Every year VMI (Vendor Managed Inventory) is becoming more and more popular and widespread. However, VMI is not a new concept, it has been standard practice since the end of last century in some industries such as the automotive industry. In the retail industry, American Walmart was a VMI pioneer launching their VMI program in the 1980’s. VMI was one of Walmart’s competitive advantages for a long time and one of the company’s cornerstones which allowed the company to expand its business fast. One of the reasons why Amazon could expand their business and dominate the online retail market is that the company actively used VMI solutions with most of their suppliers. Today, VMI is a requirement to do business in many geographies and industries. For example, in many supply chains in the Netherlands, Germany, France and Switzerland it is nearly impossible to do business without a VMI solution.
How VMI Works
The idea behind VMI is simple – the supplier keeps stock in an agreed location, guarantees availability of goods and manages stock levels. Usually, VMI stock is held at the place of consumption, although this can vary depending on supply chain logic. For example, it may make sense to keep VMI stock before the painting line in a factory in order to enable shorter lead times if there is a large assortment of colors.
There are three main differences in how VMI works compared to traditional purchasing processes:
- There are no orders – goods are automatically replenished based to consumption data
- All responsibility to maintain adequate stock levels is transferred to the supplier
- The stock belongs to the supplier until it is consumed
VMI solutions require that consumption data is transmitted to the suppliers in real time. In this way, the suppliers know what items to replenish and are able adjust stock levels if consumption levels change over time.
In a VMI solution, the transmission of consumption data can be conducted in a traditional way, i.e. a person counts what items have been consumed and sends the data to the supplier. The data transmission can also be done in a more modern way, where consumption data is registered digitally and sent directly to the supplier’s ERP system. In both cases, a VMI solution can work effectively. The main difference lies in administrative costs that are lower if the information is transmitted digitally.
What Makes VMI Attractive for Client Companies?
The three largest benefits of VMI are better availability of supplies, lower purchasing costs, and less inventory on the balance sheet.
Better Supply Availability
It’s a simple premise – that supplies must always be available. Traditionally, purchasers ensure availability by buying the right quantities. Suppliers’ only role is to deliver the goods on time. When goods do not arrive on time purchasers are responsible for not foreseeing the situation and for bad planning. By shifting the responsibility to suppliers, the availability usually improves. This is due to the promise that VMI is based upon; purchasing at any time, if goods are available. VMI turns all stock-outs into lost sales for the suppliers. With VMI, it is no coincidence that suppliers make availability their most important objective.
Another reason why availability is improved with VMI is that suppliers get better consumption data. Suppliers get more information and therefore a better understanding of possible capacity issues. Suppliers are also better vested to quickly recognize when market demand increases and when there may be shortages or delivery delays.
Lower Purchasing Costs
High-quality purchasing functions are expensive. They require good information systems, fast data processing and competent employees. Even when these three requirements are fulfilled, the question often remains – what do purchasers spend most of their time on? Usually the answer is administrative tasks such as creating, managing, monitoring and filing orders. What VMI solutions do is alter the whole ordering process. When orders are eliminated, man-hours are reduced, as are other costs associated with administrating them. However, it is important to note that VMI can almost never fully replace traditional purchasing. There are usually some items that can’t be handled effectively in VMI such as purely seasonal products or project-specific products.
As a side effect of VMI’s “no orders” operations, the hidden costs of emergency purchases will decrease. How often has someone at your company had to perform extra tasks to solve a sudden case of out-of-stock? No matter if it is making an extra phone call, driving to a shop, paying for express delivery or something else, all these activities and costs will diminish significantly with VMI.
Less Inventory on the Balance Sheet
A “VMI solution” is often referred to as a solution where a client automatically sends consumption data to a supplier. However, in real VMI solutions, the stock held on a client’s premises always belongs to the supplier. The transfer of stock ownership takes place when the product is consumed. In traditional purchasing operations there is usually some excess stock held. Because of the enhanced consumption data, VMI solutions help reduce excess stock once and for all.
The greatest VMI benefits are reached when a VMI solution is implemented at several suppliers. When this is the case, inventory reductions are often significant. Cash is freed and previously locked growth opportunities can be pursued. It’s also important to point out that if VMI is implemented correctly, there will be no increase in the supplier’s total inventory. Considering the many positive effects of VMI, why it is not the standard everywhere?
When the Value of VMI Solutions can be Questioned
VMI solutions can be very effective in a wide range of industries and supply chains, yet there are some circumstances where the value is diminished. Here are some situations in which VMI is less effective:
- Replenishment time is too long. As a rule, if replenishment time (production time, transportation time and delivery interval) exceeds 1 month, a VMI solution may not be effective. In this situation it’s difficult to avoid stock-outs, thus providing excellent availability is a challenge. It is important to note that long replenishment time is often something that can be shortened and should therefore be considered more as an obstacle than a fact of life.
- The minimum order quantity is several times higher than the short-term consumption levels. For example, if the monthly consumption is 100 pieces, but the supplier’s minimum order quantity is 300 pieces, a VMI solution would lose some of its benefits. It’s usually not a problem if this is the case for one or two VMI stock items, but if it applies to several items the solution requires the suppliers to hold excess stock.
- Consumption is very unstable or unpredictable. When the demand fluctuates a lot during a replenishment time-cycle, a VMI solution becomes an expensive option for the supplier because overstock is inevitable in this situation. It is often the case that consumption levels are relatively stable for most of the year and fluctuations only happen in certain periods. If that is the case, VMI solutions are still good options as they then only require stock management fine-tuning during the unstable periods.
- A retailer wants a VMI solution to support campaign sales without taking any risk. If a retailer wants a VMI product to be available during an entire campaign period but is unable to make a reliable prediction of the demand, the supplier ends up taking a significant risk. Also, VMI isn’t beneficial to suppliers in this situation as the products are only sold during a limited campaign period.
In this blog post we have only scratched the surface of the benefits and constraints of VMI solutions. Based on observations of thousands of VMI solution implementations, it’s clear that when a supplier’s role changes from being a passive provider of goods to a proactive VMI provider, supply planning and stock management increases. The supply chain becomes more effective and waste is reduced. VMI gives suppliers the opportunity to become even better partners with their clients and thus create even more value. These topics will be discussed in greater detail in our next blog post.