29 January, 2024

What is vendor managed inventory (VMI)? Pros and cons in 2024

Vendor managed inventory is an inventory management strategy where a supplier oversees a customer’s inventory levels to enhance efficiency and reduce costs for both parties.

Vendor managed inventory (VMI) is one of the most popular business models for managing inventory, and it’s no wonder the world’s largest corporations like Walmart and Amazon use this method.

VMI is a collaborative inventory management approach where the buyer provides data on inventory levels and the vendor takes complete responsibility of providing and maintaining the inventory at the buyer’s desired location. For this reason, VMI is also known as supplier-managed inventory, collaborative replenishment, continuous replenishment, and vendor owned inventory management.

Vendor managed inventory offers a lot of benefits for both the supplier and the buyer, like preventing excess stock, reducing costs, and guaranteeing a smooth flow of inventory. The VMI supply chain model is one of the most effective inventory management processes and helps smooth out the entire supply chain.

Read on to learn how VMI works, discover its benefits and challenges, and see real-world examples of VMI in practice.

How does VMI work?

In VMI, the responsibility of purchasing shifts from the retailer (also known as the buyer) to the supplier (sometimes called the vendor). Under VMI, the supplier contacts the retailer with a purchase order. The supplier will greenlight the purchase, ship the goods, and send shipping notices to the retailer.

Here’s what that process looks like in detail:

  • Data sharing: The buyer shares relevant data about inventory levels with the vendor.
  • Data analysis: The vendor uses software to assess and understand patterns, trends, and fluctuations in demand. This detailed analysis allows for more accurate demand forecasting for future inventory requirements.
  • Automated replenishment: Leveraging insights from demand forecasting and inventory monitoring, the vendor initiates an automated replenishment process that generates purchase orders or shipment requests to ensure the optimal quantity of products is sent to the buyer.
  • Buyer receipt of inventory: The buyer then consistently and promptly receives the right amount of stock to minimize stockouts and optimize supply chain efficiency.

A graphic illustrating the VMI lifecycle in steps.

Benefits of VMI

By allowing vendors to actively participate in inventory control, VMI optimizes stock levels, minimizes stockouts, and enables accurate demand forecasting. The collaborative model also reduces costs for both parties and fosters a stronger relationship between the buyer and vendor. 

Let’s look a deeper look at the principal benefits of VMI:

  • Avoids overstocking: With VMI, retailers don’t have to hoard products out of fear of going out of stock. The supplier manages the inventory and quantities, ensuring products are available when needed and eliminating the need for retailers to stock more than necessary. 
  • Saves money: Using quick response (Q/R) systems, the vendor reorders when inventory gets low, reducing the reorder point of goods. Regular supply to retailers helps manage transportation costs, which eliminates the extra cost incurred for expedited shipping. Vendors may also offer bulk discounts, and the supplier’s constant supervision prevents overstocking expenses for retailers.
  • Ensures a seamless flow of inventory: Automatic updates on stock levels make inventory management smooth, providing real-time accuracy. With this system, both the vendor and buyer are aware of exact inventory amounts, enabling quick reordering when levels drop. VMI also aids in predicting demand, which helps maintain the appropriate stock for each item based on future needs.
  • Improves customer satisfaction and loyalty: Customers appreciate product availability; if a product isn’t on your shelves, they may turn to competitors. Additionally, if you buy in bulk from the vendor, you can provide heavy discounts to keep your customers happy. 
  • Introduces new products for cheaper: With vendors handling inventory, introducing new products is easier and cheaper. The vendor owns the inventory and the risk that comes with it, so retailers don’t face extra costs for bringing in new products. Unsold goods are returned to the vendor at the end of a stipulated period, easing retailers’ concerns about testing new products.
  • Reduce returns: A vendor has all the inventory data, like purchase, sales, and returns, for all retailers. This gives them a clear picture of product lifecycles. For example, if retailers are returning unsold product, the supplier can gauge if it’s reaching the end of its lifecycle. The supplier can then end production of that product and discount it to clear out inventory. 

Aids inventory visibility: Vendors can easily track product performance by time, location, season, types of customers, marketing efforts, and product lifestyle stages. This supply chain visibility allows them to adjust production levels based on estimated demand.

Challenges of VMI

Every system has its limitations, including VMI. For instance, seamless communication and data sharing are crucial to VMI’s success, but ensuring accurate and timely data exchange, as well as sophisticated technology that supports this process, can be difficult to establish. Without an effective VMI system, there can be serious disruptions or errors, causing cascading consequences throughout the supply chain.

Here are some of VMI’s other disadvantages:

  • Increases bulk replenishment: The buyer must order the commodities in bulk and frequently. This requires a large business and a high market demand. It’s not the right inventory management for small businesses with limited orders and space for storage.
  • Takes time to establish trust: Trust has to be built over time as both parties relinquish some control over inventory management. Establishing confidence in the reliability of data sharing, as well as the commitment to mutually beneficial outcomes, is crucial for successful VMI implementation.
  • Adds reliance on the vendor: The vendor has to be prepared at all times with the products to be supplied as soon as needed. If the vendor isn’t able to responsibly supply the products in a given frequency, then they risk losing the buyer’s trust.
  • Relies on sound technology: A VMI system can’t flourish with inefficient or limited technology. Streamlined processes and internal systems for both parties are crucial.
  • Increases vendor costs: The administrative cost of the vendor increases exponentially compared to the customer-managed inventory system. The other significant cost is setting up a real-time IT network to connect all the locations.

