What is Vendor Managed Inventory (VMI)?
Updated: Aug 9, 2024
Vendor managed inventory (VMI) is an arrangement where suppliers manage inventory levels that have been pre-determined. In short, the supplier takes decisions on behalf of the retailer wherein the supplier replenishes the inventory continuously. Also known as managed inventory, VMI is a data-driven with advanced procurement software, which can help vendors plan shipping and production dates in advance to minimize stock-out risks.
To achieve the above-mentioned goals, suppliers need high levels of visibility and control which can only come from an inventory management software that can centralize, collate, analyze and interpret data in real time. The software lets users set stock thresholds and notify vendors each time stocks fall below minimum inventory levels. Furthermore, the supplier simulation functionality helps vendors see what impact different stock levels will have, helping them plan more efficiently.
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Vendor Owned Inventory Management
In a traditional inventory management system, the customer is responsible for managing their own inventory levels and reordering products when needed. However, with vendor managed inventory, the vendor takes on this responsibility. They use inventory management software and tools to track inventory data, analyze sales data, and forecast customer demand. By having real-time visibility into the customer's inventory levels, the vendor can proactively replenish stock and ensure that the customer never runs out of products.
How a Vendor Managed Inventory System Works
A vendor managed inventory system works through a partnership between the vendor and the customer. The vendor collects data on the customer's inventory levels, sales data, and demand forecasts. Using this information, they create a plan to replenish stock and maintain optimal inventory levels. The vendor then takes care of the entire supply chain process, from ordering products from the manufacturer to delivering them to the customer's location. This system reduces the burden on the customer and allows them to focus on their core business activities.
Vendor Managed Inventory Example
To illustrate how vendor managed inventory works, let's consider a hypothetical scenario. Imagine a retail store called Home World that sells home decor products. Home World has entered into a vendor managed inventory agreement with a furniture supplier. The supplier regularly monitors Home World's inventory levels and sales data. Based on this information, the supplier determines the optimal stock levels for each product category. When the inventory levels fall below a certain threshold, the supplier automatically replenishes the stock without the need for Home World to place an order. This ensures that Home World always has the right amount of furniture to meet customer demand.
Vendor-Managed Inventory Metrics
In a vendor managed inventory system, certain metrics are used to measure the effectiveness and efficiency of the inventory management process. These metrics help both the vendor and the customer evaluate the performance of the system and make data-driven decisions. Some key performance indicators (KPIs) for vendor managed inventory include:
On-time Delivery: Measures the percentage of orders delivered on time.
Fill Rate:Â Measures the percentage of customer orders that are fulfilled completely.
Inventory Turnover:Â Measures how quickly inventory is sold and replenished.
Stockout Rate: Measures the frequency of stockouts or situations where the customer's demand cannot be met due to insufficient stock.
Order Cycle Time: Measures the time it takes for an order to be processed, fulfilled, and delivered.
By monitoring these metrics, both the vendor and the customer can identify areas for improvement and make adjustments to optimize the inventory management process.
The 3 Factors that Make a VMI System
A successful vendor managed inventory system relies on three key factors: vendor-controlled inventory management, vendor-controlled reordering and stock keeping, and business and vendor information sharing.
Vendor-controlled inventory management: In a VMI system, the vendor takes control of managing the customer's inventory levels. They monitor the stock levels, analyze sales data, and forecast demand to ensure that the right amount of inventory is available at all times.
Vendor-controlled reordering and stock keeping: The vendor is responsible for initiating the reordering process when the inventory levels fall below a certain threshold. They also take care of stock keeping activities, such as receiving, storing, and organizing the inventory.
Business and vendor information sharing: To effectively manage the inventory, both the vendor and the customer need to share relevant information. This includes sales data, demand forecasts, lead times, and any other data that can help optimize the inventory management process.
By having these three factors in place, a vendor managed inventory system can streamline the supply chain and improve overall efficiency.
Benefits of Vendor-Managed Inventory
Implementing a vendor managed inventory system offers several benefits for both the vendor and the customer. Let's explore some of these benefits:
Reduced cost
One of the main benefits of VMI is cost reduction. By taking control of inventory management, the vendor can optimize the replenishment process and avoid excess inventory. This helps to minimize holding costs, reduce the risk of obsolescence, and decrease storage and handling expenses.
Less risk
With VMI, the customer transfers the risk of inventory management to the vendor. The vendor is responsible for monitoring and maintaining the inventory levels, ensuring that the right products are available at the right time. This reduces the risk of stockouts and enables the customer to focus on their core business activities.
Better forecasting
VMI relies on accurate demand forecasting to ensure that the right amount of inventory is available. By sharing sales data and demand forecasts with the vendor, the customer can benefit from the vendor's expertise in demand forecasting. This leads to improved inventory planning and reduces the likelihood of overstocking or understocking.
Improved Relationships with Suppliers
VMI fosters closer collaboration and communication between the vendor and the customer. By working together to manage the inventory, both parties develop a deeper understanding of each other's needs and constraints. This leads to stronger relationships and can result in better terms, pricing, and overall satisfaction.
