What Is Vendor Managed Inventory? Pros, Cons & Examples

Vendor managed inventory, or VMI, is a collaborative strategy that differs from traditional supply chain models by bridging the gap between suppliers and retailers to make inventory management a shared responsibility.

VMI can benefit both vendors and retailers if done correctly, but it requires careful setup and close communication. In this article, we’ll cover what vendor managed inventory is, how it works, pros and cons, and real-world examples.

How Vendor Managed Inventory Works

The VMI process is about setting up and maintaining a functional collaboration between vendors and retailers based on inventory needs. Here’s how it works:

1. A new VMI system starts by creating formal agreements and contracts between the retailer and the vendor. These documents clearly outline roles, responsibilities, and expectations for both parties, including inventory management, order fulfillment criteria, and performance metrics. This step ensures that both parties have a mutual understanding and commitment to the VMI process.
2. The next step is to establish a shared technology platform or integrate existing systems for seamless data exchange. This involves setting up software or cloud-based solutions that allow both the retailer and the vendor to access real-time inventory levels, sales data, and other relevant information. The aim is to ensure that both parties can synchronize their operations, giving the vendor accurate visibility into the retailer’s inventory needs.
3. With the systems integrated, the supplier begins the process by shipping initial stock to the retailer’s warehouse, fulfillment center, or other location. The initial stock level is based on forecasts and agreed-upon inventory needs to ensure that the retailer is adequately stocked without having excess.
4. From then on, the vendor assumes the responsibility of continuously monitoring the retailer’s sales patterns and inventory levels using the shared data platform. By analyzing this data, the vendor can make informed decisions about when replenishment is needed and in what quantities. This proactive approach allows for adjustments in stock levels based on actual sales trends, seasonal changes, and other market dynamics.
5. Based on this ongoing analysis, the vendor calculates replenishment needs and takes care of the reordering process without the retailer having to place orders manually, aiming to maintain optimal inventory levels at all times. The replenished stock is then shipped directly to the retailer’s location, completing the cycle and ensuring that the inventory is always aligned with demand.

Metrics Used in Vendor Managed Inventory

Several key performance indicators (KPIs) and metrics are used to evaluate the efficiency, effectiveness, and overall success of a VMI system. These metrics help both vendors and retailers monitor performance, identify areas for improvement, and make data-driven decisions:

• Inventory levels: The amount of inventory on hand at any given time. Maintaining optimal inventory levels is crucial to ensure product availability without overstocking.
• Inventory turnover rate: How often inventory is sold and replaced over a period. A higher turnover rate typically implies efficient inventory management and strong sales, whereas a lower rate may indicate overstocking or weak demand.
• Cost reduction: Savings in inventory-related costs—such as holding costs, ordering costs, and transportation costs. Effective VMI should lead to cost efficiencies for both vendors and retailers.
• Supplier performance: Multiple metrics go into the vendor’s overall performance in terms of delivery reliability, quality of goods supplied, and responsiveness to changes in demand or inventory issues.
• Order fill rate: The percentage of customer orders that are fulfilled from stock available at the time the order is placed. A high fill rate suggests that inventory levels are well-aligned with customer demand.
• Stockouts: The number of times an item is not available when a customer wants to purchase it. Minimizing stockouts is essential for customer satisfaction and sales optimization.
• Lead time: The time taken from placing a replenishment order to the delivery of the goods. Shorter lead times improve inventory agility and customer satisfaction.
• Forecast accuracy: How closely actual demand matches forecast demand. High accuracy in forecasting helps in optimizing inventory levels and reducing stockouts or excess inventory.

VMI Technology & Tools

Vendor managed inventory systems rely heavily on technology to ensure efficient communication and data exchange between all parties involved. Key tech components include advanced inventory management software and Electronic Data Interchange (EDI), which together streamline the supply chain.

Inventory management software tracks and analyzes stock levels in real time, enabling suppliers to see product availability, forecast demand, and plan replenishment accurately. This tool helps prevent overstocking or stockouts by adjusting inventory based on sales trends and predictive analytics. Modern inventory solutions allow customizable user permissions and/or dedicated vendor portals, enabling the necessary info to be easily accessible by suppliers while keeping other data secure.

Electronic Data Interchange (EDI) facilitates the automated exchange of standard business documents between suppliers and retailers, such as purchase orders and invoices. This streamlines transactions, minimizes manual data entry errors, and speeds up the overall procurement process.

Advantages & Disadvantages of Vendor Managed Inventory

Like any business decision, the pros and cons of vendor managed inventory should be weighed carefully before diving in.

Pros of Vendor Managed Inventory

VMI can be a mutually beneficial system for qualified retailers and suppliers, presenting opportunities for enhanced profitability and operations.

• Supply chain efficiency: VMI streamlines the supply chain, reducing lead times and enhancing the flow of goods from supplier to retailer. This efficiency can lead to a more responsive and agile supply chain capable of adjusting to market dynamics swiftly.
• Forecasting accuracy: Suppliers have direct access to sales and inventory data, allowing for more accurate demand forecasting.
• Strategic inventory levels: Through VMI, inventory levels are managed more strategically, ensuring that high-demand products are always available while reducing the burden of slow-moving stock.
• Labor requirements: Retailers benefit from fewer administrative needs because the responsibility of order placement and inventory management shifts to the supplier. This can free up resources to focus on core business strategies and customer service.
• Increased sales opportunities: By ensuring optimal inventory levels and reducing stockouts, VMI often leads to increased sales opportunities. Retailers can capitalize on every customer visit, and suppliers can ensure their products are always available and visible on the shelf.
• Enhanced supplier-retailer relationship: The continuous collaboration that VMI uses fosters stronger, more productive partnerships, which can lead to better pricing for retailers and consistent sales for suppliers.
• Cost reduction: By minimizing holding costs and emergency restocking, VMI can lead to substantial cost savings.

