Vendor-Managed Inventory (VMI): What is it and When Does It Make Sense to Use It.

What is vendor-managed inventory?

As the name implies, vendor-managed inventory ( VMI ) is inventory that is managed by the vendor (supplier). And while there can be more to it than this, at a minimum this means the vendor determines when to replenish and how much to replenish.

Vendor-managed inventory is nothing new; in fact it's been around a long time and is far more common than you may think. If you ever worked in a restaurant, you would have seen the "bread guy" show up every day or so, check your inventory (physically look at your breads, buns, etc.), then go out to his truck and stock you up. In a barbershop, many of the hair products your barber (yeah I'm old school, I go to a barber) sells or uses are also managed by the supplier. In this case, it’s probably the sales rep for that product that actually "manages" the inventory, and he may restock the barbershop from the trunk of his car. At the old independent hardware store, items like nuts, bolts, washers, o-rings, etc. were often managed by the vendor. In larger businesses, you may have your shipping cartons, office supplies, or cleaning/maintenance supplies managed by the vendor.

Relationship between VMI and Consignment.

There is a lot of confusion about the relationship between vendor-managed inventory and consignment inventory. So let me start by saying VMI and consignment are two completely different inventory strategies that are sometimes used together. VMI relates to the tasks associated with managing the inventory supplied by a vendor, while consignment relates to ownership of the inventory. VMI and consignment are neither mutually exclusive nor mutually inclusive. You can have VMI that is not consignment inventory, you can have consignment inventory that is not VMI, and you can have inventory that is both consignment and VMI. Read my article on Consignment Inventory for more information.

Many variations of VMI.

The term “vendor-managed inventory” covers a wide range of tasks related to managing inventory. A specific VMI program may cover a single task, all tasks, or any combination of tasks. Here are some examples.

Vendor shows up at customer’s facility, physically reviews inventory levels, immediately replenishes with inventory he has with him (actually physically stocks the inventory on the customer’s shelves).
Vendor shows up at customer’s facility, physically reviews inventory levels, places an order for replenishment inventory that will be delivered at a later date. Depending on delivery method, the vendor may do the physical restocking, or may leave it for the customer to do.
Customer periodically (daily, weekly, etc) provides vendor with current inventory levels. Vendor reviews inventory levels and creates replenishment orders. Replenishment orders are shipped to customer. Customer performs all physical tasks related to the inventory at his facility.
Vendor has direct access to customer’s inventory system and can get real-time information related to on-hand levels, open orders, forecasts, production schedules, etc. Vendor makes replenishment decisions based on this data and ships orders to customer.
Vendor provides on on-site inventory planner that works full-time at the customer’s facility managing the inventory supplied by that vendor.
Vendor leases space within the customer’s facility and run’s their own warehouse and inventory planning operation with their own employees from within the customer’s facility.

You can see how VMI can cover a broad range of tasks and methods.

Why use VMI?

This is where things get a bit murky because there’s a big difference between why you should use VMI and why businesses actually choose to use VMI. From my perspective, the best case for VMI is when the vendor can do a better job of managing the inventory than the customer. But that would just make way too much sense.

The reality is customers tend to choose to use VMI because it relieves them of the burden and responsibility of managing the inventory. And vendors choose to offer VMI because they feel it gives them a marketing advantage or because VMI is expected in their industry. I’m not saying these aren’t valid reasons, but when these are the only reasons for using it, businesses tend to not take full advantage of what VMI can actually do for them.

Benefits of VMI.

Let’s look at some potential benefits to the vendor. As an inventory management consultant, I get exposed to a lot of bad inventory management practices. The truth is very few businesses are good at inventory management, and some are absolutely lousy at it. And unfortunately, the impact of poor inventory management practices is not always isolated to the business responsible for these practices. Here are some examples of how your customer’s poor inventory management practices can impact you as a vendor.

Customer frequently runs out of stock. This results in lost sales of your product and also results the customer always needing “favors” to expedite shipments.
Customer’s ordering habits have no logic to them (or bad logic). This results in difficult-to-forecast lumpy demand, which results in you needing to increase safety stock levels to meet this demand.
Customer orders way too much of something, sits on it for a while, and then returns it to you. I actually see a lot of this when I analyze demand data for clients. This is usually with a slow moving item where a customer suddenly orders an unusually large quantity. You then replenish your inventory based on this “new demand”, or may even have to scurry just to get enough inventory to fill this order. Eventually the customer returns the inventory and you are stuck with way too much of a slow mover. Worse yet, he sits on it for so long it essentially becomes obsolete, then he returns it to you under your way-too-liberal return policy.

