East West Manufacturing Blog

Benefits of Using a Vendor-Managed Inventory Program

Written by Patty Rasmussen | October 12, 2017

You’re looking for ways to reduce costs, streamline ordering and ensure that you never run out of product. Isn’t everyone?

One solution could be adopting Vendor-Managed Inventory (VMI), an arrangement between your company and your supplier to automatically replenish stock. At the core it’s pretty simple: Your supplier either monitors your inventory using its own employees or gets stock information from you — the customer. The stock is refilled automatically, without customer initiation. Sounds pretty sweet, right? Done right, and for the right customer, VMI can be a win-win situation for you and your supplier.

Maybe you’re thinking your company is too small to benefit from inventory management systems. Not so fast. VMI has more to do with lead times than the size of your company. Talk to your supplier. By analyzing SKUs in multiple categories, your supplier can build containers to decrease overall stock and increase purchase frequency, allowing you to maximize savings. Your vendor can help you make better buying decisions, including managing costs by reducing spikes and dips in inventory.

We've identified three clear benefits to you:

1 | Lean Inventory

In business, cash flow and inventory levels go hand in hand. It’s frustrating to watch dust settle on slow-moving products sitting in your warehouse. In the case of a VMI program, your supplier takes on the burden of the tied-up cash/stock. You let your supplier know which goods you need and when, and they’ll get them to you just in time. Obviously, there are details that must be worked out. Both parties outline a detailed arrangement with clearly defined terms such as inventory hold periods, must-take deadlines, payment terms and the like.

An added bonus is that your inventory management program can help you plan for supply chain disruptors like the Chinese New Year shutdown.

2 |  Lower Operating Costs

Now that someone else is managing your inventory, you can free up capital paying for space or personnel. You’ll provide your vendor with your sales history and the amount of inventory you typically have on hand. They’ll use that data to forecast your demand and come up with a plan which includes the quantity and frequency to order. You either place the orders according to their suggestions or authorize them to order on your behalf, based on the proposed plan. Usually, once the goods are ready, they ship to your supplier’s warehouse or another 3PL location until you send an inventory release.

3 |  Stronger Supplier Relationship

You might have realized that a vendor-managed inventory program requires a high degree of trust between you and your supplier. That sort of trust develops a real partnership that brings about lower costs and higher efficiencies for you, while helping your vendor manage their manufacturing requirements and mitigate unanticipated fluctuations in seasonal demand and market shifts. This kind of insight means your supplier has your product when you need it most.

Okay, so you think VMI could be a great tool for your company. What’s next?

Establishing & Maintaining a Successful VMI Program

Is This a Good Fit?

Ask yourself these questions to determine whether VMI is a good fit for your company:

  • Are your sales a large enough percentage 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 trained employees, appropriate IT systems and warehouse space available to adequately manage your inventory?

If you answer these questions affirmatively, initiate a conversation with your supplier to find out whether they offer VMI services and whether your company qualifies.

Clarify Expectations at the Start

There are benefits and risks for both you and your supplier. Clarify expectations through open and thorough discussions. Transparency and trust, along with a clear understanding of what a VMI program entails, will increase your chances of success. Ask:

  • 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?

Don’t minimize that last bullet 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.

Establish a Smooth Transfer of Information

Now hear this: A VMI program is only as good as its quality of information exchange. 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 needs daily or weekly forecasts 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

Integrate Systems Wherever Possible

To reiterate: information exchange is essential 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

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.

For example, your supplier needs to account for Chinese New Year production shutdowns each year when planning your inventory. If they don’t communicate the impact of CNY and their plan to maintain an uninterrupted supply chain, you could be left in the dark and end up in a bad position if you suddenly need a surge of goods during the shutdown period. Other 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)

So that's vendor-managed inventory. Maybe after answering these questions for yourself, you're ready to ask some of your supplier. Who knows? VMI might be just the tool to help you move your company to the next level. 

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