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Vendor Managed Inventory


What is the difference between Vendor Managed Replenishment

(VMR) and Vendor Managed Inventory (VMI)? What are the
situations when VMI should be considered?


What are the issues that must be considered to make a Vendor

Managed Inventory program successful?


VMI relies on effective information technology for its success.

List some of the capabilities that the software should have for
successful implementation of a VMI program.

Vendor Managed Inventory

Richard McCluney,
November 29, 2010
Part 1 in a multi-part series on vendor managed inventory
Whenever I talk about the topic of VMI (which seems to be more and more frequently), I
am asked about the various acronyms associated with inventory management, such as
VMI, VMR, and SMI. In this blog, I will offer my definitions of these terms and then share
some rules of thumb for When to do VMI.
First, lets try and get the terminology straight. The key differences I am seeing between
various demand-driven replenishment models used across manufacturing verticals are:

VMR Vendor Managed Replenishment. In this model, the customer owns

inventory and the supplier is responsible for replenishment to pre-agreed, demanddriven min-max quantities.

VMI Vendor Managed Inventory. In this model, the supplier owns the
inventory and replenishes based on pre-agreed min-max quantities. The customer
owns the inventory once it is pulled, and typically has liability for inventory not yet

SMI Supplier Managed Inventory. Same as VMI. Used in many companies

because they dont want to call their supplier a vendor.
The key point to remember about VMI is that the delivery is demand-triggered, not
forecast-triggered. Inventory is allocated based on customer forecast and replenished
based on customers actual demand. Since the replenishment is driven by the supplier,
but inventory liability still belongs to the customer, it is essential that the VMI goals and
terms be clearly defined in the program. Good contracts spell out not only the basic
termssuch as minimum order quantity, min/max inventory levels, and delivery
response timebut also clearly articulate flexibility and liability parameters based
on forecast at a part number level. The point being that the contract may spell out
different levels of liability for a chipset versus a standard capacitor. In a separate blog I
will go into more detail on inventory liability and freshness.
While working with customers up and down the value chain, one question I am often
asked is: what symptoms typically signal the need for VMI? While there are no hard and

fast rules, below are three common scenarios that may mean its time to take a
closer look at VMI.


You are losing sales due to shortages or poor on-time delivery

performance by a supplier. In this case, a VMI program may be
just the ticket you need to higher service levels.


Provisions for excess and obsolete inventory are greater than

0.3% of materials spend.


Inventory turns on key parts have dropped below 10. These

particular parts may be prime candidates for VMI.

Do any of these scenarios sound strikingly familiar? Interested in learning more about
best-practices surrounding VMI implementation

Part 2: Forecast collaboration: The first

step to implementing a VMI program
In part 1, I provided an overview of vendor-managed inventory (VMI) and described a
few of the most common symptoms signaling the need for VMI. In this post, I will focus
on forecast collaboration, which is an important first step for designing and implementing
an effective VMI program.
Why share forecasts, the big win-win
When suppliers dont have ongoing visibility into your demand forecast, they manage
inventory based on agreed-upon safety stock and min-max inventory levels, historic
purchase patterns, or simply the ability to fulfill a PO once it arrives. In order to
accommodate changing demand patterns and meet service levels, suppliers often
increase their own finished goods inventory, which means additional finished goods
locations and higher overall inventory costs. Ultimately, these costs are passed on to you
in the form of higher prices.

Forecast collaboration allows you to improve the efficiency of your current inventory
management program, and also puts you in a good position to set up a more
sophisticated VMI program. Heres how:

By providing your suppliers with real-time visibility into your demand forecast,
they are able to more effectively schedule operations and plan capacity usage in order
to meet your current requirements. This means: lower costs across the boardwith
fewer manufacturing changeovers; an increased percentage of low-cost, full truckload
shipments; and the ability to replenish based on minimum economic order quantity.

By gaining visibility into your upcoming sales promotions, suppliers are able to
make and ship additional quantities during predefined promotional periods
minimizing last-minute rush shipments and reducing the risk of stock outs. Visibility
into promotions also allows suppliers to register (promotion-based) increases in
demand as one-off events, preventing distortion in average demand calculations,
which often leads to unwarranted increases in safety stock.

Gaining visibility into your demand forecast also allows your suppliers to
coordinate replenishment orders and deliveries across multiple customers in order to
improve service. For example, a non-critical part delivery can be diverted for a day or
two to another customer who needs a critical delivery without putting you at risk.
Similarly, a smaller-than-usual replenishment to you may enable a larger-than-usual
shipment to another customer in dire need, without disrupting your service levels.
What goes around comes around. By being able to balance the needs of various
customers, suppliers are able to improve the networks overall performance without
jeopardizing the service levels of any particular OEM (original equipment
manufacturer) or customer. Without demand forecast visibility, suppliers dont have the
timely, accurate information necessary to prioritize customer shipments effectively.
If you are thinking about implementing a VMI program, forecast collaboration should be a
top priority. Here are a few things to get you started:

First, understand the need for a trusting relationship between you and your
suppliersmarked by openness, frequency of interaction, and commitment.

