For some, especially manufacturers, it may seem strange that the supplier decides when, to whom, and in what quantity a given product should be delivered. However, in a situation where we do not have a perfectly constructed distribution network and sales control, VMI (Vendor Managed Inventory – also known as Supplier Managed Inventory), i.e., inventory management by the supplier, becomes the best solution when we sell a lot, on time, and to specific recipients.
VMI means optimizing supply chain operations as a result of the manufacturer’s (or, for example, distributor’s) inventory being managed by the supplier, who decides on the timing and content of the supply, guaranteeing full product availability. Thus, VMI is a process in which the supplier generates orders on behalf of the customer and according to their needs, based on demand information provided by the customer. This type of management can be treated as a tool for streamlining procurement processes.
How does VMI work?
VMI is a system designed to streamline product distribution by increasing supplier responsibilities. Currently, the market uses a solution where the distributor or manufacturer maintains inventory on their own, places orders at a chosen moment and in a chosen quantity, based on plans they create themselves.
When inventory is managed by the supplier, electronic contact is used via the Internet or an EDI system. In this way, the supplier receives data on sales, production, and inventory levels. This enables them to undertake inventory management and create supply plans that would be convenient for both parties. The number and type of ordered products are not generated by the manufacturer or distributor, but are created based on their needs by the supplier.
Unfortunately, the introduction of VMI is associated with an increase in costs for suppliers, which adversely affects their profitability. High costs often cause an increase in the unit price for supplied materials, components, semi-finished products, or products. Furthermore, high costs are the cause of difficulties related to logistics management, i.e., broadly understood transport and inventory levels. Therefore, VMI is particularly worth introducing in relationships with small customers with unsophisticated needs (e.g., weekly delivery of one type of product) or when serving very large customers.
Implementing the VMI model does not mean a change regarding the moment of transfer of ownership rights. This means that inventory supplied by suppliers remains the property of the manufacturer, and they pay for it upon delivery. This is not always beneficial, as there may be a significant surplus of production and a stagnation in sales, and the delivered products may not be used at all and lose their value. Therefore, a more favorable solution in this respect is signing a so-called consignment stock agreement. This means that at the moment of delivery to the manufacturer, the supplier retains ownership rights to the inventory, and payment occurs only at the moment of using a given material or component.
The assumption behind consignment stock clearly differs from the traditional procedure, in which payment occurs after a set time (e.g., 30 days) from receiving the delivery or invoice. In the consignment system, there is no major difference between a situation where a product is in the customer’s warehouse for 2 days and a case where it is stored for 2 years. This means that the supplier does not receive payment before their use. Unfortunately, this is not a very favorable arrangement for the supplier. It can cause the supplier to struggle with financial difficulties related to liquidity. Without current revenues, it will be difficult for them to put up money for current production. Therefore, it seems that a simpler solution is to maintain a buffer stock reserved for a given recipient at the supplier’s location.
When to use VMI and when not to?
Market experience shows that the products most suitable for VMI are products whose usage is easy to plan; products whose cost-determining factor is the cost of procurement processes, not price; and those for which the manufacturer desires a long-term contract with the supplier.
For every type of product, however, an analysis can be performed as to whether it can be used with the VMI system or not. With controlled and regular consumption of a given product, whose product specification is defined, purchase frequency is also controlled and regular, and price and supplier are constant, one can fully benefit from VMI. This product is definitely consistent with the requirements that the use of VMI entails. In the case of a defined product specification, with its irregular, though standardized consumption, there is also consistency with VMI requirements. Additional conditions are high purchase frequency, a constant supplier, and a constant price. After meeting these conditions, VMI principles can be implemented for the analyzed product.
Despite predictable but infrequent consumption of a given product, there is no consistency with VMI requirements. The reasons for this state of affairs also lie in the undefined product specification, caused by constant modifications. Even if one buys a given product quite often and has a constant supplier, together with a unique price and the previously mentioned conditions, VMI should not be used in this case.
In other cases of consumption, even if we make purchases of a given product very rarely, it may still meet the requirements suitable for VMI. However, introducing inventory management by the supplier in this case requires the greatest standardization.
