Vendor managed inventory (VMI) – when executed well – can be an efficient and cost-effective system for managing the supply of goods.
Here we give you a rundown of what VMI involves – from how this system usually runs, to the various features that a VMI system can include. We take a look at the potential advantages and disadvantages of a VMI system, and give examples of businesses that have used this method successfully.
What is vendor managed inventory?
VMI is an inventory system in which the vendor (a manufacturer or supplier) is responsible for maintaining appropriate levels of inventory for the buyer, who is a retailer who then sells the goods on to the end consumer.
In the VMI supply chain model, the buyer and vendor have an agreement that the vendor will make inventory, supply and reordering decisions for the products they provide. To make this system work, the buyer shares up-to-date information with their vendor about sales and inventory levels – often through a digital portal.
Some VMI agreements also involve a third-party logistics provider (3PL) that oversees supply chain management – receiving the vendor’s product, managing stock and then distributing it from their own warehouses or the vendor’s.
VMI uses a different approach from traditional inventory management, where the buyer usually manages inventory in-house by monitoring stock levels and preparing a purchase order for their vendor when a product reaches its reorder point.
A hypothetical example of VMI
Imagine that there is a buyer called TV World that sells televisions made by the vendor ABC Electronics.
TV World has a VMI contract with ABC, which means TV World shares up-to-date inventory levels and sales data with their vendor. The vendor (ABC) uses this information to decide when to ship more stock to TV World and in what quantity based on the inventory data, lead times and sales forecasting.
How does vendor managed inventory work?
Because a vendor must have accurate inventory information for VMI to work, it’s imperative that the buyer shares data with the vendor.
If either party doesn’t have an efficient stock management system to provide this data – or isn’t willing to share these details – then VMI simply won’t work.
This is where effective inventory management software comes in, which means real-time data can be shared digitally.
It’s also important that from the outset the two parties make an agreement on a range of details, including:
- What access the vendor will have to the buyer’s inventory system
- How to track stock performance
- How to measure the success of their VMI system
- Transaction costs
- Minimum and maximum stock levels for products
- How excess inventory will be returned
- Where stock will be stored
- Whether the stock will be on consignment – which means the vendor owns the stock until it is sold to the end consumer and that the buyer doesn’t pay for it until it is sold.
The typical vendor managed inventory process
After the vendor and buyer have detailed their VMI system in an agreement, the VMI process itself will typically follow these steps:
- The vendor begins shipping the stock to the buyer.
- The vendor – who has access to the buyer’s sales data for their products – observes and monitors sales patterns and plans ahead for any promotional periods.
- The vendor reorders stock and delivers it to the buyer, in line with the reorder point agreed with the buyer and lead times for each product.
- The vendor will usually advise the buyer that the product has been shipped – rather than the buyer having to raise a purchase order.
As you can see, VMI involves a partnership between vendor and buyer.
The buyer has to be comfortable sharing a range of sales data with the vendor, so it’s always a good idea to have a confidentiality agreement in place.
The vendor on the other hand will be keen to optimise the VMI arrangement, so may try to secure benefits like preferential placement in the store and activities to build brand awareness – and may even have sales reps regularly visit the buyer to enhance the overall relationship.
Types of vendor managed inventory
Now you’ve got the basics of VMI, let’s look at variations in how this system is implemented in practice.
The type of VMI arrangement you use will depend on what suits the buyer and vendor best. For instance, it might be just one particular product that a vendor manages for a buyer, or it could be that the vendor manages the inventory for every product of theirs the buyer stocks and sells.
Some other elements that can be included in a VMI system are:
- Vendor-led physical checks. This is where a vendor turns up to check stock levels in a store and restock where needed – for instance, when a vendor like Coca-Cola checks stock levels in a corner store and replenishes these.
- Buyers ordering inventory. This means that the buyer can still order stock from a vendor when needed and the vendor delivers it.
- Synchronised inventory systems. This is when a buyer and vendor integrate their inventory management software so they are able to synchronise their supply and demand to ensure stock levels are kept at an optimum level.
- On-site inventory planning staff. A vendor provides a planner on-site at the buyer’s location who manages inventory.
- Dedicated space for vendors. If a buyer has warehousing facilities, they may allow the vendor to use that space to manage inventory.
Vendor managed inventory: advantages and disadvantages
So who benefits from using a VMI system? And what are its advantages and disadvantages?
Here we answer these questions – from both the vendor’s and the buyer’s perspectives – so you can work out if VMI is a good fit for your business.
