The Fundamentals
Vendor-managed inventory (VMI) systems are a proven technique for improving the efficiency of supply chain operations. VMI is made possible by the implementation of an electronic means of exchanging inventory information between the buyers and sellers of products. These electronic links eliminate many of the built-in delays associated with traditional ordering systems and enable the establishment of collaborative inventory management systems. Experience has shown that improvements in these two areas can result in the elimination of between 20 percent and 30 percent of the previously required supply chain inventory. However, in order to achieve this level of success, it is critical for those companies that have not yet implemented VMI to follow a best practice approach.
Successful VMI programs take advantage of a key supply chain relationship that has been reaffirmed many times over. When trust, cooperation, and business integration among trading partners increase, the level of inventory in the pipeline can go down significantly. Assuming normal business conditions, this can be a direct, inverse relationship that leads to significant improvements to the bottom line for all participants.
Process overview
No matter what industry the process is applied to, the basic concept of VMI is the same: share inventory and other information in such a way that allows for a reduction in order response time and a subsequent reduction in on-hand safety stock inventory needed to support sales or manufacturing activity. The most common process used to support VMI is EDI-based exchange of two X12 transaction sets: the 852 Product Activity Transaction and the 855 Purchase Order Acknowledgement. Figure 1 shows a retail industry example that is described below.
 Figure 1 shows a retail industry example that is described below.
On a daily basis, the retailer organization calculates sales and inventory data for each item and forwards this information to the appropriate suppliers using the 852 Product Activity Data transaction. Upcoming promotional plans can also be forwarded within these electronic documents. Software on the manufacturer’s end calculates the level of retailer inventory required to support the current level of sales activity and planned promotions. The manufacturer’s system creates the corresponding purchase order and sends an 855 Purchase Order Acknowledgment back to the retailer. The retailer feeds this information into its system as if it were an internally generated purchase order. The entire cycle can take less than one day, compared to four to six days under the old system.
Because this electronic exchange of product information enables the entire process to move much faster than the old paper-based system it replaced, both the retailer and the manufacturer can achieve significant cost savings due to reduced supply chain inventory levels. The retailer needs less safety stock inventory in its distribution center(s), and the manufacturer is able to implement better production scheduling to match real demand and, therefore, carry less inventory in its distribution center(s).
The retailer also benefits from improved customer service: experience has shown that manufacturers can frequently forecast sales of their products better than the retailer can since the manufacturer has access to sales activities of the same products from multiple retailers and gets a better picture of actual demand and promotional results across a much broader marketplace.
VMI can directly impact the bottom line by reducing inventory levels, but it also improves top-line revenue by elimination of stockouts, which cause customer dissatisfaction in addition to the lost sales opportunity. Helping to drive the top line is often more exciting to top management than cost reduction and assists in making the supply chain function a more equal partner in running the business.
Some challenges
VMI veterans, as well as newcomers to the process, will eventually agree on one point: existing VMI processes work fine for dealing with predictable demand, but have significant problems dealing with the less predictable flow that results from sales, promotions, and other special activities. This occurs because the electronic data interchange (EDI) transactions that support VMI lack the flexibility to support true inter-company collaboration in planning for these events.
Summary of Benefits
For the buying organization:
- Lower costs: Much of the inventory planning will be done by the supplier.
- Less inventory: Better planning leads to lower safety stock levels.
- Better fill rate: Fewer stockouts, resulting in better sales and higher customer satisfaction.
For the selling organization:
- Sticky customers: The implementation of VMI processes leads to a tighter relationship with buying organizations, making them less likely to switch to a competitor.
- Reduced inventory: Increased supply chain visibility enables better inventory planning.
- Reduced cost: VMI enables tighter integration of vendor needs and production planning, resulting in more stable production and fewer “rush” orders.
Companies using VMI usually realize best in class performance.
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Figure 1
