Vendor Managed Inventory: Pros, Cons, and Best Practices
February 7, 2023
A vendor managed inventory (VMI) system can help retail businesses gain a competitive edge while providing high-end services to end consumers.
VMI reduces ordering costs and losses from poorly-optimized inventories and frees up time for businesses to grow their operations.
What Is Vendor Managed Inventory?
Also known as a supplier-managed inventory, VMI is the practice where the manufacturer or vendor assumes responsibility for replenishing customer inventories.
In a VMI system, the retailer shares their inventory data with the vendor to help them plan and optimize order sizes and replenishment operations. This is facilitated with the help of software systems that support vendor assistance in inventory management.
Vendor managed inventory software systems can forecast demand, track product information, support data exchange, and even integrate with e-commerce platforms.
How Does Vendor Managed Inventory Work?
Vendor managed inventory centers on successful collaboration between vendors and buyers.
Vendors and buyers looking to enter a VMI relationship must first outline their requirements for the collaboration. Once they agree on the terms, the buyer performs an analysis of its inventory requirements and sales, and shares the data with the vendor.
The buyer updates this data regularly as required for optimum replenishment. With the help of software, the vendor analyzes the data to adjust and manage stock replenishment for the buyer.
Vendor managed inventory contracts often include different terms depending on the field, the relationship between the supplier and buyer, and their individual operations.
VMI systems are popular with retailers and vendors for multiple reasons, but they don’t come without drawbacks. This article breaks down the pros and cons of adopting a VMI system for retail businesses.
Benefits of Vendor Managed Inventory
Better Product Availability
In the traditional inventory management models, businesses had to ensure optimum stock levels while also taking on shrinkage, shortage, and other risks. All of this affected product availability during periods when demand was high.
With vendor managed inventory, suppliers can undertake most of the management processes and reduce most risks. This leads to better lead time and allows retailers to easily match consumer demand. Ultimately, this system makes the demand variability curve smoother.
Better Customer Service
With accurate stock updates, retailers can fulfill all customer orders on time. This consistency increases return buyers and improves brand loyalty.
Protection Against Bullwhip Effect
A vendor managed inventory system also mitigates the bullwhip effect.
The bullwhip effect occurs when there is a misplaced diagnosis of demand for a particular product that disrupts the supply chain. It begins with retailers overestimating their demand forecast and ordering more inventory than necessary. It then pushes the suppliers to churn out more of those products than actual demand warrants.
Lower Operational Costs
With VMI, buyers can maintain lean stock numbers and downsize their warehouse space, thus reducing the expenses of carrying large inventories. It also reduces instances of stock-outs and overstocks.
In addition, it allows small businesses to shift some of the costs of managing inventory replenishments onto the vendor, thereby lowering their overall operational costs.
Improved Supplier-Retailer Relationship
VMI software facilitates business growth for suppliers and retailers through collaboration and data sharing.
Suppliers can offer better support for clients looking to incorporate special programs and help them achieve better results. And as retailers enjoy timely replenishment, they also benefit from a responsive supply chain.
Increased Time to Plan Growth Strategies
With a major task such as inventory management out of the way, business owners and their employees have more time and resources to dedicate to expanding operations.
Risks of Vendor Managed Inventory
Poor Vendor Support
Letting a vendor manage your inventory comes with a loss of control over crucial elements of your business operations. This won’t be an issue if each partner is trustworthy, but if there are errors or mishaps along the way, retail businesses can suffer.
Due to exclusive supplier contracts, buyers may find it difficult to source a product from another supplier. This can lead to poor quality or overpriced products, or no inventory at all.
Customer demands can change on a dime, so suppliers must allow inventory replacement when these trends shift. This is so the retailer isn’t stuck with items they can’t sell.
Managing optimum inventory levels is a huge responsibility no matter who undertakes it. It involves quite a lot of work, from managing new product introductions to phase-out plans. It’s crucial to clarify who is responsible for which tasks from the onset.
Some vendors might use retailer-provided data to exploit the VMI system. They may manipulate order sizes to send their partners more inventory to boost sales figures.
Because VMI requires data sharing, it leaves retailers vulnerable to exploitation and makes it difficult to cancel a contract.
Vendor Managed Inventory: Best Practices
Vendor managed inventory is most useful for businesses struggling with inventory control.
Here are the best practices to adopt when implementing VMI:
Set Clear and Specific Business Goals
Developing a VMI system without clear goals for your business can prove problematic and inefficient. Outlining the goals you wish to achieve with this system will help you create a productive contract with your vendor so your business can benefit. Goal-setting will help you negotiate terms to the advantage of both parties without compromising on your own objectives.
Setting clear business goals should also be ultimately beneficial in determining whether your vendor-supplier VMI relationship is successful.
In-Depth Analysis of Inventory Requirements
The most critical step to ensure a productive vendor managed inventory setup needs to happen long before vendor authorization.
This involves conducting an in-depth analysis of all inventory requirements to find the best possible vendor that can fulfill your needs. This analysis will give potential vendor partners a clear idea of your demand fluctuations and product restocking needs.
Vendor Capabilities, Software, and Tools
A robust VMI system needs a reliable vendor with a strong understanding of software tools and seamless implementation. This is crucial for real-time communication and data sharing between partners.
The task of utilizing inventory data and ensuring optimum stock levels lies with the vendors, but an effective partnership relies on both parties being open and accommodating.
Discuss Fees and Costs in Advance
Any fees or costs involved must be discussed while negotiating the contract with your vendor partner.
Make sure to consider all factors that can affect demand and all fees you will be charged throughout your partnership. From revenue share and demand function to holding costs and selling prices, being clear about these costs upfront will help you make better decisions and avoid expensive surprises later.
Ensure Vendors Can Access Key Information in Real-Time
An efficient and effective VMI system relies on open and clear communication between vendors and buyers.
Vendors must have a clear picture of the inventory at all times, and the retailer is the best source for the most important information. This is why the responsibility of updating inventory data often lies with the retailer.
It’s best to use robust software systems to facilitate such communication so data is easy to share and access in real time.
Keep Vendors Up-To-Date With Shifts in Demand
Changes in demand can be difficult to anticipate and prepare for without data. Retailers and vendors are expected to quickly adapt to situations like a dwindling demand due to natural shifts in trends or a sharp increase in the popularity of a product because of a viral meme.
When you provide inventory level updates to your vendors, they can spot shifts in demand faster and handle them better. They can stop stocking unwanted products and help retailers quickly offload those with a sudden boost in demand.
Adjust for Seasonality in Demand for Products
It is important to share all data on seasonal fluctuations in product demand with your vendors so they can adjust their restocking system appropriately.
This will ultimately prevent both parties from getting stuck with excess stocks and avoid stockouts of high-demand products.
Vendor managed inventory can make running supply chain processes smoother for all parties involved. It optimizes data to boost operational productivity for retailers and suppliers alike, enabling efficient order fulfillment and improved customer satisfaction.
We hope this guide has answered your questions about vendor managed inventory and improved your understanding of the concept. Considering the benefits and drawbacks of VMI should help you make a well-informed decision on whether such a system is right for your business.
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