Vendor managed inventory (VMI) explained

Vendor managed inventory (VMI) is fast becoming an essential service in global supply chains.

As demand for the movement of goods across the globe and rapid delivery expectations become the norm, businesses seek ways to simplify their supply chain management. VMI streamlines inventory management and order fulfilment, benefitting both suppliers and buyers. 

What is vendor managed inventory?

Vendor managed inventory is a technique in supply chain management that involves vendors (or suppliers) taking partial control of their buyer’s inventory management process. Under VMI, the vendor is responsible for optimizing the amount of inventory sent to the customer to maximize efficiency.

As buyers source components from several suppliers, they often implement a VMI program at a third-party warehouse near the production or assembly location. Suppliers are then required to hold approved goods until the buyer requests delivery.

As the buyer pulls and consumes the goods, the title passes to the buyer and the supplier can invoice the buyer. Post-delivery, the supplier must replenish the goods to a specified level, often to meet a company target, minimum/maximum level or provide 2-4 weeks of average consumption. 

Many large companies institute VMI programs because they benefit from the postponement of goods until they’re needed in production.  This provides some elasticity in the supply chain to ensure that variances in production demand can be accommodated and that the delivery of goods is not subject to transit delays since they are co-located near the production site.

How vendor managed inventory works?

Buyers that implement VMI share their inventory data, demand forecasts, and delivery parameters with the supplier. The suppliers uses the data to determine the appropriate order size to replenish the amount of inventory held in VMI.

Consequently, the supplier manages the upstream supply chain to the point of delivery to the buyer, and its buyer’s responsibility to provide accurate, timely information for forecasting.

This is different to the traditional inventory management approach, which involves the buyer taking complete ownership over the amount of inventory they buy from their vendors. In traditional inventory management, the vendor is only responsible for fulfilling customer purchase orders.

VMI creates a symbiotic relationship between buyer and supplier, enabling close collaboration for mutual benefits while shouldering the shared risk. By overseeing a buyer’s inventory and supply chain management, vendors can manage the greater portion of the supply chain, from sourcing and identifying trends to delivery.

While the supplier maintains upstream lead times and visibility, the buyer’s main focus is the delivery of the material to its final destination for production, enabling the redeployment of resources into manufacturing, demand planning,  sales, and other crucial operational areas.

What is the difference between VMI and Consignment Inventory?

In a VMI solution, vendors actively manage the supply of inventory to target levels based on the buyer’s forecast and actual consumption, while consignment inventory relates to inventory owned by the vendor but held at the buyer’s warehouse with the buyer determining the inventory replenishment strategy.

They’re similar concepts, but VMI usually involves a much greater level of collaboration, which can improve overall efficiency.

The benefits of VMI

VMI advantages for buyers

VMI allows buyers to receive inventory on the day it’s required, while the supplier-held buffer stock enables agile buyer decisions when faced with supply chain disruptions. More broadly, VMI eliminates the need for intermediaries, thus improving communication, inventory management, and the accuracy of inventory and forecasting.

Moreover, as suppliers analyze the buyer’s consumption behavior and maintains sufficient supply to meet demand, VMI prevents excessive stock build-ups that represent supply chain inefficiency.

VMI advantages for suppliers

The primary benefit of VMI for suppliers is gaining a reliable, long-term customer who is unlikely to switch to another supplier – providing they meet the buyer’s needs. And while supplier gains are negligible in the short term, they can usually manage their stock levels within a few months to increase efficiency and, ultimately, profit margins. 

The closer collaboration with the buyer forges a stronger long-term partnership and increased future revenue flows.

Overcoming the challenges of VMI  

Theoretically, streamlining process via VMI should reduce overall costs for both parties, but this isn’t always the case.

While the buyer improves it’s timely receipt of goods without the balance sheet cost of holding inventory, the supplier assumes more responsibility and expense until the buyer requests the final delivery. Suppliers also have their own balance sheet metrics to worry about.

Suppliers usually have a higher cost of capital than large OEMs and may struggle to finance inventory held in another location or warehouse. Therefore, despite the buyers operational and postponement benefits, the end-to-end transaction cost may be higher by transferring the burden upsteam.

These concerns and the ability to finance the longer transaction cycles may prevent suppliers from joining VMI programs, and without enough participating suppliers, buyers may discard the idea entirely.

While suppliers can be reluctant to join VMI programs, Taulia’s Inventory Management solution provides an excellent VMI alternative while retaining the benefits. It simplifies the process, enabling suppliers to participate in a buyer’s VMI system by outsourcing the buyer’s VMI requirements to Taulia.

By owning goods-in-transit or at a nearby warehouse, both buyers and suppliers will improve their balance sheet position via optimized inventory, production continuity, and working capital improvement.

That can lead to benefits, including:

• Reduced long in-transit times: Long lead times make it harder to manage future inventory levels against forecasted demand. Taulia’s Inventory Management solution owns inventory in transit and nearby, aligning the arrival of goods with production demand. You can further benefit from economies of scale by purchasing larger volumes while still receiving just-in-time deliveries.  This is a huge benefit to protect against disruptions and ensuring required production levels.
• Vendor participation and cost reduction: Buyers need to have VMI to stage delivery of goods without incurring the balance sheet cost until the goods are in useful production.  But transferring the cost of carry to suppliers who usually have a higher cost does not create efficiency. And if suppliers are reluctant to join VMI altogether, buyers are forced to pursue less optimal supply chain designs.  Taulia’s Inventory Management solution can be the catalyst for all parties to build lasting, efficient supply chain systems.
• Access to nearby buffer stocks: Stock outages are increasingly common; thus, companies are taking steps to boost nearby safety stocks to mitigate risk. With Taulia’s Inventory Management solution owning nearby safety stocks, we enable supply chain elasticity without impacting your balance sheet.
• Improved inventory visibility: Our enhanced solution includes full tracking at every step throughout the inventory management process. This enables you to track the movement of goods from the source through each carrier and customs to the destination warehouse. Improved dashboards for better visibility greatly assist the order process to meet demand.