What is vendor managed inventory (VMI)?

VMI meaning in supply chain

VMI, also known as supplier-managed inventory from a customer’s point of view, is a data-driven initiative where suppliers manage the inventory levels of their own products, components, or materials at the on-site location of the vendor or distributor. This helps to reduce both shortages and surpluses. By shifting inventory management responsibilities in this way, supply chains can run leaner and more efficiently – reducing overheads and improving supply chain responsiveness and agility.

Using automated data flows and advanced analytics, the VMI model improves order accuracy, reduces rework, and increases inventory turnover. Suppliers use real-time sales and demand forecast data to optimize shipments and maintain high in-stock rates, allowing them to respond quickly to market changes and protect against the supply chain bullwhip effect.

Before starting a VMI relationship, you and your suppliers will need to agree upon key performance indicators (KPIs), such as inventory turnover rate, stock-to-sales ratio, and sell-through rate to ensure mutual goals are met. This collaborative model ultimately leads to a more efficient and responsive supply chain, benefiting both suppliers and customers.

How does supplier-managed inventory work?

VMI is a collaborative strategy that can deliver impressive results, particularly when undertaken with commitment, buy-in, and with the proper tools and systems in place. It relies on the synchronization of data and communication to ensure that inventory levels are always aligned with current market demands. Below are some of the critical components of this process:

• Formal agreements from the start: Before you begin, outline everyone’s roles, responsibilities, and expectations. Both parties must agree on the operational details, such as delivery schedules, inventory levels, return policies, and min/max replenishment levels.
• Shared technology: Agreements should also include a formal commitment to use shared and integrated technology platforms to their full capacity. The willing exchange of real-time information—such as sales data, inventory levels, and other relevant details — is absolutely essential for the success of this strategy.
• Inventory management and replenishment process: From initial stock provision to continuous monitoring and demand forecasting, the supplier is responsible for managing your inventory. This is a data-driven process and works best when the supplier can leverage the sophisticated data management and AI-powered analytics within your business and integrated supply chain systems. With controlled access to a broad range of sales and supply chain data sets, your supplier can achieve greater precision and accuracy.
• Communication link: The most efficient VMI strategies are brought to life on a collaborative business network that makes it easier for all stakeholders to work together, exchange essential documents securely, and act based on shared insights.
• Vendor control: Vendors do all re-stocking and ordering, allowing you to offload tasks such as determining order times, sizes, and frequency. This data-heavy process becomes smoother and more transparent when your vendor can leverage robust informational sources on expected lead times, production levels, estimated shipping delays, and any other details that may have an impact upon inventory levels and supply and demand.
• Inventory ownership: “We have great vendors but isn’t it a little risky to put this much faith in them?” This is a common question for those newly learning about this topic. However, with the VMI approach, the vendor actually still owns the inventory. They are placing it on your premises to facilitate fulfillment and minimize time and costs. In other words, it’s a great example of a win/win business strategy.

Benefits of vendor-managed inventory

Every step toward making your supply chain more efficient can have a positive effect across your business. When you adopt VMI, you can not only boost efficiency across your supply chain, but you can also achieve the following results:

• Streamlined inventory management: By transferring inventory management to your suppliers, you can simplify operations and reduce time spent on managing inventory.
• Reduced inventory carrying costs: VMI optimizes stock levels to meet demand, minimizing storage costs and freeing up cash flow.
• Precise production scheduling: Suppliers gain better data-driven visibility into demand trends (or potential disruptions), allowing for more accurate production planning and reduced waste.
• Timely replenishment: Automated replenishment ensures just-in-time restocking, helping to prevent shortages and surpluses.
• Better, more collaborative working relationships: The collaborative and communicative nature of VMI can help you foster stronger, more trusting partnerships between you and your suppliers.
• Optimized inventory levels: When suppliers have access to real-time sales data, it allows them to maintain ideal stock levels and to develop more strategic and precise ordering.
• Resilience and risk reduction: When this core area of your business is being more strategically managed, you have more time and resources to devote to building a more resilient supply chain that can better predict and respond to disruption or risk.
• Supplier perks: When suppliers gain early insights, they can use them to drive new sales opportunities, leading to better planning, larger market shares, and, ultimately, happier partners.

