor-managed inventory can ensure optimal service levels, meaning that customers can trust the buying company to accept their orders and deliver the merchandise on time. This, in turn, improves customer satisfaction, increases customer loyalty, and props up the company’s image, which also aids in creating more business.

Benefits for the supplier

1. Easier forecasting

When a supplier has a full, real-time view of their customer’s inventory requirements, they can create highly accurate forecasts and develop their processes so that deliveries become seamless. Better communication also ensures that suppliers are kept up-to-date when it comes to the buying company’s market changes, which helps retain flexibility in case of fluctuations in demand.

2. Better inventory optimization

Vendor-managed inventory is not only beneficial in this sense to the buying company. Vendors themselves can also optimize their inventory better when they can develop more accurate demand forecasts and anticipate customer orders.

3. Stronger customer relationships

Vendor-managed inventory requires a lot of trust on the buyer’s side from the start, but if it is performed well, it can significantly increase confidence in the supplier. Business is always about providing customers with what they need when they need it. VMI gives suppliers the necessary insights to hone their processes and quickly respond to the customer’s needs.

Drawbacks of Vendor-Managed Inventory

Even though passing the buck of inventory management to a supplier can seem like a good idea, there are also some things that need to be considered on both sides.

Drawbacks for the buying company

1. Relying on another company

Choosing to implement vendor-managed inventory means relinquishing a lot of control to another company, and that might be an issue for many business owners and managers. Being unsure of the vendor’s capabilities and having security concerns is never a good basis for a fruitful cooperation and that is why trust is key to VMI.

2. Difficult re-sourcing

Having chosen a vendor to be your VMI partner, you might get the sense that from then on, everything will be running smoothly. But even with the best partners, disruptions may occur. This is why a buying company has to establish a base of backup suppliers that can come to the rescue when a disruption prevents the VMI partner from performing their tasks on the required terms. When using vendor-managed inventory, managers also have the risk of getting stuck to the supplier and passing up on partnerships with more cost-effective suppliers.

Drawbacks for the supplier

1. More responsibility

Being the supplier in a VMI partnership increases the workload of the company and makes them more responsible for the successes and failures of the buying company. Inventory management is one of the most important and most expensive aspects of a business and for some, having another company lean on yours in that matter might be a load too heavy to bear.

2. Not feasible with small orders.

The extra work put into checking, analyzing, and optimizing the buying company’s inventory also means extra labor costs. So being a vendor that manages a client company’s inventory only pays off when the business they get from them is large enough to still turn a profit.

How to implement Vendor-Managed Inventory?

If you have weighed the pros and cons of vendor-managed inventory and have decided it is a good fit for your company, here are the basic steps for starting a partnership.

1. Use a cloud-based inventory management system

Vendor-managed inventory cannot be efficiently done without a cloud-based inventory management system. Whether it is a spreadsheet that is continuously updated, or an inventory management software – it needs to be cloud-based in order to provide the supplier with real-time access to inventory data. The software obviously also has to match other needs of the buying company.

2. Draw up an iron-clad agreement

In business, trust needs to be backed up with a written agreement. In the case of vendor-managed inventory, the agreement needs to specify terms regarding inventory locations, inventory ownership, level of data access, delivery triggers and other aspects of the replenishment process, payments, performative KPIs, etc. Using a standard supplier agreement is not nearly enough and a VMI-specific agreement needs to be drawn up.

3. Provide access to the supplier

When an agreement has been signed, the supplier has to be given access to the data according to the level of access specified in the contract. This may include software areas such as inventory, sales, production, product returns, goods in transit, backorders, etc.

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Vendor-managed inventory requires the implementation of an inventory management system and providing the supplier with access to the software.

4. Evaluate performance

KPIs related to supplier performance management have to be established in the VMI agreement. During the partnership, these metrics are periodically reviewed in order to evaluate the vendor’s compliance with the agreement. Apart from helping in decision-making when it comes to continuing the partnership, communicating the KPIs to the supplier can also help them refine their processes.

Key takeaways

  • Vendor-managed inventory is a supply chain management method wherein a supplier is given access to the buying company’s inventory data and becomes responsible for optimizing and replenishing their stock.
  • The benefits of VMI for the buyer include: more efficient inventory management, reduced inventory space and costs, better communication with suppliers, and improved customer relationships.
  • The benefits of VMI for the supplier include: easier forecasting, more efficient inventory optimization, and stronger relationships with customers.
  • The disadvantages of VMI for the buyer include: difficulty giving away control over their inventory and relying on another company, and the possible complexity of changing vendors.
  • The drawbacks for the suppliers are: increased responsibility and the unfeasibility of cooperation with companies that require small orders.
  • Vendor-managed inventory requires the implementation of an ERP/MRP system on the buyer’s behalf, providing the supplier access to the system, negotiating a waterproof contract, and evaluating the performance of the vendor.

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