Vendor-managed inventory

Vendor-managed inventory (VMI) is an inventory management practice in which a supplier of goods, usually the manufacturer, is responsible for optimizing the inventory held by a distributor.

Under VMI, the retailer shares their inventory data with a vendor (sometimes called supplier) such that the vendor is the decision-maker who determines the order size, whereas in traditional inventory management, the retailer (sometimes called distributor or buyer) makes his or her own decisions regarding the order size. Thus, the vendor is responsible for the retailer's ordering cost, while the retailer usually acquires ownership of the stock and has to pay for their own holding cost. One supply chain management glossary identifies VMI as although a 2008 article notes that there is no standard definition of VMI and the term's usage varies "significantly" among companies supporting VMI processes.

A third-party logistics provider may also be involved to help ensure that the buyer has the required level of inventory by adjusting the demand and supply gaps.

Overview

One of the keys to making VMI work is shared risk. In some cases, if the inventory does not sell, the vendor (supplier) will repurchase the product from the buyer (retailer). In other cases, the product may be in the possession of the retailer but is not owned by the retailer until the sale takes place, meaning that the retailer simply houses (and assists with the sale of) the product in exchange for a predetermined commission or profit (sometimes referred to as consignment stock). A special form of this commission business is scan-based trading, where VMI is usually applied but its use is not mandatory.

This is one of the successful business models used by Walmart, Procter & Gamble and many other big box retailers. Oil companies often use technology to manage the gasoline inventories at the service stations that they supply (see Petrolsoft Corporation). Home Depot uses the technique with larger suppliers of manufactured goods. VMI helps foster a closer understanding between the supplier and manufacturer by using electronic data interchange formats, EDI software and statistical methodologies to forecast and maintain correct inventory in the supply chain.

Vendors benefit from more control of displays and more customer contact for their employees; retailers benefit from reduced risk, better store staff knowledge (which builds brand loyalty for both the vendor and the retailer), and reduced display maintenance outlays.

Usage of VMI can prevent stocking undesired inventories and hence can lead to an overall cost reduction. Moreover, the magnitude of the bullwhip effect is also reduced by employing the VMI approach in a buyer-supplier cooperation.

At the goods manufacturing level, VMI helps prevent overflowing warehouses or shortages, as well as costly labor, purchasing and accounting. With VMI, businesses maintain a proper inventory, and optimized inventory leads to easy access and fast processing with reduced labor costs.

Variant models include "consigned VMI", where the supplier or manufacturer retains ownership, and "dynamic VMI", where the buffer inventory remains located with the supplier, which can be beneficial if the supplier and retailer are located close enough together, and allows for buffer stock to be shared among distributors.

Components

1. Inventory location

In VMI practice, inventory location depends on the arrangement between the vendor and the customer. The first option is for the inventory to be located both at the customer's and the supplier's premises. For the supplier, this serves as a safeguard against short delivery cycles or unsynchronized production cycles. However, replenishing inventory levels at these specific locations can be more costly, less organized and overall more difficult to manage for the supplier.

2. Inventory Ownership

Inventory ownership refers to the ownership of the inventory and when the invoice is being issued to the retailer. In vendor managed inventory, there is a number of solutions in terms of payment and transfer of ownership.

The supplier also gets real time visibility, which allows him to have a hand on the inventory for the buyer demand forecast, which allows for projecting inventory based on future demand to target his inventory (minimize or maximize it). This stability and coordination allows to reduce the bullwhip effect, as the manufacturer has a clearer visibility on the supply chain and an overview of the incoming demand. On the retailer’s side, all the costs associated with inventory management, (holding costs, shortage costs, spoilage costs, etc.) are greatly reduced. E.g., the retailer will rarely face stock shortage and holding costs are kept at a minimum since just enough inventory is held.

Data is usually updated every week and is transmitted through an EDI, which allows forecasting actual market trends. The data is based on real quantities of produced and sold items. This agreement to share information is aimed at maintaining a steady flow of necessary goods.

Classes of mathematical model

1. Bi-Level VMI Mathematical Models

The first class of VMI, bi-level VMI mathematical model, includes two levels (or echelons) in a supply chain: vendor and retailer. There are three types of VMI mathematical models developed from this class, which are single-vendor single-retailer VMI model, single-vendor multi-retailer VMI model, and multi-vendor multi-retailer VMI model. This class has been significantly developing. For example, single-vendor single-retailer VMI model was extended for multi-product case, the consignment stock (CS), and discount.

References

External links

Vendor managed inventory , Encyclopedia on Supply Chain Management, edited by Saint Petersburg State University Graduate School of Management