Second, ensure that you have the mechanisms and technologies in place to
share inventory and demand forecast information with your suppliers that is accurate,
timely, and complete. I will discuss these mechanisms/technologies in more detail in
an upcoming post.

Third, work with your suppliers to ensure that they understand the importance of
responding to forecasts in a timely manner. Supplier commit to forecast is required to
ensure delivery to an open PO.

If VMI is on your companys agenda, forecast collaboration is a good place to start.

Whether youre a seasoned user of VMI or just getting your company started, Id love to
hear your thoughts, questions, or concerns. Im all ears.

Part 3: What makes VMI work?

In the previous sections, I discussed forecast collaboration as the foundation for any
successful VMI program. Today Id like to focus on a broader set of key characteristics,
which helps to answer the question, what makes VMI work?
Over the course of my career, I have had the privilege of helping to implement and
manage a number of effective VMI programs. Heres what they all had in common:

Commitment: The hallmark of every successful VMI program is the commitment

of senior management at both the customer and supplierto make the program work.
OEMs (original equipment manufacturer) and suppliers alike need to understand the
business value of a VMI program, and should consider it a key component of their
overall strategy to enable a demand-driven supply network. Both sides should also
have clearly defined program owners, including personnel in an operational role
responsible for the daily execution.

Supplier Agreement: Suppliers and customers should define a VMI contract at

the part-number level that clearly defines expectations, service levels, and risks.
Information spelled out in the contract should include:

Current manufacturing lead time (in weeks), and standard minimum order quantity

Number of weeks of forecast demand used for planning replenishment levels

Minimum inventory level required by the customer(typically shown in Days of


Delivery response time requirements measured in hours

Upside percentage and the availability period for that upside as well as upside
replenishment lead time

Total liability window (i.e., the number of weeks for which the customer is liable for
forecast, not to exceed standard PO cancellation terms)

Freshness (i.e., the agreed upon amount of time for which inventory remains under
the title of the supplier)

Forecast and Response: The customer should agree to provide electronic

forecasts to its suppliers, and the suppliers in turn must agree to respond (positively or
negatively) within a stipulated time period. This is critical in order to enable timely
customer visibility and action.

Waterfall Chart: The waterfall chart is an important tool to show a clear record of
transactions and inventory positions, as well as to identify the customers liability
based on the supplier agreement and validation of supplier liability claims (based on
freshness parameters).

Integration with Back-end Systems: Forecast responses and inventory levels

from suppliers/3PLs should be integrated into backend ERP systems so that they
become a part of standard business reports, including site shortage reports. ERP
integration also enables the release mechanism to be directly linked to actual
demand, including work order releases and changes in inventory levels.

Clear Framework Defined: In addition to the contractual terms, the objectives of

the VMI relationship should be clearly defined, along with any financial and nonfinancial incentives. The framework should be clearly communicated at all levels of
both organizations in order to facilitate streamlined execution.
From my perspective, these are the key attributes of any successful VMI program. Next
week, I will dive deeper into liability and freshness, which are critical aspects of
successful customer-supplier relations within a VMI context. That being said, please drop
me a line with additional functionalities that you have found important to your own VMI
implementations. Did I miss anything?

Part 4: Liability and freshness: The

hidden side of VMI
Picking up on a topic I raised in my last blog post, I want to discuss one of the hidden
(and potentially costly) issues facing OEMs, contract manufacturing service (CMS)
provider, and suppliersnamely, financial exposure from excess inventory. As
companies implement programs such as vendor-managed inventory, they delay taking
ownership of their inventory, and as a result, carry less inventory on their books.
However, while they are carrying lower inventory on their balance sheets, they are not
necessarily facing lower inventory liability risk. How is this possible?
If you look at the contract terms of a CMS provider, it is likely to say something like this:
The customer is liable for the cost of the non-standard materials and components that
we have ordered to meet the customer's production forecast but which are not used,

