Setting up a Vendor Managed Inventory Program in 5 Simple Steps

Are you looking for ways to reduce costs, streamline ordering and ensure that you never run out of product? Uh... Is this a trick question? Of course you are!

One tried and true solution could be adopting Vendor-Managed Inventory (VMI), an arrangement between your company and your supplier to automatically replenish stock.

It's a simple process: 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.

VMI requires a strong relationship and a willingness to be transparent with your supplier. You'll see in our keys below, communication is an essential element of a successful VMI program. If you think your company is ready to take the plunge, keep reading!

What are the Benefits of VMI?

Before we dig in too deeply on how to set up a VMI program, it's good to understand some of the real benefits VMI can bring to your business. For most companies, there are three three main advantages to setting up a VMI program:

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?

5 Steps to a Successful Vendor Managed Inventory Program 

1. Determine whether VMI is the right fit for your company. 

Questions to ask:

• Are your sales a large enough percentage of business for this supplier to justify assuming more risk?
• Are your sales steady? Are they 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 the answer to these questions is "Yes!" talk to your supplier to find out if they offer VMI services and whether your company qualifies.  

2. Set realistic expectations at the start. 

Open and honest discussions, as well as a thorough understanding of what's involved in a VMI program, will increase your chances of success. Talk about your expectations and be realistic. Understanding that there are benefits and risks for both you and your supplier. Ask:

• What does each party expect to gain from this agreement?
• What needs to be done before implementation? Are there obstacles that need to be overcome?
• 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. Here's how it's usually handled: the supplier owns the inventory for longer periods of time and carries more inventory risk (ties up more cash). The supplier must decide if this risk is a reasonable trade off.

3. Establish seamless information transfers. 

Now hear this: A VMI program is only as good as its quality of information exchange. Suppliers need full visibility into sales and inventory levels to effectively keep goods in the pipeline and properly manage inventory. Keep these things top of 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

4. Integrate systems wherever possible. 

While data can be exchanged and managed manually on a small scale or for a short period of time, it's not the way to do business long term. A successful VMI program will use and linking electronic data interchange (EDI) systems. This should be considered a priority. Benefits of IT integration include:

• Fewer spreadsheets
• Reduced risk for confusion or misunderstanding
• Vendor can access live information and reports to check inventory status and orders
• Greater reliability

5. Keep the lines of communication open. 

"What we've got here is failure to communicate," is a famous line from the classic movie Cool Hand Luke. (Watch it if you never have.) The end goal of this relationship is to form a mutually beneficial partnership. That can't happen if you're not talking or in contact. But when a breakdown in communication occurs, bad stuff happens in your business.

For example, your supplier needs to account for Chinese New Year (CNY) production shutdowns each year when planning your inventory. If they don’t communicate the impact of CNY and how they plan to maintain an uninterrupted supply chain, you could be left in the dark 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)

Here's a good rule of thumb when it comes to communication: Don't let a breakdown in communication occur from your side.  (After all, it's the only side you can control, right?)

That sums up the basics of the vendor managed inventory process, but one of the first steps in inventory planning is creating an accurate forecast. Click on our free download to find out what data you need to build your own forecast!