What Is Vendor-Managed Inventory (VMI)?

Smart companies constantly seek ways to strengthen their supply chain operations, reduce inventory costs, and improve customer satisfaction. Vendor-managed inventory (VMI) has emerged in recent years as an increasingly popular strategy to achieve these goals. This collaborative approach involves suppliers taking responsibility for inventory management on behalf of their buyers, leading to significant benefits for both parties.

This guide explores the key concepts, benefits, and challenges of VMI, providing business managers with the insights they need to determine whether this strategy is right for their organizations.

What Is Vendor-Managed Inventory?

Vendor-managed inventory (VMI) is a supply chain management strategy in which suppliers assume responsibility for managing and replenishing their customers’ inventory. In this collaborative approach, the vendor has access to the customer’s inventory data, which it uses to proactively make decisions about when and how much stock to replenish so that the customer always has the right quantities of inventory for each item.

Key Takeaways

• VMI is a collaborative approach to inventory management in which suppliers are in charge of managing and replenishing their customers’ inventory.
• Successful VMI implementation requires strategic partnerships, seamless technology integration, and a commitment to continuous improvement.
• This strategy offers benefits including reduced inventory costs, improved cash flow, and decreased stockouts.
• While this approach can be adapted to various industries, its core principles of collaboration, data sharing, and performance measurement remain constant.
• Implementing VMI involves change management across processes, roles, and organizational culture.

Vendor-Managed Inventory Explained

In a VMI system, the supplier receives regular updates on a customer’s sales and stock levels through electronic data interchange (EDI) or another system that enables real-time inventory tracking. Using this data and predetermined minimum and maximum inventory thresholds, the supplier generates replenishment orders and coordinates deliveries to maintain optimal stock levels at the customer’s location.

The rising popularity of this approach is quantified in an study that valued the global VMI market at $3.9 billion in 2023. The market is projected to climb to $6.3 billion in 2030, for a 5.6% annual growth rate.

A key idea behind VMI is that by outsourcing its inventory management tasks to a supplier with the right expertise, the customer can reduce stockouts and improve overall supply chain efficiency. In addition, customers are freed from inventory management work and can apply more resources to their core business activities. But VMI also benefits suppliers. For example, by managing their customers’ inventory and understanding their needs, suppliers can better plan their own production and distribution processes, leading to more efficient resource allocation and stronger, more collaborative relationships with their customers. As a result, both parties can enjoy improved cash flow.

How Do Vendor-Managed Inventory Systems Work?

VMI operates through a series of coordinated steps that start with an agreement between a customer and supplier. Subsequent steps involve integrating technology, sharing data, and continuously monitoring and adjusting inventory levels to achieve optimal performance. Here’s a closer look at the six high-level steps that make VMI systems work.

1. Vendor and customer establish agreements and parameters. The vendor and customer agree on the terms of the VMI arrangement, including desired inventory levels, performance metrics, and how responsibilities will be split up. To illustrate, consider a beverage supplier and a supermarket that strike a VMI agreement in which the supplier agrees to maintain inventory levels between 1,000 and 1,500 units of product, with a 98% in-stock rate—meaning, if 100 customers walk past a retail shelf, only two of them would be expected find a given item out of stock.

2. Technology is integrated. The vendor and customer integrate their IT systems to facilitate seamless data sharing to support inventory management. In our example, the supermarket’s point-of-sale (POS) system would be connected to the beverage company’s inventory management software for the automatic transmission of real-time sales data.

3. Vendor and customer share information. The customer constantly shares data on sales, inventory levels, and forecasts with the vendor. This information forms the basis of the vendor’s inventory management decisions. For instance, the supermarket’s system might automatically send daily reports to the beverage supplier, showing sales volumes, current stock levels, and projected demand based on historical data and planned promotions.

4. Vendor controls inventory management. Using the shared data, the vendor maintains optimal inventory levels, applying analytics and forecasting models to determine when and how much product to replenish. For example, the beverage supplier’s system might analyze the supermarket’s sales data and identify that cola products sell faster on the weekend and when the weather is hot. The supplier’s system can automatically adjust its replenishment plans to accommodate a predicted heatwave over the following weekend.

5. Vendor restocks and completes ordering. Based on its inventory management analysis and agreed-upon inventory levels, the vendor initiates the replenishment process and arranges for the delivery without waiting for a purchase order from the customer. If the beverage supplier’s system determines that one supermarket location will need 200 more cases of cola within three days to maintain an optimal inventory level, it automatically generates a delivery order and schedules a truck to deliver the stock—without any action required from the supermarket.