TABLE:

Pros Cons
  • Avoids overstocking
  • Increases bulk replenishment
  • Saves money
  • Takes time to establish trust
  • Ensures a seamless flow of inventory
  • Adds reliance on the vendor
  • Improves customer satisfaction and loyalty
  • Relies on sound technology
  • Introduces new products for cheaper
  • Increases vendor costs
  • Reduces returns
  • Aids inventory visibility

Vendor managed inventory examples

Today, some of the major corporations around the world run their inventories using the VMI model either partially or completely. Companies like Amazon, Walmart, The Home Depot, and Bosch have successfully adopted VMI into their inventory management.

Here are some fictional examples to help better understand how VMI works.

Example 1: Smartphone manufacturing

For our first example, XYZ Electronics sells a range of electronic gadgets, including smartphones and tablets. They enter into a VMI agreement with ABC Technologies, a major electronics manufacturer. In this arrangement, ABC Technologies takes responsibility for managing XYZ Electronics’ inventory of smartphones.

 

  1. ABC Technologies installs a monitoring system that tracks the real-time sales data and inventory levels of XYZ Electronics’ smartphone products. 
  2. Using this information, ABC Technologies can proactively manage stock levels and replenish inventory before it runs low. 

                a. For instance, if a popular smartphone model is selling quickly, ABC can automatically                        send new stock to XYZ Electronics to prevent stockouts. 

This VMI system benefits XYZ Electronics in several ways:

  1. It ensures the retailer always has the latest smartphone models in stock, enhancing customer satisfaction and loyalty. 
  2. The retailer doesn’t need to tie up capital in excess inventory or worry about the costs associated with stockouts. 
  3. ABC Technologies can offer bulk discounts to XYZ Electronics due to the predictability of demand and the efficiency of the retail inventory management system. 

Example 2: Wholesale coffee distribution

Here’s a more detailed example involving a wholesale coffee supplier, BrewMasters, and a local coffee shop, Urban Brew Haven. The VMI arrangement between the two parties focuses on key metrics and goals: 

  • In-stock performance: Urban Brew Haven aims to consistently have BrewMasters’ coffee products in stock, avoiding stockouts to meet customer demand. 
  • Inventory turnover rate: BrewMasters seeks to optimize its inventory turnover rate to minimize excess inventory and associated holding costs.
  • Transaction cost: Both Urban Brew Haven and BrewMasters aim to reduce transaction costs related to order processing and inventory management. 

In the VMI agreement: 

  1. Urban Brew Haven provides BrewMasters with sales data, consumption patterns, and demand forecasts
  2. Using this information, BrewMasters analyzes the optimal order size and frequency to maintain adequate inventory levels at Urban Brew Haven. 
  3. BrewMasters ships the required coffee inventory to Urban Brew Haven’s premises. 
  4. A VMI specialist from BrewMasters monitors Urban Brew Haven’s inventory levels and sales trends, adjusting orders to prevent overstocking or stockouts. 
  5. When replenishment is needed, the BrewMasters VMI specialist places the order from their inventory, and the shipment is sent to Urban Brew Haven. 

Through VMI, Urban Brew Haven benefits from a consistent supply of BrewMasters coffee, ensuring customer satisfaction and avoiding missed sales opportunities. 

BrewMasters achieves a good inventory turnover ratio, reducing holding costs and waste. The VMI arrangement streamlines the ordering process, cutting transaction costs for both parties and fostering a collaborative and efficient supply chain relationship.

Vendor managed inventory vs. inventory management software

VMI and inventory management software (IMS) are two distinct inventory management techniques, each with its own set of benefits and drawbacks. 

VMI involves a collaborative relationship between a vendor and buyer, where the vendor takes an active role in managing and replenishing inventory for the buyer. This approach relies on real-time data sharing, typically facilitated through electronic systems, to optimize stock levels and improve supply chain efficiency. 

On the other hand, IMS is a broader category that encompasses various tools and systems designed to help businesses track, organize, and manage their inventory. These inventory management software solutions often provide features like demand forecasting, order management, and reporting, enabling businesses to have autonomous inventory control.

TABLE:

Vendor managed inventory Inventory management software
Flexibility
Autonomy
Automation
Customization
Scalability
Integration with other systems
Efficiency improvement
Demand forecasting
Order accuracy
Reduced stockouts and overstock
Real-time collaboration
Cost control
Data sharing

While VMI fosters collaboration and real-time data exchange with suppliers, IMS provides businesses with greater autonomy, customization, and control over their inventory management. VMI also requires technology and IT investments that are not ideal for SMBs. We recommend that SMBs consider the best inventory management software solutions instead of using VMI. 

Learn how Connected Inventory Performance, Cin7’s cloud-based inventory management software, can help you streamline and scale your inventory lifecycles.

FAQ

Still have a few questions about vendor managed inventory? Check out the answers to these common VMI questions.

Who owns inventory in vendor managed inventory?

The vendor owns inventory in vendor managed inventory. The vendor takes an active role in managing and replenishing inventory at the retailer’s premises.

What’s the difference between VMI and consigned inventory?

With VMI, the vendor owns and manages the inventory at the retailer’s location. The retailer only pays for goods upon sale or consumption. With consigned inventory, the vendor still owns the inventory until the retailer sells it. However, the buyer is responsible for managing the inventory

Where is vendor managed inventory used?

VMI is used in various industries like retail, manufacturing, and health care. It’s often used by large companies that can afford bulk ordering.

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