provided that the material was ordered in accordance with an agreedupon procurement plan.
When OEMs implement a VMI program, they dont carry the inventory on their books or
incur any payments until the inventory is pulled from the buffer managed by their
supplier. However, the OEM still takes on inventory risk when it communicates its
demand forecast (a VMI input), so long as the CMS provider uses that forecast for
procuring additional components within contractual guidelines. This is because the
forecast is viewed by the CM provider as a trigger to commit supply in the future. In
exchange for this implied commitment, the OEM typically agrees to liability for excess
inventory resulting from procurement practices aligned with its forecasting practices. In
other words, giving a supplier a VMI forecast within the liability window is essentially the
same as sending the supplier a PO that covers requirements for that same time period.
The question, then, is does your company have the necessary controls in place to
reduce this financial exposure?
Freshness is one way that companies attempt to control the risks associated with
inventory liability. Freshness is the amount of time that the supplier inventory (built in
support of the minimum inventory levels) remains under title of the supplier before the
customer takes ownership. As a result, freshness parameters can be used to put an end
date on when an outstanding liability needs to be either resolved or pulled by the
customer. VMI contracts should define freshness as clearly as possible in order to
reduce fuzziness around who will be kept holding the bag when the music stops. By
creating dashboards that provide visibility into the value of expired freshness, a company
maintains continued visibility into its liability.
One way to reduce potential liability, then, is to identify the process and technology
improvements needed to maintain visibility into inventory freshness. With VMI programs,
the buyer-planner role becomes integrated, requiring buyers to get used to the fuzzier
areas of planning. Investing in training around liability and freshness is one way to
enable your buyer-planners to make intelligent decisions to lower inventory liability.
Another key investment area is around technologies that enable the buyer-planner to
collaborate with suppliers, and to provide them with clear visibility into consumption,
forecast, and inventory positions. Other initiatives such as planned ramp-down and a
reduction in the number of engineering change orders (ECOs) can also play a role in
reducing inventory exposure.
So while you are enjoying lower working capital costs from your VMI initiatives, it is
critical to monitor your inventory liability and make the right decisions. What is your
company currently doing to control inventory liability and financial exposure? How
effective have you found your current methods? Our readers would love to hear your

Part 5: Implementing VMI: The final

Its been a long haul, but were finally herepart 5 in my five-part series on VMI. I wish I
could cap off my VMI tirade with something exceedingly cool and exciting, but Im afraid
Ive left the least sexy part for last...internal system requirements. Sigh. Well, it has to be
done. After all, VMI is pretty much useless if you dont have the right software and
systems in place to support it. So here goes.
First, lets take a look at software requirements. In order to set upand maintainan
effective VMI program, you should invest in a supply chain solution that
offers visibility, collaboration, and control across all relevant trading partners.
Heres a more detailed checklist:

Enables near real-time inventory visibility across sites, hubs, suppliers, and in-transit

Calculates projected inventory positions and potential supply-demand imbalances

and communicates them to OEMs (original equipment manufacturer) and suppliers;

Enables OEMs to share forecasts with suppliers, and to receive near real-time

Enables exception-based configurable alerts, so that all stakeholders are notified of

potential issues and projected inventory violations;

Provides audit trails for visibility into transaction history for liability management and
dispute resolution;

Provides B2B integration options that allow you to integrate with 100 percent of your
supply basefrom sophisticated multinational companies to mom-and-pop shops;

Provides a rich set of reports and decision analytics that give a 360-degree view of
the entire inventory management processto ensure that suppliers are replenishing
inventories at required levels to meet fluctuating demand. Key reports include:

Execution versus plan reports, which track how well actual pulls compare with


Trend reports, which track inventory trends and calculate how closely they
stay within defined minimum-maximum levels

Waterfall reports, which show a clear record of forecast transactions and

inventory positions, as well as identify liability with alerts for impending freshness

Performance metrics, which track key metrics necessary for effective

inventory management, including inventory turns, aging, and valuation

I know its a long list, but VMI is a pretty sophisticated process. And to make matters
even more complicated, our software checklist needs to be complemented with a second
critical component: a streamlined supplier on-boarding program. In my experience,
this is the most significant area of unplanned risk for companies implementing VMI. By
failing to account for the significant costs/efforts associated with supplier on-boarding,
many OEMs (Original Equipment Manufacturers) run out of budget and resources
before a working process is in place.
For this reason, I recommend considering the many advantages of an on-demand (or
SaaS) software model as opposed to more traditional on-premise solutions. Ondemand providers typically have extensive experience enabling B2B connectivity with
suppliers, and are able to provide the relevant training and technologies needed to get
them up and running quickly. As a result, your overall solution is less expensive to
implement and maintain for both you and your partners. Finally, on-demand solutions
allow your organization to shift focus to inter-company collaboration (a cornerstone of
effective VMI)and away from procuring, installing, and maintaining those pesky
hardware and software systems internally.
So its pretty simple (sort of). VMI requires software that offers real-time visibility and
collaboration plus a streamlined on-boarding program. With these two areas under
wraps, youre pretty much ready for takeoff. So what are you waiting for? Drop me a line
with additional questionsor feel free to offer our readers your own perspectives on
successful (or not-so-successful) VMI enablement.