Advantages of vendor managed inventory for buyers
VMI really comes into its own with large buyers that have to manage inventory for thousands of items – especially where these are fast-moving consumer goods. Two good examples are the US giants Amazon and Walmart, which we’ll talk about more below.
For buyers the main benefit of using a VMI system is that the buyer doesn’t have to keep track of stock levels for a large number of products. Instead the vendor takes responsibility for all inventory planning and ordering – which saves time for the buyer and reduces costs significantly.
Other advantages for buyers of using VMI include:
- Less risk that goods will not sell. The vendor is responsible for managing stock levels based on inventory data and demand forecasting – meaning the buyer doesn’t purchase stock that may not sell. This is especially true where a consignment model is used.
- Less storage required. The buyer needs less storage space, since the vendor tends to ship more frequently in a VMI system.
- Less risk of being out of stock. VMI minimises the risk of stocking out, since the VMI agreement will prioritise replenishing stock before this occurs – and it’s in the vendor’s interest to ensure stock does not run out.
- Less risk of loss of inventory. Also known as ‘shrinkage’, this is when stock has to be written off due to things like shoplifting, damage, being out of date, system errors – or anything else that means the product can’t be sold. For buyers, shrinkage can be minimised by having less stock on hand.
Advantages of vendor managed inventory for vendors
There are also advantages of VMI for vendors. For instance, a vendor can:
- Make an agreement with the buyer for benefits in their retail store, like more in-store promotions, and being the preferred product sold by sales reps.
- Maintain ‘demand smoothing’: by having access to sales data and therefore more accurate demand forecasting, the vendor can more accurately plan production to meet demand, and avoid costly over- and under-supply.
- Minimise storage levels and costs by manufacturing the right quantity of product.
- Enter into a long-term financially beneficial relationship with the buyer through their VMI agreement.
Disadvantages of vendor managed inventory for the buyer
At the same time VMI has potential downsides for buyers:
- Even with the right planning in place, sometimes relationships don’t work out. And if a buyer has entered into a legally binding VMI contract with a vendor it can be a tricky, lengthy – and costly – process to get out of it.
- Sharing confidential company information with an outside organisation will always come with the risk that this will be shared with a third party.
- A buyer may be locked into using one vendor for a product – or set of products – if they have a VMI agreement, even if a more cost-effective option enters the market.
Disadvantages of vendor managed inventory for the vendor
VMI has potential downsides for vendors as well:
- When using VMI there is an increase in inventory management costs for vendors, since in-house resources will be used to manage supply for the buyer.
- The vendor may have to increase storage capacity to maintain the right levels of stock and minimise the risk of stockouts, which would jeopardise the relationship with the buyer.
- In this arrangement the vendor relies on a buyer to share relevant sales data to enable accurate forecasting – but if this isn’t shared, and in good time, it can be difficult for the vendor to do their job properly.
What companies use vendor managed inventory?
Many businesses around the world use a VMI system, including well-known firms like:
- Home Depot
- Procter & Gamble
Walmart’s VMI operations
Another example is Walmart, which stocks thousands of products in their more than 5,000 stores. Instead of managing inventory in-house, Walmart uses a VMI system with their suppliers – making the task more manageable overall.
Walmart uses centralised databases that let manufacturers and vendors to see real-time inventory information so they can make decisions about when to supply new stock and in what quantity.
The benefits for Walmart are severalfold: by effectively delegating inventory tasks to their suppliers, they reduce the amount of time spent on stock management and ensure their thousands of items were always available for customers.
Amazon’s VMI system
Amazon provides another example of VMI in action. Of the millions of products on Amazon’s platform, 50% are supplied by third-party sellers, and vendors monitor and restock their own goods in Amazon’s warehouses.
This means Amazon minimises the time they use to manage stock – which would be a monumental task on this scale – while ensuring inventory is available at the right levels at all times.
Vendor managed inventory vs consignment inventory
Often these two inventory systems are confused, but they are in fact different.
The crucial difference is that in a VMI system the vendor manages the supply of their buyer’s inventory, while on the other hand consignment inventory is concerned with ownership of the inventory.
When a consignment system is used, the vendor is the owner of the product until it’s sold to the consumer, and the buyer doesn’t pay for the stock until it’s sold.
VMI and consignment inventory are sometimes used together, but they don’t have to be. In other words, you can use VMI and consignment inventory as independent, standalone agreements – or you can use them together. As always, the type of agreement you come to will depend on what suits your industry and specifically your business.
- Read more: How does consignment inventory work?