6. Vendor and customer continuously monitor and adjust. Both parties regularly review performance against metrics and adjust inventory levels, processes, or terms of the agreement, as needed, to improve performance. For example, let’s say the VMI agreement between the supermarket and beverage supplier includes a three-month performance review. At that meeting, they both notice that diet soda sales are higher than expected, leading to occasional stockouts. They agree to increase the maximum inventory level for diet sodas from 300 to 400 cases per store to prevent future stockouts.

How Vendor-Managed Inventory Works

Vendor-Managed Inventory vs. Traditional Inventory Management

VMI differs from what is typically considered traditional inventory management practices. In a conventional setup, the customer, such as a retailer or a manufacturer, is responsible for monitoring its own inventory levels and placing orders with vendors when stock reaches a predetermined reorder point. The vendor’s role is primarily to fulfill these orders as they are received.

VMI’s shift of responsibility for inventory decisions from the customer to the vendor offers several advantages over the typical approach. Allowing vendors to manage their inventory leads to lower inventory costs for customers and improves cash flow for both parties. The continual data sharing and proactive replenishment approach inherent in VMI systems enable better alignment of supply with demand, reducing the risk of stockouts and overstocking. Moreover, VMI allows the customer to benefit from the vendor’s expertise in managing its specific products.

However, implementing a VMI system also presents challenges. VMI requires a high level of trust and collaboration between the vendor and the customer, which must be willing to share sensitive data and relinquish control over its inventory. Indeed, some customers may feel a loss of control over their inventory, as they are no longer solely responsible for replenishment decisions. Last but not least, the initial setup of a VMI system can be complex and costly, requiring the integration of IT systems and the establishment of clear communication channels and processes.

Ultimately, the choice between VMI and conventional inventory management depends on the nature of the products, the strength of the supplier-customer relationship, the technological capabilities of both parties, and other factors. Many businesses adopt a hybrid approach, in which they apply VMI to specific product categories while managing others on their own using more conventional methods. Some businesses opt for an approach known as “customer-managed inventory,” which, like VMI, is a collaboration—but one in which the customer takes on the responsibility for inventory management decisions.

Advantages of Vendor-Managed Inventory for Vendors and Customers

Many of VMI’s advantages come from the opportunity it creates to improve vendors’ and customers’ cash flow by aligning inventory levels more closely with actual demand. For the customer, VMI reduces the amount of capital tied up in inventory, freeing up cash it can use for other purposes. Additionally, the buyer typically receives smaller, more frequent deliveries, allowing it to pay for inventory closer to the time of sale. This narrows the time between cash outflow for inventory purchases and cash inflow from sales, boosting cash flow.

The supplier benefits from improved cash flow because, with access to its customer’s real-time sales data, it can better plan production and more efficiently manage its own inventory. More frequent, smaller orders from buyers can also lead to more predictable cash inflows. Furthermore, by preventing stockouts and lost sales for their customers, suppliers are likely to receive more business from them over time, positively impacting overall cash flow.

Let’s explore some more key advantages of VMI for both vendors and buyers.

Suppliers

VMI presents several opportunities for suppliers to improve their operational efficiency and strengthen their relationships with customers. Here are five key benefits:

• Reduced carrying costs. VMI helps suppliers better plan production and distribution, reducing the need to hold excess inventory. By having access to real-time data on customer demand, suppliers can more accurately forecast future needs and adjust their production accordingly. This leads to lower carrying costs, as suppliers can minimize the amount of inventory they need to store. Consider an auto parts maker that uses VMI with a major car assembly plant. The parts supplier accesses the assembly plant’s real-time production data and uses it to synchronize its own production schedule, reducing the need to store large quantities of finished parts before they’re needed—and thereby lowering its carrying costs.

• Accurate forecasting. With access to their customers’ real-time sales and inventory data, suppliers can generate more accurate demand forecasts to better plan their production, inventory, and distribution. This minimizes the risk of customers running out of stock or buying too much. For instance, a clothing manufacturer that implements VMI with a national retail chain would gain access to the retailer’s POS data, which enables it to spot best-selling fashion trends and adjust its forecasts accordingly. This reduces the risk of overproducing out-of-style items.

• Enhanced sales. By ensuring that customers always have the right products in stock, VMI can help suppliers increase their sales and revenue. After all, when customers face fewer stockouts, they are less likely to turn to competitors to fulfill their needs. Additionally, the improved collaboration and communication fostered by VMI can lead to stronger relationships between suppliers and customers, potentially leading to increased business opportunities.

