Vendor managed inventory (VMI) is a concept that has been in active use for decades, but is often so embedded into routine operations that it may not be recognized as such. An extension of the practice of consigned inventory, VMI is actually incorrectly named.
Let’s say a manufacturer agrees to buy a certain quantity of a given part over a defined period of time. Perhaps these are bulky items, made in a supplier’s plant that is far from the manufacturer’s location, and the buyer has difficulty predicting just when these parts will be needed. But when they are required, it’s usually on short notice. In this situation, it might be better for all concerned if the supplier ships a quantity of the parts to the manufacturer’s warehouse, but doesn’t consider them sold until the manufacturer actually pulls them from inventory to be used in production.
This is a classic situation for consigned inventory. The goods are physically located in the manufacturer’s (the supplier’s customer) location, but still owned by the supplier. This is a win-win for the supplier and the manufacturer. The parts are available as needed (on demand, you could say). The manufacturer does not have to buy and stock the parts ahead of time, but has immediate availability when they are needed. The supplier bears the cost of the unsold inventory, but has guaranteed sales of the parts and does not have to rush the parts to the customer when the unpredictable need occurs.
The accounting folks may have issues with goods on-site that are not legally owned by the company. They have to be added to insurance coverage as there is some liability that falls outside of typical situation, and inventory accounting must treat these items differently. But those are issues that can be resolved.
The VMI difference
VMI differs from consignment in that control of the consigned inventory remains with the supplier who is responsible for maintaining the inventory level (replenishment). Notice the previous sentence says “supplier”. In the proper definition, a vendor is an entity that is capable of providing the needed goods or materials to the customer, whereas a supplier is in a business relationship to actually supply the goods. Technically, VMI should really be SMI (supplier-managed inventory) but there’s simply too much history and inertia to correct the term. So VMI it will remain.
VMI is a common practice in grocery stores and other retail businesses. A major supplier to a retail store or a grocery store may agree to offer their products in a certain section of store space or a shelf area. The supplier’s employee, let’s say it’s the bakery truck driver, will come to the store each morning, count what remains on the shelf from the previous day, remove unsellable (stale) product, refill the shelves, and initiate the invoicing process for the goods that were actually sold. The supplier takes full responsibility for managing the store (consigned) inventory.
It can work the same way in a factory. Many plants have a VMI arrangement for small, commonly used parts like fasteners. The supplier is assigned designated space(s) in the plant where the parts are stored. The supplier’s representative regularly visits those locations and replenishes the parts after determining how many have been used and initiating the accounting and billing process. VMI agreements typically specify desired minimum and/or maximum quantities for each part.
In some cases, VMI can take the form of a supplier employee actually resident at the customer’s plant, collaborating with the planners and schedulers, and acting as the de-facto buyer for their company’s products. Many variations are possible; the key to this relationship is the supplier taking responsibility for replenishment – having sufficient parts available to meet the manufacturer’s needs – and not invoicing the manufacturer until the parts are used.
VMI obviously involves a certain level of trust between the partners, but can be a powerful mechanism for collaboration that delivers substantial benefits for both the supplier and the customer/manufacturer.
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