How to Use Vendor-Managed Inventory Programs

By Julie Rains on 2 September 2009 (Updated 26 April 2010) 0 comments

A well-run vendor-managed inventory (VMI) program could allow your business to speed up its cash flow by more closely matching your cash outlay for inventory with your cash inflows from sales and other income-generating activities. 

By tapping into the expertise of your vendors, your business may be able to:

  • minimize inventory carrying costs (that is, cash tied up in inventory or costs associated with obtaining credit to fund inventory purchases) while
     
  • maximizing sales (having the right inventory available at the right time for retail consumers or wholesale customers) and/or
     
  • eliminating production or shipping downtime associated with longer-than-desired lead times for parts, supplies, and equipment.

Companies that offer VMI programs, such as OFFWIRE (distributor of wireless accessories to mobile phone retailers) and Universal Pallet Supply Inc. (shipping pallet and crate manufacturer) also promote these benefits to their customers:

  • reduction in payroll expenses for staff who make purchasing and inventory management decisions;
     
  • fewer errors in placing orders;
     
  • reduction in expenses associated with distribution infrastructure for VMI programs that handle drop-shipments or direct-to-site shipments;
     
  • smoother handling of logistical issues and lower transportation costs associated with better planning of inventory levels and product mix.

What is VMI?

VMI is an arrangement in which a vendor manages your company’s inventory of designated items, rather than you or your staff making decisions about what to purchase and when to place orders. Typically, the vendor handles day-to-day execution of inventory plans using information such as:

  • inventory ordering or replenishment guidelines relating to product mix, safety stock levels, shipping schedules, etc. created through customer-vendor collaborations
     
  • customer/location POS (point-of-sales) data and production forecasts
     
  • projected inventory requirements based on customer-specific sales and usage trends or industry-wide consumer demand

Payment terms may vary; payment may be due upon:

  • receipt of goods by the customer
     
  • sale or use of items by the customer (basically, a consignment program tied to VMI)
     
  • receipt of goods + net 30 days (or whatever credit terms have been established by you and the vendor) 

Uses of VMI Programs

The concept of vendor-managed inventory can be applied to various situations, ranging from keeping an office supply room stocked for a small business to organizing large-scale merchandising programs at major retailers.

Depending on its customer base and business niche, vendors may

  • develop, implement, and manage merchandise programs in designated categories (all movie DVDs or a certain brand of men’s t-shirts, for example) for retailers.
     
  • deliver components and supplies aligned with production schedules for manufacturers.
     
  • maintain stock levels of certain items for distributors.

OFFWIRE, for example, determines product mix and quantities needed by its customers and ships directly to stores on a weekly basis; the company also monitors the program intensively for customers new to VMI and later through periodic reviews. Similarly, Universal Pallet Supply Inc. monitors its customers’ inventory levels on a weekly basis, tracks returns, and makes and delivers pallets to meet customers’ needs; and Fastenal provides on-site inventory management of MRO (manufacturing, repair and operations) supplies for manufacturers.

Getting Started

A successful program requires collaboration and trust between your business and the vendor managing your inventory. Ideally, the vendor will have unique, competitive insights into your industry and your business. This deep understanding may likely be developed by servicing your company and others with similar operations.

Some vendors may have certain standards for customers such as minimums for annual purchasing volumes and a good credit history. OFFWIRE requires its customers to be sound financially and have inventory controls in place, such as a weekly count and reconciliation with administrative records.

Setting up a VMI program should involve dialogue about

  • program goals including specific measurements to determine value to your company
     
  • general parameters such as safety stock levels and shipping schedules
     
  • information required to implement and manage the program

Typically, the set-up will require some sort of electronic information exchange between you and your vendor, followed by an analysis (often with specialized VMI software) that initiates shipment of items to your business. For example, OFFWIRE extracts POS data from its customers, uses a software program (SCP 4.0 by Jada Management Systems) to aid in developing orders appropriate for each location, and ships product on a weekly basis.

Risks

As a business owner, your biggest concern is likely whether your vendor can manage inventory more effectively than you or your staff can. Specific risks include:

  • having too much of the wrong inventory and not enough of the right inventory
     
  • becoming overly reliant on one vendor for certain product categories, leaving your company vulnerable (without inventory) if the vendor encounters problems with finished product or material availability, transportation, or financial solvency
     
  • experiencing lower-than-expected service levels
     
  • losing negotiating leverage because you are committed to a sole source

To mitigate risks, set VMI performance targets with timelines and consider structuring agreements to limit or end your involvement if vendors do not deliver targeted results.  

Program Metrics  

You can evaluate program effectiveness by establishing and monitoring performance prior to VMI implementation and after implementation on a regular basis. Indicators may include:

  • inventory carrying costs
     
  • inventory turnover
     
  • service levels
     
  • order fill rates
     
  • write-offs of obsolescent inventory
     
  • expenses associated with filling rush orders

The vendor may have measurement tools in place to demonstrate the value of the program and to assess its performance for the purpose of making continuous improvements. OFFWIRE offers a report card that measures two key metrics: attachment rate (accessories sold per unit sold); and profitability by attachment. Following the VMI implementation, the company reviews these metrics on a weekly basis and initiates calls to discuss any concerns. As a result, problems are quickly addressed and customers can see results in terms of increased sales and profitability.

If managing your inventory has been a costly burden or if you’d like to improve inventory performance and accelerate cash flow, ask your vendor about VMI programs.

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