What is Vendor Managed Inventory?

Big brands like Walmart manage approximately 142,000 individual SKUs in every store: thousands of inventory to track and manage each day. Inventory management is a time-consuming, if not monumental, task for businesses of all sizes. 

Making sure customers get what they want, when they want it is the core function of every brand. For this reason, vendor managed inventory (VMI) presents an effective model for vendors and suppliers alike. Here’s what vendor managed inventory entails, and how businesses can benefit from this proactive procurement process. 

What is vendor managed inventory?

Vendor managed inventory is a process in which the vendor of a product takes responsibility for maintaining the buyer’s inventory of that product. The goal of vendor managed inventory is to create a mutually beneficial relationship in which both the buyer and the vendor are able to streamline the availability of goods. 

How does vendor managed inventory work?

Vendor managed inventory requires great communication between the vendor and the buyer. But, the logistics of running a VMI model are relatively straightforward. Typically, the vendor specifies delivery quantities sent to the buyer using data from Electronic Data Interchange (EDI). The EDI transactions that concern vendor managed inventory are 852,855, and the 856. The 852, for instance, contains the sales and inventory information such as quantity sold, quantity on hand, and forecast quantity. 

“The EDI 852 information can be sent from the customer to the vendor on a weekly basis or more frequently in high-volume industries. The vendor makes the order decision based on this data in the 852 transmissions,” explains The Balance.

The vendor then fulfills the next inventory restock based on the contract and the forecasted demand. Decisions on how much inventory to send are based not only on the EDI transmission but also on the agreement between the vendor and the buyer. Again, this is where great communication is critical. According to one study, the most common cause of VMI failure has to do with communication breakdown. 

Benefits of VMI

Vendor managed inventory, when set up properly, is a win-win for buyers and vendors. 

For buyers, perhaps the biggest benefit is being able to operate with the confidence that you’ll never run out of stock. In traditional procurement, even if you place a new purchase order for an in-demand item, there’s no guarantee that the supplier will be able to accommodate your request. With no direct insight into your inventory turnover and forecasted turnover, a supplier may be caught off guard by your high sales and not be able to adjust their delivery schedule. 

Likewise, vendor managed inventory streamlines and smooths out the process of inventory management. “Because the vendor receives data and not purchase orders, the purchasing department has to spend less time on calculating and producing purchase orders,” wrote The Balance.

For suppliers and vendors, there’s a distinct advantage in creating a long-term partnership with the buyer. A VMI agreement allows vendors to maintain a steady, predictable flow of income and reduce the risk of buyers suddenly switching suppliers. This arrangement also allows vendors to monitor their operations to reduce waste and minimize the risk of overstock. 

Both vendors and buyers are able to reduce purchasing-related admin costs, optimize inventory-turnover ratios, and build some degree of predictability (and therefore, risk management) into their operations. 

Risks of vendor managed inventory

There are, however, some risks and hurdles to overcome to make vendor managed inventory work properly. 

First, vendor managed inventory benefits from the use of procurement and inventory management technology. When issuing a new supplier bid, for instance, Fairmarkit uses historical data to give buyers recommendations while structuring it to be measured and reported. With every bid, our recommendation engine improves the information for next time and helps you improve your process. This data can be foundational to setting up a VMI arrangement that is successful from the get-go. 

Vendor managed inventory programs also depend on the strength of inventory tracking systems. If there’s a glitch in inventory tracking, or if inventory tracking is done manually, the room for error to throw off ordering for the vendor can be consequential. VMI programs aren’t a “set it and forget it” solution: communication channels should be kept open throughout the agreement to mitigate any confusion. 

For buyers, there is also the risk of being too aligned with one supplier. Buyers forgo the opportunity of diversifying their supply chain. In the event of a pandemic or other global event, these buyers may be left to scramble to find other vendors to fill their needs.

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For more advice on managing inventory and streamlining procurement, check out Fairmarkit’s blog, The Source.