How to implement VMI
As mentioned earlier, it is not recommended to implement VMI for every product, so after product analysis, it should be additionally determined whether the existing motives for VMI action are important and aimed at bringing profits, whether the effects achieved with the help of the new strategy will be as expected, and whether a so-called golden mean has been found between savings and the dependence of the supplier’s business on the manufacturer’s purchasing policy. When the above conditions are positively reviewed, one can begin implementing the VMI delivery solution, which – for better organization – should proceed according to a framework plan for project implementation.
VMI implementation can be divided into several most important stages:
- Popularizing the VMI concept through interdisciplinary meetings with groups of employees affected by the project.
- Changing the business paradigm – this necessitates the involvement of management (top management) in the process of implementing and adjusting the new process. It is of fundamental importance to designate the resources necessary for the program’s implementation (min. people, software) and to estimate costs and effects.
- Obtaining the acceptance of employees currently responsible for inventory levels and convincing them that the program will not deprive them of their jobs, but will free up some of their time and allow for productive work in other areas.
- Creating a strategy.
- Defining changes in the scope of employees’ tasks and responsibilities and implementing them.
- Evaluating the product base (list of products whose purchases could take place within VMI).
- Cost-benefit analysis for individual suppliers.
- Estimating logistics parameters.
- Initial negotiations with suppliers.
- Establishing rules for insurance, payment, and invoice transmission.
- Transforming organizational cultures – in both enterprises, the solution should be treated as very important.
- Implementing tools enabling VMI operation (fax, e-mail, full ERP integration).
- Data synchronization and information standardization.
- Evaluating actual investment costs and benefits. According to the evaluation of the entire VMI program, its operation will affect both product sales (it will increase them) and logistics costs (which should be reduced).
Effects that VMI implementation can bring
The effects that VMI brings include both parties to the agreement. Thanks to such a solution, we can talk about reducing errors in data and performed operations, improving process speed, commitment to raising final customer service standards, tightening cooperation, reducing required working capital, and shortening time. Furthermore, it can be stated that there is a reduction in the number of returns and urgent deliveries.
The most significant benefits of implementing the VMI model for the manufacturer or distributor can be as follows: reduction of inventory shortages, decrease in planning and ordering costs, improvement of customer service levels, shifting responsibility for maintaining inventory to the supplier, simplification of administrative procedures, and securing the enterprise against negative situations in the markets for supplied materials and components.
The supplier, on the other hand, should gain benefits in the form of minimizing forecasting errors, reducing ordering errors, current knowledge of inventory levels, which will allow them to apply priorities in delivery execution, will be able to predict the distributor’s needs before they actually occur, and will give them premises for even greater production optimization and will introduce stability in customer relations.
Disadvantages resulting from VMI implementation
Undoubtedly, like any system, VMI is not a system without flaws. Therefore, attention should be paid to several of them. The most serious seems to be the element of difficulty in implementation and the high costs that the introduction of EDI entails; difficulties related to acceptance of the new way of working may appear, especially at the beginning of implementation. Due to its nature, the VMI solution is burdened with significant risk – losses, contract termination, and turning cooperation into conflict are possible; it is not always possible to correctly estimate the costs incurred by the supplier; it is essential to precisely determine materials and components of critical importance, the lack of which will stop production.
Why is it worth implementing VMI?
Arguments in favor of implementing the VMI model include: strengthening cooperation through shaping partnership, achieving large effects quite quickly, increasing the level of customer service, reducing inventory shortages through the use of more sophisticated inventory management techniques, reducing global logistics costs, improving information flow and sales volume – at the supplier and the manufacturer (or distributor).
Arguments against VMI implementation
Like every coin, the VMI system has two sides. In addition to the previously mentioned benefits, there are also disadvantages that it brings. Certainly, one of its greater disadvantages is the increase in the supplier’s administrative costs – as a result of increased responsibility and labor intensity, all changes in pricing strategies must be negotiated with the partner, there is a threat of losing control and flexibility, and the minimal significance of effects at low delivery volumes implies the necessity of reaching a critical mass at which the advantages of the solution are significantly greater than the disadvantages and costs.