Vendor managed inventory (VMI) is an inventory management method in which a supplier or manufacturer is responsible for tracking, optimizing, and maintaining inventory levels for a retailer.
Businesses of all sizes take advantage of VMI to simplify their supply chain management, minimize stockouts, and cut down on lead times.
In this article, we’ll explain how VMI works, its advantages and disadvantages, and whether it makes sense for your business to use it.
What is vendor managed inventory?
In a vendor managed inventory system, the supplier (vendor) agrees to handle all aspects of their customer’s inventory, including ordering, stocking, and replenishment. In other words, the distributor exchanges their demand forecasting and inventory data for streamlined inventory management.
Unlike traditional inventory management strategies that require companies themselves to juggle purchase orders, warehousing, and transportation, VMI shifts those responsibilities to the vendor. Done correctly, VMI frees up time to focus on other aspects of the business.
VMI is a type of consignment inventory, which means the vendor retains ownership of the inventory until it’s sold to consumers.
How does VMI work?
A VMI system depends on suppliers replenishing the right products at the right time. Here’s how a successful VMI relationship works:
- The vendor and buyer establish a VMI agreement. This documents which products are covered, how often they’re replenished, return policies, and a service level, which is the percentage of orders that can be filled from the VMI stock inventory.
- The vendor sends inventory to the retailer.
- The vendor tracks the retailer’s sales data and demand forecasting in real-time.
- The vendor sets reorder points.
- When the vendor gets notified that stock levels reach a reorder point, they deliver a new shipment. In some cases, a vendor rep even stocks the shelves at the retail location.
Now that we’ve covered the basics let’s take a look at VMI in action.
Vendor managed inventory example: Walmart
Walmart is the master of VMI. With over 4,700 stores and 75 million SKUs, managing all of that inventory on their own would be immensely time-consuming (and expensive). That’s why they’ve utilized VMI since the early 1980s.
Rather than devoting resources to managing all of their vendors’ products, Walmart gives those vendors direct access to data about their products at their stores. Then, it’s up to the vendors to determine the right time to replenish inventory. Under this model, Walmart can keep its shelves stocked while still running lean.
Walmart’s VMI strategy is so effective that its distribution costs comprise less than 2% of its sales—that’s about 50% better than other retailers.
3 advantages of vendor managed inventory for suppliers and manufacturers
Let’s take a look at three key benefits of VMI, whether you’re a big box retailer, an e-commerce brand, or a growing company looking for exposure at a retail chain.
1. Reduced carrying costs
When vendors know exactly how much demand there is for their products, they can accurately gauge how much inventory is being warehoused at any given time. That includes work in progress (WIP) inventory, raw materials inventory, and finished good inventory.
As a result, vendors can reduce their amount of safety stock which ultimately reduces carrying costs.
2. More control over in-store displays
Since vendors assume the responsibility of replenishing inventory at retail locations, their representatives can control how products are displayed and organized instead of leaving that up to retail employees.
For example, you might see a representative from Pepsi in your local supermarket, ensuring the brand’s products are displayed prominently and correctly.
3. Deep insights into sales data
In VMI systems, vendors get a granular look into their customers’ sales patterns and demand forecasting. This increased visibility lets vendors know how specific products perform in certain locations to make decisions about their production schedule and distribution based on solid evidence.
What are the benefits of vendor managed inventory for retailers?
Here are three ways VMI can give retailers a competitive edge.
1. Fewer stockouts
Stockouts are a nightmare for businesses—they hurt your bottom line (and your relationships with customers). Unfortunately, they can happen even if you place purchase orders when inventory levels hit the reorder point.
However, a VMI system ensures that vendors have constant insights into inventory levels, so they know precisely when it’s time to replenish. After all, it’s in their business to keep their products on the shelves at all times to maximize their revenue.
2. Lower costs
Think about all the costs associated with traditional inventory management: stock counts, IT systems, not to mention the cost of carrying excess inventory onsite. With VMI, those costs are transferred to vendors so retailers can pad their margins and allocate their funds elsewhere.
2. More time to focus on growing the business
The more time a company spends on inventory planning, creating purchase orders, and handling other inventory management tasks, the less time it has to think about high-level decisions. VMI takes much of the burden of inventory management off your team so you can devote time to other aspects of your business, like marketing or product development.
What are the disadvantages of vendor managed inventory?
VMI can be a mutually beneficial strategy for vendors and retailers. But before you jump into a VMI agreement, there are some risks to consider.
1. Some vendors might lack the proper data capabilities
VMI hinges on a vendor’s ability to assess inventory levels accurately, avoiding a surplus or stock out. However, not all vendors have the technological infrastructure to do that. Before you initiate a VMI program, verify that the vendor has adequate experience with analytics.
2. VMI relationships can be difficult to dissolve
VMI requires two organizations to be deeply integrated. There are legal documents, shared data, and confidential information that bind the two parties together. The closer the organizations become entwined, the harder it can be to cut ties.
3. VMI exposes your data
Whether you’re a vendor or a retailer, VMI only works if you share your data with the other organization. Electronic data sharing under any circumstance makes you vulnerable, so it’s vital to have an airtight non-disclosure or confidentiality agreement before you begin a partnership.
Is VMI right for your business?
Trying to decide whether VMI is the best inventory management strategy for your business? Here are two key questions to consider:
- Is there a measurable benefit for both parties? VMI only works when vendors and retailers both reap the rewards. Nobody wants to be taken advantage of, so determine exactly what’s in it for everyone.
- Are both parties willing and able to share the appropriate data? The foundation of VMI is data sharing, so retailers need a robust inventory management system and vendors need tools to receive and analyze that data.
VMI requires diligent planning, but it can slash costs and boost your bottom line when all the pieces align.