• Reduced human error. VMI systems often rely on EDI and automated inventory tracking, reducing the risk of human error in the ordering and replenishment process. Automation aims to ensure that the right products are delivered in the right quantities at the right time, minimizing the potential for under- or overordering.

• Managed stock levels. VMI allows suppliers to proactively manage their customers’ inventory levels to make certain that stock remains within agreed-upon minimum and maximum thresholds. By monitoring inventory levels in real time and using predictive analytics, suppliers can refine their replenishment schedules and quantities to reduce the risk of stockouts or excess inventory. Take the example of a chemical supplier that uses VMI with a large plastics manufacturer. Through real-time monitoring of the manufacturer’s production rates and raw material use, the supplier can fine-tune delivery schedules of various chemicals, keeping stock levels at agreed levels and preventing production disruptions due to shortages.

Customers

For customers, VMI offers a range of benefits that can help them strengthen their inventory management, reduce costs, and improve their own customers’ satisfaction. Here are five key advantages:

• Reduced safety stock. With VMI, customers can reduce the amount of “just-in-case” safety stock they hold because they can rely on their suppliers to maintain adequate inventory. For example, a hospital that uses VMI for medical supplies can maintain lower safety stock levels of items such as syringes and bandages. Its medical supply vendor takes responsibility for ensuring adequate stock, allowing the hospital to reduce inventory—and related carrying costs—without risking shortages of critical items. This reduction in safety stock also frees up the hospital’s working capital, which can be invested in other areas of the business.

• Less risk of inventory-related issues. VMI helps customers minimize the risk of inventory problems. By entrusting inventory management to their suppliers, buyers can benefit from suppliers’ expertise and resources in maintaining stock levels. This leads to fewer instances of lost sales due to stockouts and reduced risk of obsolescence due to excess inventory that sits for too long.

• Minimized overhead and risk. VMI allows customers to reduce their inventory management overhead and associated risks. Outsourcing inventory management responsibilities to their suppliers means businesses can save on costs related to inventory planning, ordering, and monitoring and, instead, focus their resources on core business activities. Consider a smartphone manufacturer that implements VMI for electronic components. With the supplier managing inventory, the manufacturer can reallocate staff and resources that had been involved in component inventory management to product development and marketing.

• Less inventory shrinkage. VMI can help customers reduce inventory shrinkage, or the loss of inventory due to factors such as theft, damage, or expiration. With VMI, suppliers have a vested interest in ensuring that their customers’ products are properly managed and accounted for, as the suppliers retain ownership of the inventory until it is sold or used. For example, say a pharmacy chain implements VMI for prescription drugs. The pharmaceutical supplier responsible for inventory management implements advanced tracking systems and works with the pharmacy to improve storage conditions, significantly reducing losses due to theft and expired medications.

• Improved relationship with suppliers. VMI fosters a collaborative relationship between customers and suppliers, which work together to improve inventory management and overall supply chain efficiency. This enhanced collaboration can lead to better communication, trust, and long-term partnerships.

Potential Challenges of Vendor-Managed Inventory

To achieve the numerous benefits that VMI can offer to both suppliers and customers, it’s important to recognize and proactively address the potential challenges that may arise when implementing and maintaining a VMI system. These hurdles can range from loss of control and limited flexibility for buyers to data privacy concerns and communication issues. Let’s explore 10 common challenges associated with VMI.

• Loss of control: One of the primary concerns for customers in a VMI arrangement is a perceived loss of control over their inventory. As suppliers take on the responsibility for managing stock levels, buyers may feel like they have less visibility into their inventory and less ability to make quick decisions in response to changing market conditions. This can be particularly challenging for businesses that are used to having complete control over their inventory, requiring a shift in mindset and trust in the supplier’s ability to manage stock effectively.

• Limited options: In some cases, VMI agreements may limit a customer’s ability to work with multiple suppliers or quickly switch suppliers if needed. This can be problematic if the buyer experiences issues with the current supplier or finds a better deal elsewhere. Moreover, if VMI agreements are tied to specific technology or systems, customers may be limited in their ability to adopt new technologies or processes that could improve operations.

• Less agile market responsiveness: While VMI can help improve overall supply chain efficiency, it could also result in slower responsiveness to sudden market changes or customer demands. That’s because suppliers are managing inventory based on predetermined parameters and historical data, so they may not react as quickly to unexpected spikes in demand or changes in customer preferences. This can lead to stockouts or excess inventory, negatively affecting the company’s ability to meet its own customers’ needs.

• Insufficient data privacy measures: VMI relies heavily on the exchange of sensitive data, such as sales figures, inventory levels, and customer information, between buyers and suppliers. If proper data privacy and security measures are not in place, this information could be vulnerable to breaches or misuse. Suppliers must have robust systems and processes in place to protect their customers’ data.

