For some companies, estimating future inventory levels can be a major source of stress. Overestimating demand for products can result in excess inventory, which not only takes up valuable warehouse space but can also force companies to discount products to clear shelves. Underestimating demand, on the other hand, can result in lost sales opportunities because companies have no products to offer.
To ease the stress of inventory management, some companies have adopted a new process, known as vendor managed inventory (VMI), in which suppliers agree to maintain inventory levels on a business’s behalf. Outsourcing inventory management helps businesses stay focused on other elements of their operations while ensuring that inventory remains at the right levels at all times. Many retailers choose this route, for example, because it can help take the guesswork out of managing stock levels.
VMI may not make sense for every business, however. The following list of VMI’s advantages and disadvantages can help you decide if it’s right for your business.
Advantages of VMI
VMI agreements can take many forms, but in most cases, buyers provide sales data and inventory requirements to a supplier, who assumes responsibility for ordering new inventory. As a result, the supplier shares the inventory risk, because unused inventory sits on their shelves, not the buyer’s. In some cases, buyers don’t pay for products until they’re sold, which further reduces their risk. There are a number of benefits to VMI, including:
Improved Efficiency
Having too much inventory can be costly because it takes up valuable real estate on your shelves, while too little inventory can mean lost sales opportunities and delayed customer orders. The VMI process can help balance inventory more efficiently because buyers communicate more directly with suppliers about their product needs. As a result, suppliers use up-to-date data to immediately generate purchase orders only when buyer inventories dictate it. Some suppliers even have systems that can automatically generate purchase orders based on inventory data, helping to reduce the risk of data entry errors.
The VMI process helps balance inventory more efficiently because buyers communicate more directly with suppliers about their product needs.
Cost Reduction
Carrying unused inventory can be expensive, because valuable shelf space is wasted on products that aren’t selling. That means companies may not be able to stock more popular items that customers want. In addition, to clear unused inventory, companies may often resort to discounting, which shrinks profit margins. On the other hand, when inventory gets too low, companies often need to place expensive rush orders to fill shelves. With VMI, inventories can be much more balanced, eliminating – or at least reducing – these unnecessary costs.
Reduced Complexity
Working with a VMI partner to handle inventory means not having to deal with multiple vendors, such as for storage facilities and additional transportation. The complexity of managing multiple vendors can not only be expensive, but it can also slow down processes and increase the potential for breakdowns in the supply chain. VMI streamlines processes, reducing complexity and building a predictable and reliable inventory delivery schedule.
Improved Data Insights
At the heart of a strong buyer-vendor relationship is shared data and open communication about inventory needs and shifts. As the relationship between a vendor and a buyer grows, the level of communication can grow as well. As a result, suppliers can often anticipate demand in lockstep with buyers, making data-driven decisions to handle shifting market trends.
Disadvantages of VMI
While there are many benefits to VMI, it’s not entirely risk free. Before partnering on a VMI relationship, consider the following challenges.
Loss of Control
Sharing access to data with a third party can be uncomfortable for some businesses. For example, you may have reservations about sharing data because of security concerns. In addition, VMI requires that buyers cede a considerable amount of inventory decision-making authority to an outside partner, which can also create discomfort, especially if you’re unsure of your vendor’s ability to handle your unique needs.
Limited Options
Agreeing to work with a VMI partner is a big commitment. Any problems in the relationship can put your supply chain at risk. In addition, if you find other suppliers that are more cost-effective or have better products, your VMI agreement might limit your ability to make a change.
Less Agile Market Responsiveness
If you feel your expertise in forecasting demand fluctuations is your strong suit, entering into a VMI relationship might not be the best option for you. A VMI supplier works with your data to make inventory decisions, but likely won’t have access to the full data set you have – or your well-honed instincts – for decision-making. As a result, your VMI supplier might not be able to react as quickly as you would in the event of unpredictable market shifts.
Is VMI Right for You?
As the advantages and disadvantages above illustrate, VMI isn’t necessarily a good fit for every business. To determine if VMI is a good option for you, here are some factors to consider:
Product Type
The more complex your inventory needs are, the more likely it is that you may want to take advantage of VMI. If your products have long shelf lives, inventory management is likely simpler and easier for you to manage yourself. If your products often expire, however, a VMI supplier can help manage the churn. In addition, if your inventory consists of many different products, a VMI supplier who can manage inventories for multiple products can be helpful.
Product Demand
Do customer preferences often change in your line of business? Is there a big swing in demand based on time of year or season? Understanding how market trends fluctuate can be tricky. In some cases, business owners know best. Some vendors, however, have years of industry expertise to help maintain ideal inventory levels, even as market conditions change.
Inventory Management History
If you’ve found yourself short on inventory or carrying too much on a frequent basis, it could be an indication that you could use outside help from a VMI supplier. In addition, if you have a lean staff that needs to focus on other aspects of day-to-day operations, outsourcing inventory management can reduce a huge burden.
Vendor Reputation
A VMI solution is only as good as the vendor you choose. Like most business decisions, it’s important to vet your potential partners. Does your potential vendor also work with others in your industry? Is the vendor well-liked? Can the vendor handle your specific needs? Will the vendor provide a point person upon whom you can rely to make adjustments to your arrangement as needed?
The Bottom Line
VMI can be an excellent option for businesses looking for a cost-efficient way to handle inventory. By reviewing VMI pros and cons, in addition to doing your own research on potential VMI partners, you can work towards finding a solution that best fits your company’s needs.
Photo: Getty Images