You can see how there is potential here for you to reduce lost sales due to stockouts, reduce your safety stock levels by having more control over shipment quantities and times to your customer, and prevent excess and obsolete inventory due to customer errors.

To take it a step further, if you can get access to your entire customer’s planning data, you can potentially use that to better plan your inventory levels. If you know how much they have in stock and what they expect to sell or consume (based on their forecast or production schedule), you can use that to plan your inventory. This can result in both better fill rates and lower inventory levels.

VMI also makes it more likely the vendor will supply all products within a product group (rather than the customer having multiple vendors within a group). It also makes it more difficult for the customer to change suppliers since he will need to either find another supplier that can do VMI and work out all the details, or he will need to take the responsibility on himself..

VMI may also give the vendor a little more control over his shipping schedule since he will be determining when orders are placed.

From the customer’s perspective, if the vendor can actually manage their inventory better than them, VMI can be an effective option in both increasing their inventory management effectiveness and reducing their costs associated with managing this inventory. Or, as long as the vendor can do at least as good of a job as the customer was doing, there is still savings on the customer side related to not having to manage the inventory.

Downsides of VMI.

Well of course there are potential problems with VMI. From the customer’s perspective, what if the vendor does a worse job of managing their inventory? It's very possible. Small businesses often mistakenly assume larger businesses are better at doing this type of stuff. I can assure you that is not the case.

In addition, depending on the VMI arrangement, you (the customer) are giving up control of certain aspects of your business. You may also be providing the vendor with access to business information you consider to be confidential. Your vendor could be charging you for inventory you never received, using information they got from you to cut out the middleman (you), or selling or sharing your business information with competitors.

And, as mentioned earlier, it is more difficult for a customer to change suppliers once VMI has been implemented. It also makes it less likely the customer will shop around to other suppliers within a product group.

From the vendor’s perspective, he may be taking on the added task of managing his customer’s inventory (and the costs associated with that) without receiving any of the inventory management benefits. Theoretical benefits are just that—theoretical. You need to take steps to make sure theoretical benefits become actual benefits. In some cases, the vendor's costs for managing his customer’s inventory could be greater than the customer’s costs would have been to manage the same inventory. If this is the case, costs are being added to the supply chain without any benefit. Ultimately this will likely hurt both the vendor and the customer.

Controls on VMI.

If you are a customer entering into a VMI arrangement with a supplier, you need to carefully consider controls you may want to put in place. These controls could include controls on quantities (max quantities, min quantities), controls related to expected fill rates, controls of space allocated for the inventory, controls on physical access to your facility, and controls on data and other information made available to the vendor.

You need to be realistic about any restrictions you put in place. You don’t want to make the process so restrictive and cumbersome that the vendor has a difficult time performing the necessary tasks. But you also don’t want to give the vendor free reign and then just hope for the best. You have to be very careful when setting fill-rate requirements. Don't require 99% fill rates without an increase in inventory levels if you were only getting 95% when you managed the inventory.

Ultimately, VMI can potentially provide benefits to both the vendor and the customer when properly applied. It all comes down to thinking through the process, making sure the benefits are real, and making sure there are enough controls in place to protect both parties.

What is Direct Store Delivery (DSD) and is it different than VMI?

Direct store delivery (DSD), describes a distribution method used in grocery/retail where the supplier delivers product directly to the stores. This bypasses the retailers distribution network. In some cases this is more than just a delivery method, but also a VMI method whereby the supplier manages the inventory process, physically delivers and stocks the product on the retailer's store shelves. If you gas up regularly at a convenience store, you've probably encountered a beverage supplier pull up and restock the shelves.

So while the core of DSD is the "delivery" aspect (or more specifically the fact that delivery bypasses the retailer's distribution network,) DSD is not necessarily VMI, but often is.

Go to Articles Page for more articles by Dave Piasecki.

Dave Piasecki, is owner/operator of Inventory Operations Consulting LLC, a consulting firm providing services related to inventory management, material handling, and warehouse operations. He has over 25 years experience in operations management and can be reached through his website (https://www.inventoryops.com), where he maintains additional relevant information.