• Inventory fluctuations: VMI aims to smooth inventory peaks and troughs, but fluctuations in stock due to promotions or other unanticipated factors that change demand could occur. Such fluctuations can strain a VMI system and lead to temporary stockouts or overstocking. For example, if an unseasonable cold snap hits a city, causing a sudden surge in demand for heating equipment, a supplier may struggle to maintain agreed-upon inventory levels. This could result in stockouts at retail locations, leading to lost sales. And if the supplier overcompensates as it struggles to catch up, both parties could end up with excess inventory when temperatures normalize.

• Slow-moving inventory: In some cases, VMI may not be as effective for managing obsolete or slow-moving inventory. Suppliers may be less inclined to proactively manage these items, as they generate less revenue and might require more effort to monitor and replenish. As a result, buyers may end up with excess slow-moving stock that ties up capital and storage space. This challenge highlights the importance of clearly defining the scope of the VMI agreement and establishing processes for managing less popular or end-of-life products.

• Sudden demand increases: While VMI can help improve demand forecasting and inventory planning, sudden and unexpected increases in demand can still pose challenges. If a supplier is unable to quickly ramp up production or secure additional stock to meet the increased demand, buyers may face stockouts and lost sales. This can be particularly problematic for businesses in fast-paced or highly competitive markets where the ability to meet customer demand is critical to success.

• Ineffective communication: Effective communication is essential for the success of any VMI program. However, if communication channels are not well-established or misunderstandings occur between buyers and suppliers, it can lead to inventory discrepancies, stockouts, or overstocking. For example, if a customer runs a successful promotional campaign without adequately communicating the expected demand increase to the supplier, the supplier may struggle to maintain agreed-upon inventory levels, leading to lost sales or excess stock. Establishing clear communication protocols and regularly reviewing performance metrics can help mitigate this challenge.

• Cultural resistance: Implementing a VMI system often requires significant changes to processes and mindsets within both the customer and supplier organizations. Employees may resist these changes due to concerns about job security, unfamiliarity with new systems, or doubts about the benefits of VMI, all of which can potentially undermine this program. For example, if a retailer’s purchasing staff is used to managing orders manually, they may feel threatened by the automation of the ordering process under VMI. Similarly, if a manufacturer’s operations managers are hesitant to share production data with suppliers, it can hinder the supplier’s ability to manage inventory. Overcoming this resistance requires clear communication, comprehensive training, and effective change management strategies to be sure that all stakeholders understand and support the VMI initiative.

• Performance measurement challenges: Agreeing on performance metrics for a VMI system can be a complex task for both customers and suppliers. Traditional inventory metrics may not fully capture the unique benefits and challenges of VMI, potentially leading to misaligned goals or misinterpreted results. For instance, a supplier may prioritize maintaining inventory levels, while a buyer may be more focused on increasing inventory turnover. Developing a balanced set of metrics (detailed later) that satisfies both parties’ needs and properly reflects the performance of the VMI system is critical. Furthermore, ensuring that both parties also have the necessary capabilities to accurately measure and report on these metrics in a timely manner might require significant investments in data collection and analysis systems, as well as ongoing collaboration and communication between the two parties.

Best Practices for Seamless Vendor-Managed Inventory Integration

To ensure a smooth implementation of VMI and maximize the benefits once it is up and running, businesses must adopt best practices that foster collaboration, transparency, and continuous improvement. The following guidelines can establish a strong VMI foundation and minimize the potential challenges outlined above.

1. Define boundaries, roles, responsibilities and fees. Before launching a VMI program, its scope must be clearly defined, including which products and business locations will be involved. Buyers and suppliers should agree on their respective roles and responsibilities, such as which party will be responsible for handling returns. It’s also important to discuss any associated fees or costs, such as inventory carrying costs or service charges, to be certain that both parties clearly understand the financial implications of the arrangement.

2. Establish and regularly review goals and performance metrics. To be sure that the VMI program is meeting the needs of both buyers and suppliers, it’s necessary to establish clear goals and performance metrics. These may include targets for inventory turnover, stockout rates, order fill rates, and customer satisfaction. By regularly reviewing these metrics and comparing them against benchmarks, businesses can identify areas for improvement and make data-driven decisions to optimize their VMI program. For example, if a supplier notices that a buyer’s inventory turnover rate is consistently below target, they can work together to adjust stock levels or explore ways to increase sales.

