The Pros and Cons of Vendor Managed Inventory

October 23, 2024 - 11 minutes read

Effective partnerships benefit retailers as well as suppliers.

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Inventory management can be complex, labor intensive, and costly for companies of all types and sizes. What if there was a way to minimize this burden by outsourcing inventory management to someone else? And who better to assume this responsibility than the suppliers who provide or manufacture the items and are familiar with their features and status. That is the basic premise behind vendor managed inventory (VMI).

As an offshoot of lean manufacturing and just-in-time (JIT), VMI takes a holistic approach to supply chain management that reduces unnecessary part movement, storage, and scrap. While the logic behind this idea is easy to appreciate, vendor managed inventory can also introduce pitfalls and challenges that undermine its value. We take a closer look at the pros and cons of this novel inventory management concept.            

“I learned this early on in the variety business: You’ve got to give folks responsibility, you’ve got to trust them, and then you’ve got to check on them.” – Sam Walton

What is vendor managed inventory?

Vendor managed inventory (VMI) is a type of partnership between retailers and their suppliers that puts the onus for storing, managing, and replenishing inventory on the supplier. This makes the vendor responsible for assuring inventory is on hand when needed. In a twist from the conventional model, the supplier is also responsible for determining how much stock should be delivered at any given time, based on past, present, and future demand.

Vendor managed inventory is not a new concept. Wal-Mart partnered with Proctor & Gamble almost 40 years ago to simplify their logistics, giving P&G complete control over their own product placement and replenishment within Wal-Mart stores. Since this early success story, the VMI concept has spread to smaller businesses and E-commerce retailers as they look for new ways to streamline operations and improve product availability.

Benefits of vendor managed inventory

Partnering with suppliers to streamline inventory management can produce significant benefits, with retailers no longer spending long hours monitoring and planning inventory levels, and vendors developing optimized strategies for their customers and themselves.  

1. Reduced stockouts

Customers expect products to be available when they need them, so stockout conditions when inventory is unexpectedly exhausted can be a serious blow to the reputation of an E-commerce or brick-and-mortar retailer. When vendors stay dialed into demand, parts-on-hand, and the upstream supply chain, they can anticipate these conditions faster and proactively replenish stock before it is fully depleted. VMI also minimizes costly overstock conditions that can result from inaccurate forecasting or over buying to mitigate supply chain risks.    

2. Improved supplier collaboration  

Vendor managed inventory can only be successful when accompanied by open communication channels and transparent data sharing. This heightened level of collaboration helps to minimize surprises and misunderstandings as the two companies align on common goals. Inventory management software improves collaboration by giving both parties a common frame of reference, including real-time information and data analysis features.

3. Reduced storage requirements

Shifting inventory management to suppliers also shifts the responsibility for maintaining floor space, shelving, and handling equipment to the vendor. VMI ensures products are replenished just as they are needed to minimize the amount of stock held in warehouses or retail locations. With rented warehouse floor space costing retailers an average of $8 per square foot per year, reduced storage requirements can significantly lower operating expenses. 

4. Streamlined operations

Vendor managed inventory allows both retailers and suppliers to focus on what they do best. For retailers, this means creating compelling E-commerce storefronts, marketing campaigns, and omni-channel commerce experiences that capture customer interest. For suppliers, VMI minimizes delays and uncertainty between orders, allowing them to plan raw material deliveries strategically, schedule shipments in advance, and set appropriate staffing levels.

5. Customer satisfaction

Consistent product availability and reduced clutter in retail stores improves customer loyalty and brand reputation, which in turn increases revenue for retailers and their suppliers. VMI empowers businesses to offer a wider variety of product offerings, since they don’t need to allocate space for products with low demand. Drop shipments from supplier sites are another useful element of VMI, enabling E-commerce customers to receive their orders faster. 

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Drawbacks of vendor managed inventory

The benefits of vendor managed inventory are clear. However, there are some potential drawbacks and pitfalls that illustrate why VMI is not the right solution for every retailer.

1. Reduced control        

Allowing suppliers to assume responsibility for inventory management can be risky, since it means trusting them to protect your business interests and reputation. Any errors, inefficiencies, or unexpected delays can have a huge impact on order fulfillment. Each retailer must decide for themselves which of their suppliers can be trusted to maintain these high-level partnerships and make your business their top priority. Supplier relationship management (SRM) practices can help retailers build trust and visibility with their suppliers.

2. Data integration issues

Effective VMI requires retailers and suppliers to share accurate data consistently to prevent shortages and fulfillment issues. This can be problematic when the companies operate on different inventory management platforms or the integration between them is not smooth. Verifying system compatibility should be a prerequisite for launching a new VMI program. The level of data sharing required to make vendor managed inventory successful can also introduce cybersecurity risks if sensitive information is hacked or intercepted in transit.

“In a world of more data, the companies with more data-literate people are the ones that are going to win.” – Miro Kazakoff

3. Administrative costs

Suppliers benefit from the convenience, control, and exclusivity brought by VMI, but the costs associated with additional labor and overhead must be passed along to the retailer. Depending on the specific arrangement, these expenses can come in the form of increased product prices, service fees, or both. It is important for retailers to weigh the administrative costs of vendor managed inventory against the potential savings and other benefits.   

4. Communication issues       

The improved collaboration brought by vendor managed inventory is counterbalanced by potential risks and challenges when communication breaks down. Retailers must remember that their suppliers can only be successful with the right guidance and information. One of the best ways to set clear expectations for supplier communication is by creating a VMI contract or agreement with input from both sides. This agreement can also include things like storage space limits, shared goals, and KPIs.

5. Reliance on technology  

Collaboration and alignment are essential, but VMI also relies heavily on advanced software technology to collect and share real-time data, perform analytics, and avoid errors that are magnified as they reverberate through the supply chain. Retailers considering VMI implementation should already be equipped with inventory management software, point of sale (POS) systems to capture real-time sales data, and an electronic data interchange (EDI) to seamlessly and securely transfer data.

When does it make sense to use vendor managed inventory?

Industry pioneers like Wal-Mart and Amazon have been reaping the benefits of vendor managed inventory for decades, with suppliers conforming to their predefined standards in exchange for the opportunity to sell to a wider audience. As technology has improved, the benefits of VMI have spread to small retailers and E-commerce businesses. Factors that can tip the scales towards making VMI a worthwhile proposition include:

• Stable and consistent (e.g., not seasonal) demand
• Strong supplier relationships and partnerships
• A high number of SKUs purchased from the same supplier

On the other hand, businesses that sell high-value commodities, require higher levels of security, or do not have suppliers with the technology or willingness to participate may find that VMI is not the right solution for them.  

Vendor managed inventory: Final thoughts    

With the right technology and intentions in place, the silos between retailers and suppliers continue to evaporate. Customers are the ultimate beneficiaries of this improved visibility and cooperation. The enticing benefits of vendor managed inventory require a shared commitment that is bolstered by the best inventory management and order management software.

Agiliron offers a full suite of cloud-based software solutions, including warehouse management, inventory management, and full-featured customer relationship management (CRM). Mobile POS allows retailers to sell anywhere at any time, even without an internet connection. All our solutions are designed to integrate seamlessly with the leading E-commerce platforms.

Vendor managed inventory is yet another example of technology taking inventory management to new heights. Software tools put this option within reach for retailers of all types and sizes, but it’s not for everyone. Contact us today and allow our solution experts to explain the value of VMI and other inventory management processes that have the power to transform your business.