Potential risks of a vendor-managed strategy

Below are a few examples of the more common challenges associated with a VMI strategy – and some tips for mitigating them:

• Lack of control/dependency on supplier: You may lose control over inventory levels and become too dependent on suppliers. Mitigation: Establish clear contracts and SLAs with performance metrics and real-time inventory management systems to maintain visibility and control.
• Ill-suited systems and messy data: VMI's effectiveness depends on accurate data shared between partners. Mitigation: Invest in built-for-purpose systems that allow parties to transmit and work on documents in a secure way.
• Communication failures: Miscommunication can lead to inventory discrepancies and inefficiencies. Mitigation: While a collaborative business network is essential, it’s also important to continually encourage and support a silo-smashing and collaborative culture with all your teams and stakeholders.
• Data security concerns: Sharing sensitive data increases the risk of breaches. Mitigation: Implement advanced cybersecurity measures and encryption protocols to protect data integrity and confidentiality. Undergo regular team training to keep up with the ever-changing landscape of cyber risk.
• Inflexibility to market changes: Predefined algorithms may hinder swift responses to market shifts. Mitigation: Use flexible AI-driven analytics tools to adjust forecasts and inventory strategies based on real-time data from both inside and outside your supply chain.
• Demand changes: Unexpected demand spikes or reductions can disrupt forecasts and restocking. Mitigation: Good data analytics will help you forecast many potential scenarios. But it’s essential to have alternate contingency plans and workflows in place with your teams and vendors, so you can pivot quickly if the market demands. And by leveraging a solution that supports integrating your VMI processes with a consignment program, you can keep inventory levels within your ideal upper and lower bound.

VMI vs other types of inventory management

Access to connected technologies and AI-powered tools has unlocked the potential to modernize and optimize numerous inventory management models. Below are some of the more common ones:

• Traditional inventory management: The business is solely responsible for ordering and managing their own inventory, often leading to larger safety stocks and higher holding costs.
• Just-in-time (JIT) inventory: JIT reduces inventory costs by receiving goods only as needed, but lacks VMI's flexibility and continuous replenishment, making it more vulnerable to disruptions.
• Consignment inventory: The supplier owns the inventory at the retailer's premises, reducing the retailer’s capital in stock but without active management by the supplier.
• Drop shipping: The business does not keep the products it sells in stock but instead transfers customer orders and shipment details to a third party, typically a wholesaler or manufacturer, who then ships the goods directly to the customer.
• Cross-docking: This model minimizes inventory storage through the direct transfer of materials between inbound and outbound transportation, whereas VMI uses data to optimize stored inventory management.
• Consignment managed inventory (CMI): With CMI, the vendor owns the inventory until it is sold which reduces retailer financial risk – but it doesn't offer the same level of active inventory management as VMI.

Vendor-managed inventory examples

VMI is effectively employed across an enormous range of industries – each with their own challenges and potential. Below are just a few sectors and scenarios where VMI is helping to ramp up the game:

• Manufacturing for the automotive industry: Here, VMI is used to effectively manage the supply of critical components like electronics and fasteners directly at assembly sites. Suppliers are responsible for maintaining inventory levels in sync with the manufacturers' production schedules, ensuring timely availability of parts and preventing production delays.
• Distribution of pharmaceutical medications: To accurately coordinate drug supplies at healthcare facilities and pharmacies, VMI ensures that essential medications are available for distribution, particularly those requiring stringent regulatory compliance and storage conditions.
• Component supply in the consumer electronics industry: For manufacturers of consumer electronics, such as smartphones and laptops, VMI is ideal for managing component inventories like microchips and displays. Suppliers monitor production forecasts and actual sales data to adjust inventories accordingly, helping to mitigate the risks associated with fluctuating demand and technological upgrades.
• Aircraft assembly and maintenance in the aerospace sector: VMI systems are used to regulate the inventory of high-value components and maintenance supplies. They allow suppliers to directly control and replenish stocks of critical materials, like aluminum sheets and engine parts, that are crucial to both manufacturing new aircraft and maintaining operational fleets.
• Retail/consumer packaged goods (CPG): For major retailers and CPG companies like Walmart or Amazon, VMIs are used to optimize inventory management. With SKUs literally in the millions, vendor-managed inventory allows them to keep shelves stocked with minimal overstock, reduce inventory carrying costs, and maintain availability for their customers.

