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Today, as more and more organizations strive to improve productivity and profitability by dedicating the bulk of their resources to their core competencies, many of them are looking for efficient and cost-effective ways to outsource ancillary and support activities. In fact, leading research firm IDC reports show that, in 2006, companies spent over $425 billion to outsource secondary and back-office business functions. And, the same study predicts that the market for outsourced business services will reach over $641 billion by 2009.
Nowhere is this trend more prominent than among supply chain-centric organizations such as retailers, wholesalers, distributors, and manufacturers. But, as many of these companies have begun to reduce staffing levels and related expenses through outsourcing strategies, they have been challenged to dedicate the needed resources to effective inventory management – hindering both sales efforts and customer service delivery. This growing problem has forced them to re-examine the way they manage their inventories, and find new ways to address this critical business function without diverting staff time from activities that directly impact sales and profits.
As a result, many supply chain firms are turning to Vendor Managed Inventory (VMI) as a means of overcoming this challenge. In VMI arrangements, suppliers take full responsibility for monitoring and maintaining the inventory levels of its products at customer facilities. AMR Research predicts that the use of VMI models and related best practices methodologies will grow at a rate of 10 percent through the end of this year, with growth of more than 6 percent annually expected in the longer term.
Unlike consignment agreements, where the supplier retains ownership of the product until it is consumed, the product becomes the customer’s asset immediately after purchase with VMI models. Additionally, VMI eliminates the need for third-party arrangements, where distributors or logistics providers act as paid middle-men to handle inventory administration. Well-designed VMI arrangements can offer tremendous value to both buyers and suppliers, boosting the efficiency and profits of both parties.
When developing a new VMI agreement, both suppliers and their customers should carefully consider the following items:
- Which product or products will be covered under the arrangement
- The minimum, maximum, and target inventory levels to be maintained
- Re-order trigger points and related processes
- Product replenishment frequency
- Material return policies
Ensuring VMI Success – The Risks and How to Avoid Them
Although the benefits are significant, there are some risks involved for both customers and suppliers when entering into a VMI program. For example, suppliers may face higher administrative costs. Additionally, they will need to allocate additional staff resources to handle those replenishment activities that were previously performed by the customer. In order to justify these added burdens, suppliers must have sufficient sales volumes and gross margins. Possible customer risks include a decrease in control over replenishment activities.
Additionally, supplier performance becomes an increasingly critical factor in the vendor-client relationship, since there is a newfound reliance on a single source of supply. But, just because a customer enters into a VMI agreement with one strategic supplier, does not mean they cannot maintain relationships for the same products with secondary suppliers – as doing so can dramatically minimize risk. Another issue customer may face relates to cost savings. If not structured and managed properly, VMI arrangements may not deliver the expected reduction in overall operating expenses.
But, perhaps the greatest risk with VMI programs is the potential exposure of confidential information. In order to properly replenish customer inventory, suppliers must have access to sensitive information such as past usage patterns and demand projections. All the risks listed above can be mitigated with a VMI program that is properly planned, structured, and executed. Therefore, the successful implementation of a VMI agreement can be ensured with:
- Continuous inventory monitoring by the supplier. Suppliers must know – at all times – what products need to be replenished, and what quantities are required. So, they must be able to readily access timely and complete information about product consumption and related transactions at each customer’s site.
- Monthly recalculation of replenishment parameters. The following replenishment parameters should be recalculated at least once each month: o Items with recurring usage. Anticipated demand for products that are sold or used on a regular basis must be accurately calculated by the supplier.
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