3. Maintain open and transparent communication. Communication is the foundation of a successful VMI partnership. Customers and suppliers should establish regular touchpoints, including scheduled meetings, email updates, and a shared collaboration platform. With consistent communication, both parties can address concerns, share insights, and work together to improve the VMI program. For instance, if a customer learns of an upcoming regulatory change that will affect product specifications or packaging requirements, it should promptly inform the supplier. This allows the supplier to adjust production plans, manage inventory of soon-to-be outdated items, and arrange to comply with the new standards, all while minimizing disruption to its supply chain.

4. Continuously monitor and enhance performance. VMI is not a one-time implementation. Buyers and suppliers should regularly assess the performance of their VMI programs, identify areas for improvement, and implement changes as needed. This might involve adjusting inventory targets, refining demand forecasting models, or exploring new technologies to automate more processes. Embracing a culture of continuous improvement is key to keeping a VMI program agile and responsive to changing market conditions and business needs.

5. Provide regular and comprehensive data updates. VMI success relies heavily on the accuracy and timeliness of data shared between buyers and suppliers. Customers should provide regular updates on sales, inventory levels, and demand forecasts, while suppliers should share information on production schedules, shipping dates, and potential supply chain disruptions. Automated data exchange through EDI or API integrations can help simplify this process and reduce the risk of errors.

6. Invest in integrated information systems. To support seamless data sharing and collaboration, buyers and suppliers should invest in integrated information systems that provide real-time visibility into inventory levels, demand patterns, and supply chain performance. Many organizations opt for an enterprise resource planning (ERP) system that offers an integrated suite of business management applications with a central database. Some ERP systems already include modules for inventory management, demand planning, supply chain visibility, financial management, and accounting. By leveraging these technologies, businesses can automate key processes, reduce manual errors, and gain actionable insights to drive improvement.

7. Offer training and support to stakeholders. A new VMI program often requires significant changes to processes, roles, and responsibilities for both the buyer and supplier. It’s essential to provide comprehensive training and support to all stakeholders involved in the VMI program. This can include training on new technologies, processes, and best practices, as well as ongoing support to address questions and concerns. Investing in the development of their teams can help businesses foster a culture of collaboration and continuous learning, which is critical for the long-term success of any VMI partnership.

VMI KPIs

For a VMI program to deliver on its promise of continuous improvement, businesses must track a set of relevant inventory-related key performance indicators (KPIs). The 16 KPIs listed below are particularly useful for VMI, providing valuable insights into the efficiency, effectiveness, and overall health of a VMI partnership.

Overview of VMI KPIs

Financial KPIs	Operational KPIs	Supplier Performance KPIs
Return on Investment (ROI)	Order Fill Rate	Supplier Quality Index
Inventory Turnover Rate	Inventory Availability and Stockouts	Supplier Lead Time
Stock-to-Sales Ratio	Sell-Through Rate	Order Accuracy and Capacity
Inventory Carrying Cost	Backorder Rate	On-Time Delivery Rate
Cash-to-Cash Cycle Time	Forecast Accuracy
	Overall Program Performance
	Customer Satisfaction

• Return on Investment:

  Return on investment (ROI) measures the financial benefits of a VMI program relative to its costs. To calculate ROI, divide the net benefits (cost savings and increased revenue) by the total cost of implementing and maintaining the VMI program. The higher the ROI, the more value the VMI initiative is generating for the business. Companies can use ROI to justify the investment in this approach and make informed decisions about expanding the program.

• Inventory Turnover Rate:

  The inventory turnover rate measures how quickly inventory is sold and replaced over a given period. To calculate this KPI, divide the cost of goods sold (all the direct costs incurred creating a company’s products during a certain period) by the average inventory value (the average value of company inventory during the same period). The higher the turnover rate, the more effective the VMI program is at managing inventory levels and minimizing holding costs. Companies can use this KPI to optimize stock levels, identify slow-moving products, and improve cash flow.

• Stock-to-Sales Ratio:

  The stock-to-sales ratio compares the amount of inventory on hand to the sales volume over a given period. To calculate this ratio, divide the average inventory value by total sales. A low stock-to-sales ratio suggests that the VMI program is efficiently aligning inventory levels with demand, reducing the risk of overstocking or tying up excess capital in inventory. Businesses can use this KPI to fine-tune their inventory management strategies and improve financial performance.

• Inventory Carrying Cost:

  Inventory carrying cost measures the total expense of holding inventory over a specific period. To calculate inventory carrying cost, add up all costs associated with storing and maintaining inventory, including warehousing expenses, insurance, taxes, depreciation, and the opportunity cost of capital. This KPI is typically expressed as a percentage of the total inventory value. The lower the inventory carrying costs, the more efficient the VMI program is at managing inventory levels and minimizing the financial burden of holding stock. Businesses can use this KPI to identify opportunities to reduce costs, optimize inventory levels, and improve cash flow. They also can make informed decisions about inventory management strategies and assess the financial impact of their VMI programs.

