What is vendor managed inventory and how your business can benefit
Have you ever wondered how supermarket giant Walmart keeps their shelves stocked in 4,000 stores in the U.S. with approximately 142,000 individual SKUs in every store? It’s a herculean task to say the least. But you see, Walmart doesn’t need to place purchase orders themselves every time an item hits the reorder point. What happens instead is: their vendors take care of all their restocking needs - delivering new shipments every time a product hits the reorder point. And this method of inventory management is known as Vendor Managed Inventory (VMI) - in which suppliers take care of their products within a retailer’s inventory.
We know what you’re thinking. It’s one thing for one of the world’s largest retailers to get their suppliers to manage their individual inventories within Walmart’s warehouses, but as a small or medium independent retailer, how do you convince your suppliers to take on the added trouble of maintaining their inventory in your store?
Well, rest assured. It’s a win-win situation for both sides, and if you’re purchasing a significant volume from your suppliers, letting them manage your inventory will only bring the two of you closer.
Benefits of VMI for retailers
1. You’ll never go out of stock
Running out of stock can drastically impact your service levels and leave you with disgruntled customers. Even if you place new purchase orders the moment inventory levels hit the reorder point , it’s possible that your supplier (having no prior insight into your inventory levels) may not be fully aware of how quickly their products are selling and end up being unable to adjust their delivery schedule as required. Also, there’s a high chance your supplier sells to other retailers and has to keep them all happy as well. But switching to a VMI-system means your suppliers take on the responsibilities for keeping your inventory stocked, and that will (ideally) improve inventory management.
2. Say hello to lower carrying costs
With your supplier delivering the required quantity whenever needed, you won’t have to worry about purchasing sub-optimal quantities. Let’s say you’re selling artisanal chocolates with a short shelf-life. Your supplier may require a minimum order of 300 pieces while the optimum quantity for you is 250 (but you place orders more frequently). In light of this, having your supplier to take care of supplying the required quantity whenever needed can allow you to manage your inventory more efficiently. This also lets you decrease your carrying costs, as you reduce carrying excess stock, and in turn reduce the cost of carrying it.
3. You can focus all your attention on growing your business
Retailing is only a fraction of your business. In addition to the actual work put into building your brand and selling, you’re also likely to spend a significant portion of your time on the day to day work of running a business. That includes stuff like having to monitor and manage inventory levels, write purchase orders for stocks that need to be replenished, and so on. Having someone to take care of these details for you allows you to devote your time to growing your business - be it finding new channels to sell on, or experimenting with an awesome new product line.
Think of how much more you could do!
Benefits of VMI for suppliers
1. You’ll be able to adjust output to suit demand
If you’re wholesaling, maintaining your retailers’ inventories will give you a much needed insight into the demand for your product. Unlike your retailers, you don’t actually get to monitor inventory levels across the board, so you’re subjected to crazy demand fluctuations. Moreover, it’s always possible that your retailers may not actually know how much they need and they’ve been forecasting wrong all this while. And as a result, you’re always forced to take back dead stock due to your all too liberal return policy or expedite shipping at your own expense because your retailer asked for a “favor”.
With better knowledge of demand for your products, you’ll have a good gauge of how many items will be in your warehouse at any given time. That lets you decrease the amount of safety stock kept on hand (for a supplier, that’s quite a sizeable amount). And ultimately this reduces your carrying costs.
2. It locks your retailer in a relationship with you
Once your retailers have decided to enter into a VMI relationship with you, it means you’ve been invited to partake in the intimate details of their business operations. While it’s true that taking on the task of managing your inventory on your retailer’s side is added work and costs, look at it from a long term perspective. By offering VMI, you’ll be able to bind your retailer to your brand, as the amount of trouble involved in moving to a competitor would be pretty effective at dissuading them from pursuing alternatives. After all, they’d have to start managing their inventory again, dealing with reorder points, and not to forget - you’ve already got an insight into their business, which will make leaving you a lot trickier.
Sharing information is crucial for VMI success
Ultimately, by choosing to enter in a VMI relationship, both parties will have to work together to make this inventory management method work. After all, there’s a sizeable amount of shared risk, with retailers effectively giving up control of a part of their business, and suppliers taking on more work by managing their retailer’s inventory.
Sharing information is key to a good VMI relationship. While retailers don’t have to go as far as sharing every last detail of their inventory movement with their supplier, the supplier has to know if there’s a seasonal spike in demand, or if the retailer is thinking of venturing into selling on another channel (which means a high likelihood of an increase in demand).
For retailers, you’d also want to put some controls in place, like establishing what your suppliers can and cannot access. These can range from physical space, to online inventory databases, and perhaps even limiting the minimum-maximum amount of stock in your warehouse at any given time. Also, expecting your suppliers to work miracles with your inventory is likely to end in disappointment. If you’re hitting a 95% fill rate of orders, expecting your suppliers to increase it to 99% is not likely to happen. Especially since a fill rate above a certain amount usually results in diminishing returns… which isn’t going to benefit anyone.
Read next - A Beginner's Guide To Inventory Management