Basics of Vendor Managed Inventory

Collaborative Planning, Forecasting and Replenishment (acronym CPFR) is an integrated approach which aims at achieving high degree of coordination and collaboration between vendor/manufacturer/supplier and customer/buyer. Essentially, it involves in itself various practices and techniques which allows for greater sharing and transparency between the two parties to achieve high degree of accuracy in planning (procurement, ordering, delivery), forecasting(based on historical sales, promotional and seasonal factors, inventory levels etc) and replenishment.

We further discuss one such technique which has gained its significance in leaps and bounds in past few years and has gone on to become one of the most important and successful technique in supply chain management domain. It is Vendor managed inventory or VMI.

Vendor managed inventory, simply put, is a system where the inventory of the customer or buyer is managed by its supplier or vendor. Sounds easy?

To understand what goes behind it and appreciate the complexity involved, we must decode the word ‘manage’ first. Manage here means –

• Taking an account of the customer’s inventory levels on a real-time basis
• This is achieved by employing technical innovations like Electronic data Interchange (EDI), Radio-frequency Identification(RFID), Extended Markup Language or XML etc
• Understanding the inventory requirements in future for the customer based upon number of factors like –
• Product related - product demand, promotions etc
• Macro factors - market situation, competitive scenario, demand-supply balancing etc
• Taking into consideration historical information on product and category sales
• Creating replenishment orders for the customers and stocking it at the right place at the right tim
• The stock can also be delivered as consignment inventory which means that only the physical ownership of the stock is transferred to the consignee(one who has received the stock) while the title remains with the consignor(one who has sent the stock)

The below figure will make the interactions between the parties more clear.

Hence putting the above diagram in simple steps, we demystify the VMI as follows –

1. Customer shares information related to his sales, stock available on individual sku level in real-time mode
2. The vendor received this information and uses it as an input along with other information he receives like promotions running on any particular product or categories, historical sales of the given categories and products and other macro-influencers
3. This information is then processed to achieve a forecast which is more accurate and robust than the traditional methods of forecasting
4. This allows supplier or vendor to create a replenishment order for the customer
5. The details are shared with the customer for him to acknowledge the order and prepare himself for the delivery
6. Supplier or vendor replenishes the stock at the given stock station or warehouse
7. Advice is generated and depending on the types of stock (consignment or not) the billing is executed for the customer

VMI hence provides host of benefits to either parties.

If you are a customer involved with a VMI model , you have following advantages –

• Reduction in stock-outs as well as inventory levels(and hence attached costs!)
• Significant reduction in planning and ordering costs(since they are now taken care of by vendor)
• Improved service levels for their customers due availability of the right item at the right time in right the quantity
• Allows the customer to focus on core operation due to freed-up time and investments

*(Think on what could be the disadvantages of employing VMI as a customer)

As a supplier, VMI is beneficial in a number of ways like 

• Visibility of the POS data for customer gives you a better understanding of what is selling and what is not
• Reduction in errors in ordering due to manual reasons and intentional mistakes (panic ordering etc)
• Higher degree of accuracy in forecasts for the customer demand as well as overall demand
• Allows the vendor to build an environment of trust and hence ensure a long-term partnership with its customers

*(Think on what could be the disadvantages of employing VMI as a vendor)

To work on VMI though, certain very basic ground rules must be set as prerequisite. They are –

•              An environment of trust must be fostered between vendor and customer (data sharing is required)
•        Both the parties must be on similar technological platform (to ensure greater synergy & integration)
•        Commitment from higher management and stakeholder (It takes some time for benefits to be seen)

     **Read on how Walmart and P&G entered into a VMI agreement leading to multiple benefits for both the partners.

 Cheers,