• Cash-to-Cash Cycle Time:

  Cash-to-cash cycle time measures the duration between when a company pays for inventory and when it receives payment from customers for the sale of that inventory. To calculate cash-to-cash cycle time, add days inventory outstanding (the number of days’ worth of sales a business keeps in inventory) and days sales outstanding (the average number of days it takes a business to receive payment for goods and services purchased on credit), then subtract days payable outstanding (the average number of days between the time the company receives an invoice and when the invoice is paid). The shorter the cash-to-cash cycle, the more the VMI program is helping with working capital, improving cash flow and reducing financial risk. Companies can use this KPI to assess the efficiency of their entire supply chain, from procurement to sales. Optimizing the cash-to-cash cycle can help businesses free up capital for other investments, reduce borrowing needs, and improve overall financial performance.

• Order Status:

  Order status KPIs track the progress and timeliness of orders within the VMI system. These KPIs include metrics such as order fill rate (the percentage of orders fulfilled completely), on-time delivery rate (the percentage of orders delivered by the promised date), and order accuracy (the percentage of orders fulfilled without errors). Monitoring order status KPIs helps businesses identify potential issues in their fulfillment process and take corrective action to improve customer satisfaction and operational efficiency.

• Inventory Availability and Stockouts:

  Inventory availability and stockout KPIs measure the effectiveness of the VMI program in maintaining optimal stock levels and preventing stockouts. Key metrics include in-stock rate (the percentage of time that a product is available for purchase) and stockout frequency (the number of times a product is out of stock over a given period). Tracking these KPIs helps businesses assess the reliability of their supply chains and take steps to improve inventory management and customer service.

• Sell-Through Rate:

  The sell-through rate measures the percentage of inventory that is sold within a specific timeframe, typically a month or a season. To calculate the sell-through rate, divide the number of units sold by the initial amount of inventory on hand. The higher the sell-through rate, the more effective the VMI program is at forecasting demand and maintaining stock levels. Companies can use sell-through rate to identify top-performing products, adjust inventory levels, and optimize pricing and promotions.

• Backorder Rate:

  The backorder rate measures the percentage of orders that cannot be fulfilled immediately due to insufficient stock. To calculate the backorder rate, divide the number of backordered units by the total number of units ordered. The lower the backorder rate, the better the VMI program is at managing inventory and minimizing stockouts. Businesses can use the backorder rate to identify potential supply chain issues, improve demand forecasting, and enhance customer satisfaction.

• Overall Program Performance:

  Overall program performance metrics provide a holistic view of the effectiveness and efficiency of the VMI program. These KPIs include total cost savings, customer satisfaction scores, and inventory accuracy. By tracking overall program performance, businesses can assess the impact of the VMI initiative on their operations, financial performance, and customer relationships. Companies can use these KPIs to make data-driven decisions about program optimization, resource allocation, and strategic planning.

• Forecast Accuracy:

  Forecast accuracy measures how closely actual demand aligns with predicted demand in the VMI system. To calculate forecast accuracy, subtract actual demand for inventory during a specific period from the forecasted demand and divide the result by actual demand, then multiply the answer by 100 to express the quotient as a percentage. The higher the forecast accuracy, the better the VMI program is at effectively predicting customer demand, which is key for maintaining proper inventory levels and reducing inventory costs. Companies can also use the forecast accuracy KPI to improve their demand planning processes and refine forecasting models.

• Customer Satisfaction:

  Customer satisfaction measures the degree to which customers are happy with the products and services provided through the VMI program. This can be measured through various customer success KPIs, such as net promoter score (NPS), customer satisfaction score (CSAT), and a variety of customer retention-related rates. To calculate NPS, for example, survey customers on their likelihood to recommend the product or service on a scale of 0 to 10, then subtract the percentage of detractors (scores 0 to 6) from the percentage of promoters (scores 9 to 10). The higher the customer satisfaction score, the more effective the VMI program is in meeting customers’ needs and expectations. Businesses can use customer satisfaction KPIs to identify areas for improvement in their VMI programs, enhance product availability and service quality, and strengthen customer relationships. Improved customer satisfaction can lead to increased customer loyalty, higher sales, and positive word-of-mouth referrals.

