Small Business Supply Chain: Vendor Managed Inventory (VMI)

In VMI a vendor takes responsibility for maintaining an agreed inventory

Inventory Optimization

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Vendor Managed Inventory (VMI) is a business model where the buyer of a product provides information to a vendor of that product and the vendor takes full responsibility for maintaining an agreed inventory of the material, usually at the buyer's consumption location.

A third party logistics provider can also be involved to make sure that the buyer have the required level of inventory by adjusting the demand and supply gaps. VMI makes it less likely that a business will unintentionally become out of stock of a good and reduces inventory in the supply chain.

Some vendors supply an advance ship notice (ASN) to their customers to inform them of an incoming order, which is known as EDI 856. The ASN differs from the purchase order acknowledgment in both timing and content. The 856 is sent to the customer after the shipment has been made instead of at the time of the purchase order.

Benefits of Using VMI

One of the benefits of VMI is that the vendor is responsible for supplying the customer when the items are needed. That can lead to:

  • Removal of safety stock
  • Lower inventory levels
  • Reduction in purchasing-related admin costs

VMI removes the need for the customer to have significant safety stock because the supplier manages the resupply lead times. Lower inventories for the customer can lead to significant cost savings.

The customer also can benefit from reduced purchasing costs. Because the vendor receives data and not purchase orders, the purchasing department has to spend less time on calculating and producing purchase orders.

In addition, the need for purchase order corrections and reconciliation is removed which further reduces purchasing costs. Cost saving can also be found in reduced warehouse costs. Lower inventories can reduce the need for warehouse space and warehouse resources.

Benefits for the Supplier/Manufacturer

The supplier/manufacturer can gain some benefits from vendor managed inventory as they can gain access to a customer's point of sale (POS) data makes their forecasting somewhat easier.

Manufacturers can also work their customers' promotional plans into forecasting models, which means enough stock will be available when their promotions are running.

As a manufacturer has more visibility to their customers' inventory levels, it is easier to ensure that stock-outs will not occur as they can see when items need to be produced.

VMI - when deployed correctly - is one way to help you supply your customers what they want, when they want it - because - assuming your vendors are managing your inventory in an optimized fashion - you should always have stock on hand. And will be able to ship on time.

VMI can also help you keep your costs down, since the goal of VMI is to keep your inventory levels lowered and provide your resupply as needed.

Disadvantages of VMI

The disadvantages of VMI include needing to allow a non-employee access to your inventory data and sometimes your actual physical inventory. You're also relying on a third party to keep your inventory levels where you need them to be, and that perceived lack of control can sometimes be unnerving to supply chain professionals. 

One of the biggest drawbacks to VMI, however, can be its impact on sourcing. Oftentimes, supply chain managers will feel like they can't find another source for a product that is being managed by a supplier they trust.

If a supply chain manager becomes too reliant on a supplier to manage its inventory, the supply chain manager may live with higher prices, reduced quality or other supplier-related issues. 

Supply chain managers also find it difficult, at times, to have multiple sources for a product that's being managed by a supplier. As a supplier, if you can earn the trust of your customer and demonstrate the ability to optimize your customer's inventory using VMI, you know that you are likely going to remain the supplier of that product for the long haul.

It's difficult enough for a supply chain manager to engage in a sourcing project when there is no VMI impact. A well-run VMI makes a re-sourcing exercise not just onerous, but a very low priority.

Article has been updated by Supply Chain & Logistics Expert, Gary Marion