Managed Stock Levels
With VMI, the customer no longer needs to worry about monitoring and maintaining stock levels. The vendor takes care of this responsibility, ensuring that the inventory is replenished in a timely manner. This helps to avoid stockouts and enables the customer to meet customer demand consistently.
Fewer Human Errors
By automating the inventory management process, VMI reduces the risk of human errors. Manual inventory management can be prone to mistakes such as incorrect data entry or miscalculations. With VMI, the reliance on manual processes is minimized, leading to more accurate and efficient inventory management.
Implementing a vendor managed inventory system can bring significant benefits to both vendors and customers. However, it is important to consider the potential drawbacks and best practices associated with VMI to ensure successful implementation and operation.
Why do so Many Large Businesses use VMI?
Vendor managed inventory has become increasingly popular among large businesses due to the numerous advantages it offers. Let's explore some of the key reasons why large businesses choose to implement VMI:
Better Relationships with Suppliers
VMI promotes closer collaboration and communication between the vendor and the customer. By working together to manage the inventory, both parties develop a deeper understanding of each other's needs and constraints. This leads to stronger relationships and can result in better terms, pricing, and overall satisfaction.
Less Need for Safety Stock
Traditional inventory management often requires businesses to maintain safety stock as a buffer against stockouts. With VMI, the vendor takes on the responsibility of monitoring and replenishing the inventory levels. This reduces the need for safety stock and enables businesses to operate with leaner inventory levels.
Less Upfront Supply Chain Management
Managing the supply chain can be a complex and time-consuming process. With VMI, the vendor takes care of the entire supply chain process, from ordering products to delivering them to the customer's location. This reduces the upfront supply chain management required by the customer, allowing them to focus on other core business activities.
Reduced Purchasing Costs
By implementing VMI, businesses can benefit from economies of scale and reduce purchasing costs. Vendors often have better bargaining power with manufacturers due to larger order volumes. This can result in lower unit costs for the customer, leading to overall cost savings.
Less Inventory Needed
VMI helps to optimize inventory levels and reduce excess inventory. By closely monitoring inventory levels and demand forecasts, the vendor ensures that the right amount of inventory is available at all times. This reduces the need for large stockpiles of inventory, freeing up working capital and warehouse space.
Easier Forecasting for Vendors
Accurate demand forecasting is crucial for effective inventory management. With VMI, the vendor gains visibility into the customer's sales data and demand forecasts. This enables them to plan their production and replenishment activities more effectively, resulting in better inventory management for both parties.
Fewer Stockout Situations
Stockouts can be detrimental to businesses, leading to lost sales and dissatisfied customers. By implementing VMI, businesses can reduce the risk of stockouts. The vendor takes responsibility for monitoring and replenishing the inventory, ensuring that the customer never runs out of stock.
The advantages of VMI make it an attractive option for large businesses looking to streamline their supply chain, reduce costs, and improve efficiency. However, it is essential to follow best practices to ensure successful implementation and operation.
Best Practices for Vendor Managed Inventory
Implementing a vendor managed inventory system requires careful planning and execution. Here are some best practices to consider:
1. Set Boundaries and Fees
Clearly define the responsibilities and boundaries of both the vendor and the customer. This includes the products covered by VMI, target inventory levels, and any fees associated with the service. Having clear boundaries helps to avoid misunderstandings and ensures that both parties are aligned on expectations.
2. Create Goals and Metrics for Success
Establish clear goals and key performance indicators (KPIs) to measure the success of the VMI program. This could include metrics such as on-time delivery, fill rate, inventory turnover, and stockout rate. Regularly monitor these metrics to identify areas for improvement and make data-driven decisions.
3. Provide Frequent and Abundant Data
Effective communication and information sharing are essential for successful VMI. Provide the vendor with frequent and abundant data, including sales data, demand forecasts, and lead times. This enables the vendor to optimize inventory management and make accurate replenishment decisions.
4. Keep your Vendor Updated and be Honest
Maintain open and honest communication with your vendor. Keep them updated on any changes in your business, such as new product launches or promotional activities. This helps the vendor to align their inventory management strategies with your business needs and ensures a collaborative approach.
By following these best practices, businesses can maximize the benefits of vendor managed inventory and create a successful partnership with their vendors.
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Conclusion
Vendor managed inventory is a collaborative approach to inventory management where the vendor takes control of managing and replenishing the customer's inventory. This strategy offers numerous benefits, including reduced costs, better forecasting, and improved relationships with suppliers. Large businesses often choose to implement VMI due to the advantages it brings, such as better supplier relationships and reduced inventory needs. However, it is essential to follow best practices and consider the potential drawbacks to ensure successful implementation and operation. By carefully evaluating the specific needs of the supply chain and establishing clear boundaries and metrics for success, businesses can maximize the benefits of VMI and create a successful partnership with their vendors.
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