• Supplier Quality Index (SQI):

  The Supplier Quality Index (SQI) measures the overall performance of a supplier in terms of product quality, delivery reliability, and responsiveness. SQI is typically calculated using a weighted average of various metrics, such as defect rate, on-time delivery rate, and order fill rate. The higher the SQI, the better the supplier is at meeting or exceeding performance expectations, contributing to the success of the VMI program. Companies can use SQI to evaluate supplier performance, identify areas for improvement, and make informed decisions about supplier relationships.

• Supplier Lead Time:

  Supplier lead time measures the time it takes for a supplier to deliver an order once it has been placed. To calculate supplier lead time, track the number of days between order placement and delivery for each order, then find the average across all orders. The shorter the lead time, the more responsive and efficient the supply chain is. Businesses can use this KPI to identify potential bottlenecks, adjust inventory levels, and improve customer service.

• Order Accuracy and Capacity:

  Order accuracy and capacity KPIs measure the supplier’s ability to fulfill orders correctly and efficiently. Order accuracy is the percentage of orders that are fulfilled without errors, while capacity is the maximum number of orders that a supplier can process within a given timeframe. The higher the order accuracy and capacity, the more reliable and efficient the supply chain. Companies can use these KPIs to evaluate supplier performance, identify potential issues, and make informed decisions about inventory management and order fulfillment.

• On-Time Delivery:

  On-time delivery measures the percentage of orders that are delivered by the promised date. To calculate on-time delivery, divide the number of orders delivered on time by the total number of orders. The higher the on-time delivery rate, the more reliable and efficient the supply chain is, which is crucial for maintaining optimal inventory levels and customer satisfaction. Businesses can use this KPI to evaluate supplier performance, identify potential issues, and make decisions about inventory management and logistics.

Industry-Specific Applications of VMI

VMI is deployed by companies in a diverse range of industries, each with its own requirements. The industry-specific discussions, below, show the diverse ways in which VMI can drive benefits, although the benefits themselves are quite consistent across the themes of lower inventory carrying costs, reduced risk of stockouts or overstocking, improved cash flow, and increased agility in responding to changes in customer demand. Let’s explore how VMI can be applied in various industries.

Retail

In the retail industry, VMI strives to ensure that products are always available on store shelves by analyzing real-time sales data, which reduces the risk of stockouts and lost sales while improving cash flow. For example, a large department store chain may implement VMI with its key suppliers, such as a clothing manufacturer, to be certain that the hottest styles are always in stock and to minimize the risk of overstocking less popular items.

Consumer Packaged Goods

One way a consumer packaged goods (CPG) company can benefit from VMI is by becoming the supplier in a close collaboration with its retail partners to maintain inventory levels and improve supply chain efficiency. In this scenario, CPG companies gain valuable insights into consumer demand patterns, allowing them to adjust production and distribution plans accordingly. For instance, a leading CPG company may use VMI to monitor inventory levels at its key retail customers’ warehouses and stores, checking that its products are always available, and reducing the risk of lost sales due to stockouts.

Electrical

Using real-time consumption data and VMI, suppliers can help streamline the supply chain for their electrical manufacturer, distributor, and contractor customers. For example, an electrical distributor could implement VMI with its critical suppliers to ensure that critical components are always available for contractors who are working on time-sensitive projects.

Ecommerce

Ecommerce businesses can enter into VMI contracts with their suppliers to optimize their inventory levels and improve their order fulfillment processes. For instance, an online retailer might use VMI to provide the suppliers of its best-selling products with access to its real-time sales data and demand forecasts, and also make them contractually responsible for ensuring that those products are always in stock and ready to ship.

Food and Beverage

VMI can help food and beverage companies manage perishable inventory more effectively, reduce spoilage and waste, and improve their responsiveness to changing consumer preferences. For example, a restaurant chain may use VMI with its key suppliers to guarantee that fresh ingredients are always available and to reduce waste due to overstocking.

Pharmaceuticals and Healthcare

VMI can help pharmaceutical and healthcare companies manage their complex supply chains more effectively and improve patient care, making sure, for instance, that critical medications and supplies are always available when needed.

Aviation

In the aviation industry, VMI can help airlines, aircraft manufacturers, and maintenance, repair, and overhaul (MRO) providers optimize their spare parts inventory and improve operational efficiency, based on real-time consumption data and maintenance schedules. For example, an airline may implement VMI with its essential suppliers to ensure that critical spare parts are always available for scheduled maintenance and unexpected repairs, minimizing the risk of flight delays or cancellations due to part shortages.

