Vendor Managed Inventory and Vendor Managed Availability

Stephen DeAngelis

April 12, 2011

In a recent post, I reviewed what some analysts are writing about the future of just-in-time inventory and manufacturing strategies (see Just-in-Time Logistics Scrutinized Anew). Today I want to examine another inventory management scheme based on the same principles. As an entry in Wikipedia notes, “Vendor-managed inventory (VMI) employs the same principles as those of JIT inventory, however, the responsibilities of managing inventory is placed with the vendor in a vendor/customer relationship. Whether it’s a manufacturer managing inventory for a distributor, or a distributor managing inventory for their customers, the management role goes to the vendor.” Parts shortages that emerged in the aftermath of the earthquake/tsunami combination that struck Japan have brought the subject of inventory management to the forefront of supply chain discussions. Just days before the massive Japanese earthquake struck, James LaTart wrote:

“Remember when inventory was just something off the production line stored in a warehouse until it was pushed out to customers? In the past, companies worried about how much safety stock to keep, along with inventory turn rates and the associated carrying costs, but the most important thing was keeping production lines running, driving the most efficiency one could from the machines. Fast forward to today, and those production lines are likely halfway around the world. The machines belong to third parties. The whole idea of inventory storage is being replaced with processes and technology to direct and speed inventory flow. Warehouses are being converted to cross-dock, mixing center and flow-through facilities. And most are challenged with direct-to-store and direct-to-consumer distribution as well. Storage is out, and flow is in, from anywhere in the world to anywhere in the world. Life is a whole lot more complicated for supply chain professionals.” [“Inventory–Not What It Used To Be,” Logistics Viewpoints, 8 March 2011]

LaTart writes that “concerns about safety stock, turn rates, and carrying costs are taking a back seat to agility needs, and meeting ever-changing customer demand.” I suspect that “safety stock” is no longer taking a back seat in many C-level executive discussions. LaTart continues:

“After decades of buying technology to reduce safety stock and carrying costs, we have more of it than ever, spread across much longer supply chains. Business today has to react more quickly to demand, despite longer supply chains. There’s also more competition and price pressure, so whatever anyone does to make it happen has to drive out costs. The answer isn’t simple, but certain basic things have to happen. To start, we need to recognize that flow and silos will never work together. Most people know this, but change is often difficult to realize since performance metrics and reward systems are still based on those silos. Optimizing one part of a business might de-optimize another. Supporting flow requires a strong leader who can change the metrics and reward systems to foster cross-functional processes that obliterate the silo mentality.”

Long-time readers of this blog know that eliminating silos from corporate structures is one of favorite topics (see, for example, posts entitled The Curse of Silo Thinking, Breaking Down Silos, Silos in the Supply Chain, and Rethinking Supply Chains). Eliminating (or reducing the impact of) silos improves transparency and collaboration throughout an organization. LaTart concludes that technology can also help. He concludes:

“Technology has to support flow as well. Industry platforms have to facilitate flow across each trading network. Retail platforms, consumer goods platforms, high tech platforms – flows are different for each industry. These platforms need underlying technology based on services-oriented architectures and Web services to support network-wide visibility and the ability to quickly adjust mid-stream to meet customer needs. The good news is these systems exist. No, inventory isn’t what it used to be. And neither are the organizational structures, processes and technology needed to support the new flow paradigm.”

Turning to the subject at hand, Malory Davies, editor of Supply Chain Standard, reminds us, “It’s now more than 20 years since the notion of vendor managed inventory entered supply chain thinking.” [“Time to raise your game?” 11 October 2010] According to Secil Savasaneril, “VMI started as a pilot program in retail industry between Procter & Gamble and WalMart in [the] 80’s and resulted in significant benefits, such as lower inventory levels, fewer stock-outs and increased sales.” [“An Analysis of Manufacturer Benefits under Vendor Managed Systems“] Davies continues, “While there seem to be obvious benefits in involving the supplier in the management of a customer’s stock, the technique has not always produced the results hoped for. If a supplier has good visibility of a product’s sales through a particular retail outlet, it should be possible to manage the level of inventory more effectively.” According to the site QuickMBA:

“With VMI, the vendor specifies delivery quantities sent to customers through the distribution channel using data obtained from EDI. Vendor Managed Inventory, Just-in-Time Distribution (JITD), and Efficient Consumer Response (ECR) all refer to similar concepts, but applied to different industries. For example, the grocery and apparel industries tend to use ECR, whereas the automobile industry tends to use VMI and JITD.”

