What is Vendor Managed Inventory?

By
Elizabeth Scolari
June 14, 2016

Vendor Managed Inventory (VMI) is a B2B business strategy where a company that buys or distributes a product (let’s call them Company A) allows the vendor or seller of that product (Company B) to maintain and manage the inventory of that product after purchase so that Company A does not have to maintain that inventory in its own warehouse.

When does a Vendor Managed Inventory strategy make sense?

Vendor managed inventory has been around in various forms for many years. It is an important tool for maintaining a lean supply chain and reducing inventory storage costs. Companies that need to control their inventory management costs may benefit from the Vendor Managed Inventory approach. Many companies use Vendor Managed Inventory to control their inventory storage costs and to keep more room in their warehouse for other products. The strategy makes a lot of sense as well for companies that simply don’t have a lot of shelf or warehouse space to work with.

Who uses Vendor Managed Inventory?

All kinds of businesses – from restaurants and small retail shops, to big box retailers, to large manufacturing firms – may use Vendor Managed Inventory to ensure that they have the products they need to do business, without having to take up excessive room on their shelves or when products cannot be stored for long periods. For instance, when shopping at your local grocery store, you may have noticed that on certain mornings, a variety of delivery trucks pull up in front of the store. Bread is a great example: the bread delivery driver pulls up, goes inside, counts the bread that the grocery store has in stock, and brings in enough bread to restock the grocery store shelves to an agreed upon level, often referred to as “par.” At your local coffee shop, a milk delivery truck will pull up and do the same thing – he counts the number of milk cartons in the shop’s cooler, and drops off enough cartons of milk to refill the par level. Obviously, Vendor Managed Inventory makes a lot of sense in a context like this­­––involving products that are not shelf stable. These simple examples are also examples of Direct Store Delivery. As the name suggests, Direct Store Delivery means a supplier delivers goods straight to the store. One of the main differences is that with Direct Store Delivery, the store might be counting the inventory (for instance, if the grocery store manager counts the bread and places the order). With Vendor Managed Inventory, the vendor is counting and keeping track of the inventory and delivering the bread based on his own count. Other companies use Vendor Managed Inventory in more complex ways. For instance, an aerospace manufacturer that purchases a certain type of bracket from a supplier near its factory. The aerospace manufacturer might ask that supplier to manage and keep track of the inventory it has purchased, only sending enough brackets at a time to fulfill a specific manufacturing requirement. This would support a lean manufacturing process using a Just-In-Time supply chain management approach. Big box retail stores like Wal-Mart are also well known for their use of the Vendor Managed Inventory strategy: Wal-mart has been using the strategy since the 1980s to reduce its inventory storage costs and improve profitability. This strategy, along with other innovative inventory management and distribution practices such as cross-docking (which involves moving products from an inbound truck directly into an outbound truck without the product ever actually entering a distribution center) has allowed Wal-Mart to evolve into the number 13 supply chain in the world according to Garner.

When does Vendor Managed Inventory work best?

Vendor Managed Inventory works best when a supplier has a manufacturing or warehouse facility that is in relatively close proximity to the purchasing company. This is why you often see manufacturing suppliers clustered around a large customer in one geographic location – for instance, our aircraft manufacturer might be surrounded by suppliers such as the bracket-maker, a tire manufacturer, or a sheet metal manufacturer. Any of these could be called upon to provide Vendor Managed Inventory. Companies that opt to use a Vendor Managed Inventory approach will also need to have the capability to analyze their inventory both prior to instituting Vendor Managed Inventory, to ensure that both the vendor and the purchaser understand what the “par” levels should be, and how much inventory will need to be stored and accessible in the supplier’s warehouse to fulfill demand. For smaller companies that have less complex supply chain requirements, this might simply mean analyzing your demand levels so that you know how much of a certain item you go through each week. For companies with more complex supply chain requirements it may mean implementing an ERP system and inventory management application, and integrating these with the ERP of your supplier. This upfront knowledge will allow you to place any needed controls on the vendor to ensure costs stay within an appropriate range.

Vendor Managed Inventory: What are the risks?

Like most business strategies, Vendor Managed Inventory is not all upside and no risk. There are risks to both sides: vendors run the risk of creating more inventory costs for themselves. The purchaser runs the risk of losing control of their inventory and potentially having higher costs associated with that. The key for successful Vendor Managed Inventory is for vendors and purchasers to have a good understanding of how the Vendor Managed Inventory arrangement is likely to impact the entire supply chain, and to place appropriate controls on how the vendor is to manage the inventory in question. Is your company considering Vendor Managed Inventory, or are you using the strategy now? We’d like to hear your experience and questions in the comments.