Manufacturing

Manufacturing companies can benefit from VMI by allowing their suppliers to manage inventory levels using real-time production data and demand forecasts. Consider an electronics manufacturer that implements VMI with its semiconductor suppliers to secure a steady supply of critical components. With direct access to the manufacturer’s production schedules and forecasts, the semiconductor suppliers can adjust their own production and deliveries accordingly. This helps the electronics maker reduce production delays due to parts shortages while minimizing excess inventory. It also lets the manufacturer respond more quickly to changes in consumer demand for different product models or unexpected surges in orders.

Oil and Gas

VMI can help oil and gas companies manage their complex supply chains more effectively, seeing to it that critical equipment and supplies are always available when needed. For example, an offshore drilling company may adopt VMI to ensure that it has critical spare parts and supplies available at all times for scheduled maintenance and unanticipated repairs, minimizing the risk of downtime due to part shortages.

Automotive

Automotive companies can leverage VMI to maintain inventory levels and improve their supply chain efficiency. For instance, a car manufacturer may use VMI to ensure that critical components, such as engines and transmissions, are always available for production, while minimizing the risk of overstocking less frequently used parts. This helps the manufacturer maintain a lean inventory, reduce costs, and respond quickly to changes in consumer demand.

Optimize Your Vendor Managed Inventory With NetSuite Inventory Management

To fully realize the benefits of VMI, businesses need a robust, flexible, and scalable inventory management solution that can seamlessly integrate with their suppliers’ systems and provide real-time visibility into inventory levels, demand patterns, and supply chain performance. NetSuite Inventory Management, part of the company’s comprehensive, cloud-based ERP system, offers a range of powerful features and capabilities that can help businesses adopt and optimize their VMI programs to achieve long-term success. It provides real-time visibility into inventory levels, advanced demand forecasting, and automated replenishment capabilities, so that companies can make better-informed decisions that ensure the right products are always available.

NetSuite can help automate and improve key VMI processes, such as order management and invoicing, while the platform offers numerous options to integrate it with other systems to facilitate seamless communication between businesses and their suppliers. By leveraging NetSuite’s advanced features, companies can improve transparency, reduce manual processes, and strengthen supplier relationships. In addition to its core inventory management capabilities, NetSuite’s financial management tools and reporting analytics help businesses track and analyze the performance of their VMI programs. With NetSuite, companies can optimize their VMI processes and drive stronger results.

VMI is a powerful strategy for enhancing inventory management and strengthening supplier-buyer relationships. With VMI, businesses can leverage the expertise and resources of their suppliers to reduce inventory costs, improve efficiency, and elevate customer satisfaction. However, the success of a VMI program depends on effective collaboration, clear communication, and the right technology. By implementing best practices and leveraging advanced inventory management solutions, companies can overcome the challenges of VMI and realize its full potential.

Vendor Managed Inventory FAQs

What is the purpose of VMI?

The primary purpose of vendor-managed inventory (VMI) is to optimize inventory management and improve supply chain efficiency by leveraging the expertise and resources of suppliers. VMI aims to ensure that the right products are available in the right quantities at the right time while minimizing inventory carrying costs and the risk of stockouts. By shifting the responsibility for inventory management to suppliers, VMI helps businesses focus on their core competencies, improve cash flow, and strengthen supplier relationships.

What is a disadvantage of VMI?

One potential disadvantage of VMI for businesses is the loss of control over inventory management. Handing inventory management over to suppliers may leave businesses feeling in the dark about how much stock they have or helpless to changing market conditions. Additionally, VMI may limit a company’s flexibility to work with multiple suppliers or quickly switch suppliers if needed, as VMI agreements often involve long-term commitments and integration of systems and processes.

What is the VMI method?

The VMI method is a collaborative inventory management strategy in which suppliers take responsibility for monitoring and replenishing their customers’ inventory. In a VMI system, suppliers have access to real-time data about their customers’ sales, stock levels, and demand forecasts. Using this information and predetermined minimum and maximum inventory thresholds, suppliers generate replenishment orders and coordinate deliveries to maintain optimal stock levels at their customers’ locations. The VMI method involves continuous data sharing, proactive inventory management, and a close working relationship between suppliers and their customers.

Who owns inventory in vendor-managed inventory?

In a VMI arrangement, the ownership of inventory can vary depending on the specific agreement between the supplier and the customer. In some cases, the supplier retains ownership of the inventory until it is sold or consumed by the customer. In other cases, the customer takes ownership of the inventory upon delivery, but the supplier remains responsible for managing and replenishing the stock. Regardless of which party owns the inventory, the key aspect of VMI is that the supplier assumes the primary responsibility for making sure that the right products are available in the right quantities at the customer’s location.