Best practices for a successful VMI strategy

We’ve established that for VMI to be successful, the technological capacity for real-time data sharing and collaboration is mission critical. But for many of your best team leaders and staff, it represents a new (albeit more efficient) way of working. Digital transformation is one part of this process – but never underestimate the importance of good change management strategies and of setting clear expectations and goals. The following practices can help pave the way:

• Open and transparent communication: In addition to implementing a business network platform, you’ll also need to maintain a commitment to clear and consistent communication channels with every key team member and stakeholder involved in the VMI process.
• Agreed KPIs (key performance indicators): From the shop floor to the top floor, there are subject specialists across your business. Ensure that you communicate with all relevant team leaders to define and agree upon clear KPIs. In this way, you can be sure to measure and track all the essential moving pieces in your VMI environment.
• Clear roles, responsibilities, boundaries, and fees: Define these parameters for each party involved in the VMI process to prevent misunderstandings and ensure accountability. And as above, remember to ask the right experts within your team to ensure that these regulations are sufficiently broad and robust.
• Training and support: Up to 70% of digital transformation projects fail. Not because of the technologies but because of poor planning, siloed cultures, and insufficient training and communication. VMI can be a win/win for everyone in your network. But it’s up to you to ensure that good education and top-down support commitments are in place from the start.
• Stamping out data squirrels: Information is power and even with the best of intentions, there may be people on your teams who are reluctant to integrate certain data sets into a centralized platform. Establish a consistent and standardized set of data management guidelines to demonstrate your fair and equitable application of necessary regulations.

What to look for in a vendor-managed inventory system

Wherever you are in your digital supply chain journey, it’s important to balance managing your immediate fire-fighting needs with your longer-term commitment to strategic improvement and scalable growth. Here are the VMI system features that deliver the greatest impact on both fronts:

• Inventory visibility and collaboration: Choose software that provides a real-time view of replenishment orders, scheduling agreements, and inventory levels.
• Seamless integration: The solution should be able to play well with your ERP system and with your other supply chain and e-commerce platforms. This connectivity allows accurate transaction data to be shared in real time and also supports push-based replenishment based on min/max inventory policies.
• Shared forecasting: Select a solution that gives all trading partners visibility into forecasts, including demand and production line capacity. The best systems provide alerts about commitments and adjustments for a swifter response to potential disruptions.
• Real-time data updates: Ensure the system provides real-time updates on inventory and sales data for quick responses.
• Cloud platforms for real-time access to inventory data: Cloud-based solutions offer flexibility, scalability, and remote access to inventory data.
• Integrated analytics for decision support: Look for systems with integrated analytics for deep insights into inventory performance.
• Machine learning for enhanced analytics: Choose systems incorporating machine learning for precise inventory optimization.
• Scalability: Ensure the system can scale with business growth and increasing inventory demands.
• User-friendly interface: Select a system with an intuitive interface for easy adoption and efficient use by your team.

Take the next steps

Explore vendor-managed inventory software built to enhance collaboration, visibility, and automation across your network. By integrating planning, inventory, and quality management processes, they can help eliminate manual silos and drive efficiency—empowering you to seize opportunities as well as mitigate risks. When you can respond swiftly to demand fluctuations and are confident in your inventory management strategy, your operations become more resilient and more competitive.

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