Vendor Managed Inventory

1 What is VMI?
2 Variations in Use
3 Supply Chain Impact
4 Keys to Success

What is VMI?

In its simplest form, Vendor Managed Inventory is the process where the vendor assumes the task of generating purchase orders to replenish a customer’s inventory. VMI is a term that is used to describe many types of supply chain initiatives. These different ‘VMI’ activities can vary substantially in purpose and application.

In all of its forms VMI should be about improving visibility of demand and product flow in a supply chain, facilitating a more timely and accurate replenishment process between a supplier (vendor) and an inventory site (customer, distributor, distribution center, etc…). The application of VMI can be at any point within a supply chain:

Manufacturer – Wholesale Distributor
Wholesale Distributor - Retail
Manufacturer - End Customer/OEM
Wholesale Distributor – End Customer/OEM
Manufacturer – Internal Inventory Sites

The VMI process is a combination of e-commerce, software and people. The e-commerce layer is the mechanism through which companies communicate the data. VMI is not tied to a specific communications protocol. VMI data can be communicated via EDI, XML, FTP or any other reliable communications method. The key feature of the e-commerce layer is that the data be timely and accurate. The balance of this paper will focus on the interaction between the people and software to create and execute a VMI process that is germane to the business and delivers tangible benefits to the supply chain partners.

Variations in Use

The real world implementations of VMI can be broken into three main categories: collaboration, automation, and cost transference.

A Collaborative Planning model consists of sharing data, and jointly developing forecasts and/or production schedules amongst supplier chain partners. This collaborative process occurs at the tactical or item level. The ‘buyer’ collaborates with the supplier on demand/usage plans in order to develop an agreed upon consensus forecast of future demand that both companies will use to drive their business. This strictly collaborative model is applicable to supply chains were a few, distinct items (Stock Keeping Unit|SKU’s) generate substantial volumes of business. In this environment it is valuable for people to review and arrive at consensus on forecasting and replenishment plans for each SKU.

A Mandated Transfer model is a very simple process where the main goal of the buying organization is to transfer the activity and costs of managing inventory to the supplier (vendor). The execution of this model is very simple and requires minimal, and oftentimes no, integration efforts by either party. This process can be as simple as the supplier dispatching a person to the customer’s site to count the inventory on the shelf and compare the current counts to the previous counts to determine usage and replenishment. This process provides some value to the customer by offloading work and responsibility for inventory management, but the total supply chain benefit is nil as the supplier takes up the work saved by the customer. Ultimately the costs are either transferred back to the buying organization, or erode the supplier’s operating profit. The Mandated Transfer model is typically seen where a supplier must provide a ‘VMI service’ as a condition of business and lacks the parity of bargaining position, resources or time to implement an automated, mutually beneficial solution.

A Fully Automated replenishment model combines the positive elements from the other two models with a more comprehensive goal of total supply chain cost reduction for the replenished site and supplier. This VMI model begins with a collaborative process to define the goals and constraints of the VMI relationship at the macro level. With goals established for inventory performance (turns) and service (fill rate), the VMI software develops the replenishment strategy at the micro level (SKU level) to achieve the established goals at the lowest total cost. Execution against the replenishment strategy is done automatically based on the daily changes in inventory and demand at the replenished site. The diagram below describes the four stages of the Fully Automated VMI model. The remainder of this paper will be focused on this model of VMI.

FOUR STAGES OF THE FULLY AUTOMATED VMI MODEL
(four stages of the fully automated VMI model)

Collaboration

In business environments where thousands (or 10’s / 100’s of thousands of) SKU’s have to be managed daily, collaboration at the tactical (item) level is impractical, costly and error prone. The more effective collaborative process is at the strategic level, where overall service and inventory investment goals are agreed upon, along with the constraints within each company. The collaborative stage is critical in establishing the goals and key performance indicators for the VMI relationship. Periodically, this stage is revisited to review current performance and adjust or reconfirm the goals and constraints. The impact of this strategic collaboration is a commonality of metrics and focus between supply chain partners.

Planning

The key to automating a replenishment process, and achieving world-class inventory /service performance is employing comprehensive, dynamic, exceptions based replenishment software. Software tools that are comprehensive enough to effectively manage a variety of demand patterns. Dynamic enough to automatically detect and adjust to changing demand patterns, goals and constraints. Exceptions based to allow for an automated flow of information and product when the outcomes are within expectation. If exceptions are detected, they are analyzed for degree of importance and the user is automatically prompted for action.

Execution

In dynamic, volume intensive supply chains inventory conditions can change suddenly. One day inventory levels are adequate, the next day the inventory may be depleted (due to increasing sales!) or critically low, creating the likelihood for a service interruption. Each day the current supply chain positions (inventory, booked orders, special commitments, in-transit and future requirements) are analyzed against the plans to automatically determine the course of action. When the Collaboration and Planning stages are done properly, the Execution stage becomes automated with very few exceptions, requiring scant human interaction on a daily basis. Furthermore, the Execution stage can provide suppliers with valuable information beyond a purchase order quantity, enabling improvements to the order fulfillment and inventory allocation processes.

Assessment

The old adage holds true in VMI, what gets measured gets fixed. Set the goals, determine the plan, execute against the plan, then measure how you did. The Assessment stage tells the VMI partners how they are doing against the goals. And within the software, diagnostic information is fed back into the planning stage in a continuous effort to close the gap between theory (plan) and reality (result). In many instances a VMI relationship is the first time supply chain partners both have access to, and are measuring performance using the same metrics. When two companies are focused on the same goals and have access to the same key performance metrics, a true supply chain partnership emerges, resulting in a better performing supply chain.

Supply Chain Impact

Inventory is the proxy for information. In the absence of timely and accurate consumption data, each node in the supply chain compensates for the lack of information with inventory. Not only does poor information flow build supply chain inventories, but it also restricts each company’s ability to react to increases in demand, causes extended outages, service interruptions and lost sales. As actual demand for products is disseminated up the supply chain in a more real time environment, the more closely aligned production is with demand. As the gap between production and demand diminishes, so to does supply chain inventories and service level interruptions.

The ultimate goal is supply chain excellence, as defined by service, speed and cost. Delivering the best service at the point of consumption in the least amount of time at the lowest total cost. The result is a supply chain that has an automated, timely flow of information triggering replenishment activities that anticipate demand accurately.

For the replenished location, the major benefits are:

Increased Service Level To The End Customer
Increased Sales
Increased Return On Assets
Elimination Of Routine Replenishment Activities
Reduced Fulfillment Costs / Lead Times
Improved / Expanded Relationship With Supplying Organization

For the supplier, the major benefits are:

Increased Service Level To The End Customer
Increased Sales Through To The End Customer
Reduced Fulfillment Costs / Lead Times
Improved / Expanded Relationship With Replenished Organization
Smoother Demand Patterns
Elimination Of Human Errors

Keys to Success

Done effectively, VMI delivers tangible results throughout the supply chain. As the concepts and practices of ‘lean’ extend beyond the manufacturing floor down through the supply chain, VMI is the enabling process to drive out costs and time. To ensure you realize the full impact of the VMI experience, follow these keys to success:

Set, review and maintain performance goals
Manage all SKU’s through VMI to minimize supply chain transactions
Spend the time and effort up front to ensure data accuracy
Utilize local market intelligence to augment the automated replenishment decisions
Conduct periodic performance reviews
Use the metrics to find cost and inefficiencies, then work together to eliminate

This article is licensed under the GNU Free Documentation License. It uses material from the Wikipedia article "Vendor Managed Inventory".