What is Vendor Managed Inventory?
Vendor Managed Inventory (VMI) is a supply chain management practice in which the vendor or supplier of a product manages the inventory of that product at the customer’s location. In VMI, the supplier takes responsibility for monitoring the inventory levels of their products at the customer’s location and ensuring that the customer never runs out of stock.
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One of the important goals in supply chain management is to keep inventory levels as low as possible. Organizations keep an inventory of raw materials, component parts, work-in-progress (WIP), and finished products to manage fluctuations in material requirements and finished goods demands.
The cost of holding inventory is generally considered a waste, as in theory, it reflects the inability to accurately forecast requirements.
Although procurement management does not involve inventory management, it can play a major role in supply chain optimization. In blanket purchase orders, purchasing and inventory functions overlap. Blanket purchase orders allow system-generated release orders that are sent as and when a shipment of raw material is required, thereby reducing unnecessary purchasing and maintenance of raw material inventory.
The Vendor-Managed Inventory (VMI) is a more sophisticated concept that merges purchasing and inventory management functions. It is a streamlined system or approach to managing inventory and meeting purchase orders. In this system, the purchasing department gives information related to a product requirement to a supplier/vendor of that product.
In turn, the supplier fulfills the orders by ensuring that an adequate level of inventory of that product is normally available at consumption centers. A third-party logistics provider can also get involved to make sure that the customer (purchasing organization) gets the required product by plugging in the demand and supply gaps.
Similar to blanket orders, where material replenishment is made without routing through purchasing, VMI also allows vendors greater control so that they can directly replenish the inventory based on production requirements. In VMI, the vendor decides the level of inventory be maintained and manages it based on information-sharing between the manufacturer and vendor.
VMI helps the vendor in specifying product quantities that need to be sent to the manufacturer by the use of data received through Electronic Data Interchange (EDI). In this manner, VMI prevents stock-out situations by providing information with respect to inventory requirements in advance and maintaining an appropriate level of inventory in a supply chain.
Another important dimension of VMI is its role in supply chain optimization. Supply chain management is a concept utilized by organizations to improve their competitive position in the marketplace. Supply chain management involves close coordination and synchronization of information and material flows between the manufacturer and the supplier.
Usually, in traditional manufacturing organizations, inventories are replenished based on inventory management techniques, like min-max, economic re-order quantity, automatic re-order systems, automatic release orders, etc.
Inventory once purchased and shipped from the supplier is held at the manufacturing organization and owned by it. This traditional way of managing inventory is considered inefficient for integrated supply chains. For example, in order to fulfill replenishment orders, the supplier also needs to keep inventory stocks at his own manufacturing location, thereby duplicating inventory requirements.
This can be costly when the supply chain is viewed as a whole where both the manufacturer and the supplier are treated as parts of a single value chain. A bottleneck or inefficiency in one place can impact the efficiency of the entire supply chain.
If this duplication of inventory can be eliminated, it can greatly optimize the supply chain. This objective is actually the origin of the concept of Just-In-Time (JIT) manufacturing where the aim is to eliminate inventory at the manufacturer’s location. This requires highly efficient suppliers who can provide uninterrupted and continued supply.
But Just-In-Time (JIT) manufacturing shifts the problem of holding unnecessary inventory at the supplier’s end, though the overall quantum could be lesser. This is especially so when the supplier has to stock additional inventory to take care of the fluctuating production demands. This burden of holding additional inventory can be eliminated if there is close coordination between the manufacturer and the supplier with the possibility of transparent information sharing and ownership of overall costs.
The concept of VMI greatly helps in efficient collaboration between the supplier and the buying organization. In the traditional SCM scenario, the inventory replenishment is done as per MRP and inventory-planning systems. The supplier then plans his production as per the demand forecast and keeps sufficient inventory in stores to manage the fluctuating demand requirements. In the case of VMI, the responsibility of managing inventory to meet demand requirements is shifted to the supplier himself.
The manufacturer authorizes the supplier to make all inventory replenishment decisions including the quantity of inventory to be maintained, the timing of shipments, and re-order quantities. Based on inputs received from MRP and the demand planning systems of the manufacturer, the supplier assesses the incoming demand and plans his production schedule accordingly. Thus, VMI is a collaborative strategy that optimizes the availability of inventory at a minimal cost to both the manufacturer and the supplier.
The APICS dictionary defines VMI as a means of optimizing supply chain performance in which the supplier has access to the customer’s inventory data and is responsible for maintaining the inventory level required by the customer.
Features of Vendor Managed Inventory (VMI)
The important features of VMI can be listed as follows:
- A close partnership exists between the manufacturer and the supplier with efficient coordination of inventory and purchasing functions.
- The objective is to collaborate together to reduce excess inventory and enable efficient operation.
- The manufacturer shares forecasts with the supplier. A possible close-to-real-time information sharing on the production schedule, customer demand, and inventory data are envisaged.
- The supplier takes the responsibility of managing the inventory, though already shipped to the manufacturer’s location.
- The supplier constantly monitors and reviews on-site inventory with respect to the requirement forecast.
- The supplier ships or replenishes inventory based on pre-defined requirement levels.
- There will be no need to route shipments through the purchasing cycle of the procurement department, though purchasing and payables departments may be kept informed.
- The supplier invoices the manufacturer based on the inventory drawn for production. This ensures that the supplier has the incentive to keep as low inventory as possible.
- Once the inventory is shipped to the manufacturer’s location, the ownership of inventory shifts to the manufacturer through the management of inventory rests with the supplier.
A further extension of VMI is the consignment mode VMI, wherein the supplier ships the inventory to the shipping location specified by the manufacturer but retains the ownership of the inventory. The manufacturer will consider the inventory as purchased only when the inventory is drawn for production.
Benefits of Vendor Managed Inventory (VMI)
The important benefits of VMI to a manufacturing organization are:
- Supply chain optimization
- Effective integration of purchasing and inventory functions
- The reduced total cost of ownership
- More efficient supply chain by the removal of inventory bottlenecks
- Major reduction in inventory investment
- Reduced inventory-carrying and administrative costs
- Low safety stock requirements and fewer stock-outs
- Higher turnover of working capital
- Optimal product mixes
- Low replenishment costs
The VMI concept was initially popularised by big retailers like Walmart which has been successful in adopting the methodology. For example, in the VMI relationship between Procter & Gamble and Walmart, P&G gets access to Walmart’s sales data, based on which, it directly manages its product inventory at Walmart.