Vendor managed inventory — benefits, risks, and best practices

Inventory management often relies on retailers’ predictions of their needs, which may or may not be accurate. Purchasing too much product can lead to overspending while ordering too little can lead to missed sales. Vendor managed inventory (VMI) solves these issues by putting the supplier, or vendor, in charge of inventory — even once it’s in the retailer’s warehouse.

This post will discuss the benefits of vendor managed inventory and how to implement it successfully. It covers:

• What vendor managed inventory is
• How VMI systems work
• Benefits of VMI
• Potential issues with VMI
• Best practices for VMI

What is vendor managed inventory?

Vendor managed inventory (VMI) is a partnership between a vendor and a retailer in which the vendor takes control of the retailer’s inventory. It’s an inventory management system that puts the seller (the vendor) in charge of inventory instead of the buyer (the retailer).

This means the retailer doesn’t need to actively order more inventory to stock its shelves because the vendor has access to inventory levels and determines when the business needs more stock.

The goal of VMI is to reduce inventory-related costs for both parties. When suppliers manage inventory, stock is replenished only when necessary, which reduces overstock and costs for the retailer. It also streamlines operations for the vendor by creating a more predictable business pattern.

How does a VMI system work?

There are three distinct factors that make VMI different from other inventory management systems.

• Businesses and retailers must share information.
• Vendors control the inventory management.
• Vendors do all re-stocking and ordering.

Vendor managed inventory works by building a strong communication system between the seller and the buyer. The first step is for both parties to set metrics for success and agree on terms and conditions for the partnership.

Next, the vendor begins shipping products to the retailer. Throughout the process, the retailer provides current inventory data to the vendor so they can monitor stock levels and purchasing trends. Without this data, it’s impossible for vendor managed inventory to work.

Using the data shared by the retailer, the vendor ships new inventory as needed — taking that pressure off the retailer. The vendor also has the best knowledge of production times, shipping delays, and estimated lead time. Knowing when and how much inventory to ship can make or break the potential cost savings of VMI.

At some stage in the process, the retailer will pay for the new inventory. The timeline for payment is determined by the agreement made with the vendor. Agreements can vary. Some retailers pay upon the arrival of the stock while others pay when the stock is sold.

Imagine a pet store chain uses VMI to manage their dog food inventory. The pet store stocks their shelves with a specific brand of dog food and an inventory manager at that dog food company receives regular sales data from the pet store. The inventory manager decides when and how much dog food to restock at that location, based on the parameters and goals set by both parties.

VMI can be especially useful for stores that sell a wide range of products from different vendors. Managing a large assortment of goods can be daunting for the retailer, so shifting the responsibility to the vendor is convenient for both companies.

Benefits of VMI

Vendor managed inventory offers many benefits to vendors and retailers. Some of the most immediate benefits include reduced overhead cost, better forecasting, less risk to the retailer, and more.

Reduced cost

The primary benefit of VMI is that it helps businesses save money in all areas of the supply chain. It reduces time spent on inventory planning on the retailer side, since stock is managed by the vendor. It also reduces unnecessary ordering and the need for excess storage space. Less inventory sitting around means there are lower carrying costs. In many cases, retailers don’t even pay for the stock until they sell it. This gives the business more cash to work with for other business needs.

Managing inventory for several retailers helps vendors reduce costs too. When they’re in control of inventory shipments, vendors’ schedules become more predictable and streamlined.

Less risk

Working directly with vendors reduces the risk of ordering too much or not enough inventory. And because vendors have control over the inventory, they accept the risk of product not selling fast enough.

Better forecasting

The constant flow of data between retailer and vendor allows for more consistent and timely stock updates and orders. Other supply chain management systems rely on rough predictions, but VMI uses current sales as a guide for more strategic inventory ordering.

Vendors are also able to analyze the data from several retailers together to recognize and plan for local trends.

Improved relationships with suppliers

VMI is a symbiotic relationship between the retailer and the vendor. When everything is running smoothly, it should enhance and reinforce the relationship between the two. This improves the retailer’s confidence in their product supply and it strengthens the vendor’s long-term business prospects.

Getting started with VMI also requires careful strategy. Many retailers are more loyal to VMI vendors to avoid repeating lengthy onboarding processes.

Managed stock levels

Managing stock levels is a task that retailers and other sellers have to think about constantly . The more products the company sells, the greater the complexity.

With VMI, retailers don’t have to worry about any of that, which means hours they would spend monitoring inventory levels and sending out purchase orders are now freed up to take care of other tasks. Managed stock levels lead to higher team efficiency.

Vendor managed inventory helps sellers with stock levels too. When vendors can make long-term, data-driven plans and manage shipments between several different retailers, they can move products more efficiently.

