Simplify inventory management with vendor managed inventory (VMI)

Ecommerce has made business more competitive than ever. Almost every department — from sales to marketing to customer service and more — has had to adjust. Warehouse management has gotten more complicated too because companies need to keep up with heavy back-end management such as purchasing, storing, and tracking inventory.

One way to organize and streamline your inventory management is to adopt vendor managed inventory (VMI). VMI can dramatically reduce the effort and anxiety associated with inventory management, freeing up time for business owners and operations managers to tackle more strategic projects.

This post will explain:

• What vendor managed inventory is
• How vendor managed inventory works
• Advantages of vendor managed inventory
• Disadvantages of vendor managed inventory

What is vendor managed inventory?

Vendor managed inventory is a partnership between a company purchasing products (the “buyer”) and a supplying vendor in which the vendor agrees to maintain a certain inventory level at all times. VMI can benefit both parties — the vendor has a steady income stream and the buyer has a stable product supply.

A common difficulty is that buyers don’t always know how to find a good vendor for VMI. That's when third-party logistics buyers can help. These companies combine data from suppliers and sellers to improve the supply chain process.

Third-party buyers can also help in emergency situations. For example, if vendors find that items are out of stock, a third-party buyer can contact other vendors in its network to get product to the buyer that needs it.

Third-party buyers also work with vendors to recommend new product orders to buyers. This ensures that vendors don’t have unneeded inventory but still have enough to keep up existing agreements with other buyers, matching supply and demand gaps.

Now that you understand what VMI is, let’s dive deeper into how the VMI process works.

How vendor managed inventory works

Keeping up with customer demand is a big issue for ecommerce stores because there are so many competitor options available to shoppers. If you’re out of stock even once, customers lose trust in your organization and look for a similar product elsewhere — and you might lose that customer for good. VMI minimizes the chances of that happening by aligning vendor and buyer priorities and instituting checks and balances throughout the process.

The VMI process starts with the vendor and the buyer determining what goals they want to achieve and when. There are some common KPIs for these objectives.

• In-stock performance. This metric reflects how well in-stock inventory is selling.

• Inventory turnover rate. To calculate inventory turnover, divide the cost of that inventory by the average inventory for the same period. A high ratio indicates that inventory is selling well and a low ratio indicates weaker sales.

  

• Transaction cost. Transaction costs should stay relatively stable. If there is high variation from one month to another, there could be a disruption in the supply chain.

The two parties also decide whether the buyer will pay for the inventory upon acquisition or after a customer has purchased a product and how inventory returns will be processed.

Once those decisions are made, VMI generally follows a standard operating procedure.

1. The vendor ships inventory to the buyer. Often, vendors supply an advance ship notice (ASN) on behalf of a buyer. An ASN is similar to a purchase order — a legal document that approves a specific purchase — but it differs in that it’s sent after the vendor makes its shipment. Advanced ship notices help finance teams on both the buyer and seller sides keep track of transactions and inventory. These documents flow automatically into each company’s financial systems, reducing accounting inaccuracies.
2. The vendor monitors sales and inventory. Once shipments are made, vendors pay close attention to the buyers’ sales and determine whether the original forecast was correct.
3. The vendor makes calculations based on demand forecasting and lead time for reorders. Because vendors are continuously monitoring inventory, they know whether previous forecasts were accurate and when slow or busy seasons are. With all this information in mind, the vendors run their reports and make recommendations.
4. The vendor places reorders. After a final review, the vendor places reorders and sends an ASN if necessary.

The process repeats unless the vendor or buyer terminates the relationship. With practice, this flow becomes a seamless routine for team members on the buyer and vendor sides.

Advantages of vendor managed inventory

VMI is a simple strategy that helps companies improve a lot of inventory goals.

• Reduced risk. VMI naturally balances out inventory among buyers in accordance with typical spend and seasonality, sparing those companies from spending money on items that will never sell.
• End of cash flow restrictions. Most buyers try to structure contracts with vendors to pay for inventory when it’s sold. And both buyers and vendors monitor VMI processes carefully to optimize inventory replenishment. These practices reduce unnecessary spending and increase companies’ spending power.
• Lower levels of inventory. Optimized inventory means there is little to no overstock — even during busy or slow periods.
• Decreased carrying costs. VMI reduces excess stock, eliminating the need for large storage centers. This allows companies to save on real estate.
• No safety stock. Safety stock (or buffer stock) ties up money and opens buyers up to future revenue loss. When vendors gain access to buyers’ sales data, they can combine it with their lead time to get just enough inventory to buyers — right on time.
• Limited inventory shrinkage. Since VMI reduces inventory, there’s less of it to worry about. That means fewer cases of shrinkage due to manual clerical errors or stolen, lost, or damaged inventory.
• Fewer stockouts. VMI establishes fluid, consistent product replenishment, meaning less uncertainty about reorders. This fine-tuned, automated process decreases the chances of stockouts.
• Diminished costs. With VMI, planning, ordering, and inventory costs no longer burden merchants. They all fall to the vendor, supplier, or manufacturer.
• Better sales and brand loyalty. Customers are more likely to buy your products if you’re a reliable, trustworthy ecommerce seller. Having stock when customers need it is critical to their retention. VMI also increases your staff’s product knowledge through frequent contact with vendor representatives. This helps get them the insights they need to answer customers’ questions.

When executed well, vendor managed inventory models can streamline operations, reduce financial errors, boost customer trust, and increase cash flow.

Disadvantages of vendor managed inventory

There are some disadvantages of vendor managed inventory that companies should know before entering into a partnership.

• Possible analytics gap. Some vendors don’t do data analytics, but data is a huge part of VMI. Monitoring your inventory levels, customer behavior, and sales numbers — particularly during seasonal spikes and lulls — is crucial to ecommerce success. During initial discovery calls, confirm that your favored vendor has proven analytics capabilities.
• Difficulty severing relationships. Deeply integrated relationships are great when business is humming along, but this also makes severing relationships especially challenging. Make sure your VMI contract takes this into account and you know exactly how to cut ties without causing legal difficulties.
• Increased vulnerabilities. Whenever you share data, you put your company at risk of a data breach, theft, or leak. For that reason, you should always sign an airtight confidentiality agreement and ensure that your online security is fully up to date.

While there can be downsides to using VMI, the pros often outweigh the cons. And with the proper setup, many potential VMI drawbacks can be avoided.

Take control of your inventory

Paying close attention to sales patterns, making accurate forecasts, and ensuring enough inventory is in stock can be challenging. VMI decreases that pressure on ecommerce brands, guaranteeing that stock will be there when customers want it. VMI also lowers carrying costs, avoids shrinkage, and boosts cash flow by matching vendors with buyers for an improved supply chain process. But VMI is hard to get started without the right tooling in place.

As ecommerce continues to make business more competitive than ever, Adobe Commerce can help. As the premier platform for ecommerce and vendor management, Commerce allows you to monitor your inventory in real time to ensure you’re meeting customer expectations across all channels. Adobe Commerce’s sourcing algorithms also help you accurately predict how much inventory you need without overspending.

Want to see Adobe Commerce in action? Sign up for a free demo today.