Regardless of how you refer to this basic strategy, the intent is to reduce stock-outs and inventory in the supply chain. QuickMBA notes that along with its numerous benefits, VMI has implementation challenges as well. “The problem is not just one of logistics. VMI often encounters resistance from the sales force and distributors. At issue are roles and skills, trust, and power shifts.” The sales force can be concerned about loss of control (if not loss of jobs) and distributors are concerned about inheriting inventory risks among other things. Since the real concern for manufacturers or retailers is not inventory but availability, Davies notes that “VMI is increasingly being replaced by VMA – vendor managed availability.” He writes:

“Telefónica O2 is one of the organisations that has been working hard on VMA. Nick Lefever, general manager supply chain, says the key difference is the point at which the retailer takes ownership of the product. Under VMI, Telefónica O2 would take ownership of the product at the distribution centre, but under VMA it does not take ownership until the product reaches the point of sale. This results in a significant reduction of capital invested in stock. There are also benefits to the supplier in terms of real time visibility of its sales – though I suspect that some suppliers, which are used to a steady flow of deliveries, might find it quite unsettling to be exposed to the peaks and troughs of the retail market. And, of course, if the supplier owns the product right up to the point of sale, then it is taking on not just greater cost but also greater risk. So it is critical that it can use the information supplied by the retailer to manage its production and optimise its own inventory levels. More and more organisations are starting to take up vendor managed availability – and as a result the pressure is going to increase on suppliers to raise their game in terms of supply chain management.”

It is easy to see why retailers would embrace VMA — they can push almost all of their inventory risks and costs onto the supplier. Professor Warren H. Hausman believes that Vendor or “Supplier Managed Availability (SMA) is an important change in mindset.” [“Supplier Managed Availability,” Supply Chain Online, October 2003] He continues:

“Inventory at the downstream site isn’t a goal in itself (for example, if the downstream node is a retailer, inventory is just an enabler of sales); the true goal is availability of product when and only when a particular site needs it. Can you think of different ways of providing increased supplier flexibility so that less inventory can be held at the customer site while still maintaining availability? Here are several examples:

  • “Use of faster (expedited) transportation
  • “Excess ‘surge’ capacity available at the supplier
  • “Faster production time at the supplier
  • “Holding some uncommitted inventory at the supplier’s site

“The mindset change from ‘inventory’ to ‘availability’ enables the supplier to take into account these additional ways of dealing with demand variability; the result is even lower inventories than with ‘standard’ VMI. For example, it may be more economical for the supplier to invest in supplemental capacity, to be used only when needed, instead of maintaining large quantities of inventory at a customer site; or the supplier may decide to pay for faster transportation on an as-needed basis.”

Of course, suppliers were happier under the old system where customers assumed responsibility for inventory management. With retailers like Walmart demonstrating an enormous capacity to establish and enforce rules, I wouldn’t bet on a return to the “good old days.” Hausman doesn’t seem much bothered by that reality. In fact, he sees VMA (or SMA) as a strategy that provides suppliers with a number of options. He writes:

“With SMA, we go a step beyond focusing on inventory and focus on availability; we also remove the min-max inventory requirements. Now the supplier has additional options to choose from: he may choose to use a faster transport mode, … or have surge capacity available at a moment’s notice to ramp up when unexpected demand occurs. … SMA could be called ‘VMI+’ since it extends the supplier’s options considerably. SMA works so well because the supplier has an incentive to provide availability downstream (in order to sell their product to customers, as with VMI), but the supplier also recognizes that there is a tradeoff between inventory held there (e.g., holding cost and obsolescence risk) and premium transportation and/or surge capacity at the factory.”

There seems to be a bit of over-optimism in Hausman’s writings. His SMA framework appears to assume a world with few or no disruptions. That certainly is not the world in which we presently live. I do agree with Hausman that for any good inventory management system to work, you need good sharing of information. He concludes:

“For SMA to work in practice, just as with VMI, both parties must have information systems linked to one another so that the supplier can indeed view downstream inventory and consumption data at the customer’s site. Then the supplier monitors that information and determines the most cost-effective way to meet projected availability requirements, rather than simply staying within predetermined min-max inventory targets. Under SMA, the supplier makes the economic tradeoff between meeting those availability needs via inventory, via surge capacity and/or expedited transportation, or (most likely) some combination. … In order to have SMA (or VMI) work, the downstream partner must develop sufficient trust in the process so that it is willing to relinquish its traditional ordering/replenishment decisions. Establishing this trust is typically the most difficult part of implementing VMI and SMA, but as more companies explore this area, a growing number of success stories are paving the way for greater adoption of these exciting new strategies.”

I suspect that as we learn more from disruptions caused by the disaster in Japan we will also be reading a lot more about inventory management. I look forward to the discussion.