Fewer human errors

Human error can complicate inventory management in so many ways. Maybe one department forgot about a certain product or a training manager miscalculated. Overestimates and underestimates can be costly, and sometimes retailers just type one too many zeroes.

Because the vendor shoulders the responsibility for ordering, you no longer have to worry about your team misordering product. Human error committed on the vendor’s part is theirs to resolve.

Potential VMI issues

Issues can arise anytime a new system is implemented. Understanding potential challenges early will help you prepare for complications.

Lack of data proficiency

A vendor needs to understand your inventory data or the whole operation can quickly break down. A vendor’s ability to analyze data from the retailer and know when to order new inventory is essential to successful VMI. This responsibility falls on the vendor, but the retailer should consider the vendor’s data proficiency when choosing a partner for VMI.

Inventory changes

Anytime a retailer decides to start introducing new products or removing old ones, clear communication with the vendor is essential.

Introducing new products is tricky because there is no data on those items for the vendor to forecast. This means the business has to be in constant contact with the vendor to tell them how well the new product is selling.

Similarly, if a product is being phased out, the vendor needs to be informed so they don’t continue to order extra inventory. Holding onto old or excess stock can be costly and takes up valuable storage space.

Slow-moving stock

If inventory isn’t selling fast enough to need restocking, including it in your vendor managed inventory data could force you to pay for any overstock, which is what you’re trying to avoid by using VMI. Be strategic with the products you choose to carry by paying close attention to your target market and sales history.

Demand spikes

If demand spikes unexpectedly, it will interfere with the forecasts vendors are using to determine restocks. If this happens, stock may be low for a while, and how quickly the vendor can get more inventory to the retailer depends on the vendor’s flexibility.

Occasional spikes shouldn’t affect your overall sales goals too drastically, but it is important to discuss flexibility while vetting possible vendors.

Poor communication

The easiest way for VMI to fail is if the vendor and the retailer aren’t communicating properly. Almost all potential problems can be solved by the vendor and the retailer openly communicating and helping each other.

The vendor takes on a lot of the responsibility in VMI, but that doesn’t eliminate the retailer’s responsibility in the relationship. Communicate often and make sure your business is providing accurate, updated data.

Best practices for vendor managed inventory

Communication is the most important practice for successful VMI, but there are other secrets to success. Be sure to set boundaries and fees upfront, create goals and clear metrics for success, provide frequent and abundant data to the vendor, and keep the vendor updated on any and all changes.

1. Set boundaries and fees

The first step any business should take is to set appropriate boundaries and establish them in writing. It’s important to set limits on how much inventory your business is willing to hold at any given time, as well as how much space you have available for storage. The retailer should also establish whether they are paying for inventory on arrival or upon sale and the return policy for any unsold stock.

The vendor needs to know what inventory you expect them to manage. All costs should be determined before entering into the agreement, otherwise both parties could incur unwanted fees.

2. Create goals and metrics for success

Set long-term goals and establish the metrics you will use to measure them. Both parties need a target to work toward. This will also help keep both the vendor and retailer focused when short-term issues come up.

Both sides should know how the agreement will benefit them, and having data to back it up will keep everyone happy.

3. Provide frequent and abundant data

Vendor managed inventory can’t work without a flow of data between the two parties. This includes inventory levels, sales numbers, and any other information that will help the vendor keep the business well-stocked.

The more data you can share the better, but make sure your data is protected in the event of a leak or vendor mismanagement. Adding a confidentiality agreement to your contract with the vendor can help avoid unwanted issues. If you have proprietary data, you can always opt not to share it with the vendor as long as it won’t compromise the vendor’s ability to do their job.

4. Keep your vendor updated and be honest

Automated, real-time data is the best option for keeping a vendor updated. If real-time data isn’t possible with your systems and an upgrade isn’t in the budget yet, try to get as close as possible. Schedule data sends often.

In addition to providing updated data, discuss any changes that could affect your business’s sales or inventory levels with the vendor. Seasonality, demand spikes, slow-moving products, new competition, or new sales channels can all impact inventory needs. The earlier you prepare the vendor for any changes, the better.

Getting started with vendor managed inventory

Vendor managed inventory reduces costs and risks, allows for better forecasting and managing of stock levels, builds stronger relationships between vendors and retailers, and reduces human error.

The first step to ensuring successful vendor managed inventory is having an ecommerce solution that can integrate seamlessly with the systems of a third-party logistics provider. Furthermore, maintaining full control over all your incoming and outgoing data is crucial to smooth inventory management.

Adobe Commerce uses artificial intelligence to provide data analysis and fulfillment information, which can be automatically communicated to vendors. Get started by watching the Adobe Commerce overview or requesting a demo.