Vendor Managed Inventory (VMI) is an inventory replenishment arrangement whereby the supplier either monitors the customer's inventory with its own employees or receives stock information from the customer. The vendor then refills the stock automatically, without the customer initiating purchase orders. (source)
Vendor Managed Inventory was first tested on a large scale by Procter & Gamble and retail gaint Walmart in the 1980s. Perfecting this process has allowed Walmart to maintain its position as the largest retailer in the world (and the second largest company in terms of revenue). When Walmart signs a contract with a new vendor, their product SKUs are added to Walmart's infamous Retail Link site, and the vendor is responsible for managing its own stock levels.
1. Determine if VMI is a Good Fit for Your Business
First things first: Is Vendor Managed Inventory even a good fit? While it sounds like a sensible and beneficial strategy, it isn’t the right solution for every company. Here are some questions to ask yourself:
- Are your sales a large enough % of business for this supplier to justify assuming more risk?
- Are your sales steady? Or highly seasonal? Or mostly make-to-order?
- Is your supplier able to adapt quickly to changes in your forecast?
- Does your supplier have the resources (trained employees) and infrastructure (sophisticated IT systems, warehousing space) readily available to adequately manage your inventory?
Decide if this strategy makes sense for your unique position (here is a helpful article), then initiate a conversation with your supplier.
2. Clarify Expectations at the Start
Open and thorough discussions with your supplier about starting a Vendor Managed Inventory program will increase your chances of success. Because there are benefits and risks for each party, expectations must be clarified at the beginning.
This last bullet point should be a big talking point. What usually happens is this: the supplier owns the inventory for longer periods of time and thus carries more inventory risk (ties cash up). The supplier must decide if this risk is a reasonable tradeoff.
- What does each party expect to gain from this agreement?
- What hurdles need to be tackled before implementation?
- What is a reasonable timeline for implementation?
- How many months of safety stock should the supplier have on hand at any given time?
- Are there inventory must-take terms (30, 60, 90, 120 days)?
- Which party accepts responsibility for slow-moving items?
- Will material handling, storage and trucking costs be billed separately or bundled into unit price?
- How will each party's cash flow be affected?
3. Establish a Smooth Transfer of Information
A VMI program is only as good as its quality of information exchange! Trust us, this is absolutely true. For the supplier to effectively keep goods in the pipeline and properly manage inventory, they will need full visibility to your sales and inventory levels. Here are a few things to keep in mind:
- Supplier will need daily or weekly forecast from customer
- Actual sales and current stock is better than a forecast (no guessing)
- Supplier can plan for upcoming shifts or seasonal spikes in demand
- Supplier should provide order status reporting so customer can view live information
- The ultimate goal is transparency from both sides
4. Integrate Systems Wherever Possible
As mentioned in the above point, information exchange is key to a successful VMI program. While data can be exchanged and managed manually on a small scale or for a short period of time, this is not a sustainable way to operate. Using and linking electronic data interchange (EDI) systems is the best solution, so make this a priority if possible. Below are some benefits of IT integration:
- Reduced number of spreadsheets
- Less risk of confusion or misunderstanding
- Vendor can access live information and reports to check inventory status and orders
- More reliable
5. Keep Communication Lines Open
The most common cause of failure is a breakdown in communication. Both parties must be willing and able to keep lines of communication open. The goal here is to form a mutually beneficial partnership, so you need to be on the same page. Here at East West, we have to account for Chinese New Year production shutdowns each year when planning inventory for our customers. If we do not properly communicate the impact of CNY and our plan to maintain an uninterrupted supply chain, our customers could be left in the dark and end up in a bad position if they suddenly need a surge of goods during the shutdown period. Here are a few examples of when open communication is especially important:
- If demand changes and goods need to be expedited or stored for a longer period
- If an order will be late or there is some other disruption in the supply chain
- If there is an extenuating circumstance and customer needs flexible terms for a decided upon period of time (e.g., must-take term extended from 60 to 90 days)
Vendor Managed Inventory offers benefits for both vendors and suppliers. Here are just a few:
- Lean inventory
- Reduced operating costs
- Stronger supplier-vendor relationship
- Increased sales for supplier
- Better service levels
To read more about how we manage this process here at East West, check out our post:
Benefits of Using East West VMI