Cons of Vendor Managed Inventory

VMI isn’t the best inventory management method for every retailer or supplier. It requires a unique operational setup, so reversing course from this system can be challenging, making it crucial to weigh the potential downsides carefully.

• Loss of control: Retailers have less control over their own inventory selections, potentially limiting their ability to tailor product offerings to customer preferences.
• Implementation complexity: Setting up a VMI system can be complex and resource-intensive. Both parties must invest in compatible IT systems and train staff to manage new processes.
• Adjustment period: The initial phases of VMI can be challenging as both suppliers and retailers adjust to new roles and responsibilities. Miscommunications and misalignments in this period can affect service levels, stock, and operational efficiency.
• Potential for inventory mismanagement: If not executed correctly, VMI can lead to inventory mismanagement, where suppliers might prioritize their goals over the retailer’s needs, leading to overstocking or stockouts.
• Data privacy concerns: Sharing sensitive sales and inventory data may raise data privacy concerns. Both parties must establish trust and ensure robust data protection measures are in place.
• Risk of over-dependence on suppliers: Retailers may become overly dependent on suppliers for inventory management. This overdependence can be risky if the supplier faces disruptions, affecting the retailer’s ability to meet customer demand.

Who Should Use Vendor Managed Inventory

Vendor managed inventory is a very common practice in certain industries, including consumer packaged goods. That said, it’s not a one-size-fits-all solution, and some businesses are better suited for it than others.

When to Use VMI

Vendor managed inventory is a good fit for the following situations:

• High inventory turnover: Businesses with products that have short life cycles or seasonal demand peaks benefit greatly from VMI. It ensures inventory is replenished accurately and just in time, reducing the risk of overstock and waste.
• Complex product assortments: For retailers with a wide variety of products in different categories, VMI simplifies inventory management by allowing suppliers to manage the diversity of stock and ensure each category is aligned with customer demand.
• Multiple suppliers: When a business sources products from a wide network of suppliers, coordinating orders and managing stock levels becomes a logistical challenge. VMI enables suppliers to take charge of their inventory, streamlining the supply chain. Learn about the different types of retail suppliers.
• Expansion or scaling: For businesses looking to expand their operations or scale up quickly, VMI offers a way to manage increased inventory needs without proportionally expanding their administrative burden or needing extensive capital investment in stock.
• Predictable demand: When demand is stable, forecasting accuracy improves significantly, allowing for the most effective vendor managed inventory replenishment and resource use.
• Hands-off management: Retail and ecommerce businesses looking to streamline operations, cut costs, and boost customer satisfaction may find VMI beneficial. This model enables them to concentrate on business expansion, leaving inventory tasks to suppliers.

When Not to Use VMI

Vendor managed inventory may not be suited for:

• Small-scale operations: Small businesses with minimal inventory needs or those where the owner prefers hands-on management might see VMI as an unnecessary complexity rather than a benefit. See our guide to inventory management for small businesses.
• Startups: For startups or young businesses still fine-tuning their products and market strategy, the structured approach of VMI can be too rigid, limiting their ability to adapt to changing needs quickly.
• Slow-moving inventory: For products with long shelf lives or slow turnover, the continuous replenishment model of VMI might not align with the business’s sales pace, potentially leading to overstocking issues.
• High production costs: Businesses dealing with high-cost goods where each product requires a significant investment might need to retain control over inventory decisions to align with strategic financial planning and cost management.
• Limited edition or custom products: Companies specializing in limited runs, bespoke, or custom-made products may not be a good fit for VMI, as the model is best suited for more predictable, standard inventory replenishment.
• Highly variable demand: If a business experiences highly erratic demand that is difficult to predict, VMI systems might struggle to adapt quickly enough, leading to either shortages or excess stock.

Real-world Examples of Vendor Managed Inventory

Case studies from both retail and ecommerce businesses demonstrate the benefits of VMI, including improved inventory turnover, cost savings, and enhanced supplier relationships.

Walmart is one of the most notable examples of vendor managed inventory. The retailer uses it in all of its 5,000+ stores as well as its ecommerce site and online marketplace. Rather than overseeing inventory internally, the company collaborates with a large number of suppliers to simplify the process.

Using centralized databases, both Walmart and its partnered suppliers can see real-time inventory data, enabling the best forecasting and reordering practices. Some vendors even send their own employees to merchandise their goods and stock new inventory on Walmart shelves.

By handing over inventory management responsibilities to its suppliers, Walmart minimizes the time and resources needed to manage stock and guarantees that its extensive range of products is consistently available to customers.

Other brands that use vendor managed inventory include:

• Home Depot
• Amazon
• Bosch
• Procter & Gamble

Bottom Line

Vendor managed inventory changes how suppliers and retailers work together to make the supply chain smoother and more efficient. It brings several advantages, such as better inventory control, lower operating costs, and improved customer satisfaction. However, VMI doesn’t work for every situation—it’s best suited for businesses with predictable demand, and might not do well in markets with frequent fluctuation or for products that need a lot of customization.

Companies considering VMI should consider if this approach fits their strategic objectives, operational strengths, and market needs. If applied carefully, VMI can forge strong relationships between suppliers and retailers, leading to shared growth and success.