Vendor Managed Inventory VMI

Vendor Managed Inventory

Supply Chain And Operations Management:

Supply chain management is a major concerned of all large and small firms in today's highly unpredictable business environment. While the buyers or distributors are worried about timely deliveries of products and efficiency of products, manufacturers are more concerned about how their customers judge demand and place orders. This is because unpredictable changes in demand can force the customers to place orders for products whose production level has not yet been increased. For this reason, supply chain management has become a major issue.

Supply chain management sounds like a complex series of integrated activities but it all boils down to one simple end i.e. customers must always have the items as and when required. Roger Blackwell, a professor of business studies at Ohio State University and acclaimed author of quite a few best-selling books on the subject of supply chain says, "Supply-chain management is all about having the right product in the right place, at the right price, at the right time, and in the right condition." (Tom Stein and Jeff Sweat, 1998) It is extremely important to understand what constitutes a supply chain in order to understand the significance of emerging operations management methods. This chain helps in efficient and smooth overall operations of the company and thus must be in coordination with its policies and management strategies.

Ram Ganeshan and Terry P. Harrison (1995) define supply chain in these words: "A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers. Supply chains exist in both service and manufacturing organizations, although the complexity of the chain may vary greatly from industry to industry and firm to firm." (Ram Ganeshan and Terry P. Harrison, Department of Management Science and Information Systems, Penn State University, 1995)

Changing nature of supply chain management

Supply chain thus occupies a very important place in the management of the company and its efficient implementation is usually the biggest of most organizations. In the modern business world of today, supply chain management is no longer connected with movement of products from manufacturer to customers. It has become highly complicated because of the unpredictable nature of demand and intense emphasis on customer service. Many companies are trying to make use of emerging technologies to develop a more efficient supply chain. This is where we encounter new management methods, some of which focus on certain sections of the supply chain and not the entire chain.

The four important decisions made in this connection are associated with location, production, inventory and transportation/warehousing. With changes in the business environment and more stress on customer service, it is important to address each section separately. Not only this, companies are also required to develop more harmonious relationship with various intermediaries of the supply chain. Better collaboration can lead to more cost efficiency and improved customer service. This can later have a profound impact on the operations of the company including its management strategies. For this reason, we must accurately assess the changes in the business environment including subtle changes in demand patterns. This helps in developing and adopting a better operations management strategy. Commenting on the changing nature of supply chain management, Tom Stein and Jeff Sweat (1998) write:

Many critical elements make up any successful supply chain. First, companies must learn to trust their business partners -- an enormous psychological hurdle. There is a very real -- and sometimes justified-fear that information sharing can turn into a competitive disadvantage. But supply-chain partners that exchange information on a regular basis are able to work as a single entity. Together, they have a greater understanding of the end consumer and are better able to respond to changes in the market place. These companies also realize they must harness the power of technology to collaborate with their business partners as never before. That means using a new breed of supply-chain management applications -- and the Internet and other networking links-to look at past performance and historical trends to determine how much product should be made, as well as the best and most cost-effective methods for warehousing it or shipping it to retailers." (InformationWeek, 1998)

VENDOR MANAGED INVENTORY:

Vendor managed inventory refers to relatively new supply chain management method in which consuming party or buyer's inventory is maintained and monitored by the supplier. Some well-known firms adopted this method in the 1980s and its success indicates that it is an effective and efficient manner of controlling and maintaining inventories. Vendor managed inventory is also known as supplier managed inventory and as the name indicates it is the supplier a very important role here. The vendors keep an active record of the inventories of their distributors or buyers and make supply or purchase orders on their behalf. Supplier can be a manufacturer or reseller but the fact remains that he is the person who is responsible for keeping an eye on inventories of his buyers either by physically or through electronic means. Supplier then makes all the decisions regarding new orders including timing and size of the purchase order. This system has helped some major companies like Wal-Mart and Johnson increase the efficiency of their inventory system.

New operation s management systems are needed because suppliers and buyers want to be better prepared to satisfy the needs of a new more demanding customer. Customers are no longer interested in buying only a product; therefore they keep a watchful eye on the service offered by the company. In other words, they purchase both the product and a service. For this reason, it is important for companies to adopt strategies, which are customer-oriented, and not me merely profit-centered. Suppliers and distributors thus understand the growing need for smoother and more efficient operation management and thus better supply chain management techniques are being rapidly adopted. Heather Harreld (2001) explains:

Manufacturers and suppliers are abandoning their traditional adversarial relationships characterized by price haggling and hedging bets on product orders in favor of a collaborative-commerce model designed to be mutually beneficial. To pave the way for these new alliances, vendors are rolling out enhanced supply-chain planning and forecasting tools and SRM (supplier relationship management) technologies that provide real-time access to the demand, inventory, price, sourcing, and production data to be shared by manufacturers and their suppliers. This evolving collaborative-commerce paradigm has resulted from the balance of power in business relationships shifting to the customers, be they manufacturers or end-users, says Jeff Shuman, a professor ad director of entrepreneurial studies at Bentley College in Waltham, Mass., and co-author of Collaborative Communities: Partnering for Profit in the Networked Economy. "Because you have an empowered customer,... To satisfy that customer now companies realize that they can't go it alone, because the demanding customer won't settle for things they used to settle for," Shuman says. "The customer is saying, 'I want to sit at the table and collaborate with you.'" (InfoWorld, 2001)

VMI is a form of outsourcing, which has not gained rapid acceptance because of various reasons including use of similar electronic data interchange and bar codes formats. The retailer or manufacturer usually expect the buyers to adopt these measures in order to make VMI system more efficient but not every company has been able to comply. This is the reason VMI is still in its infancy and it is believed it would take few more years to grasp and embrace this supply chain management method completely.

Companies that are adopting this system are noticing a marked change in their inventory efficiency; still we cannot exactly call this system problem free. For one all item details have to be properly communicated to the supplier with increase or decrease in prices due to promotions and sales. Grocery stores thus face more problems than other sectors because the amount of products involved can sometimes hinder the process of data transmission to the supplier. This is one reason why its adoption in grocery stores has been slower than in other sectors. Some suppliers also face resistance from buyers and distributors who lose control over their own inventories once VMI is implemented. But benefits of VMI are numerous which is why it is likely to become a solid alternative to lengthy supply chain management systems currently operating in large firms. VMI can shorten the supply chain and also reduces the risks of item shortage. Centralized forecasting helps in controlling the frequency of reorders.

Commenting on this new system and its key features, Riikka Kaipia and Kari Tanskanen from Helsinki University of Technology write:

VMI is an operating model in which the supplier takes responsibility for the inventory of its customer. In a VMI partnership, the supplier makes the main inventory replenishment decisions on behalf of the customer. The supplier, which may be a manufacturer, reseller or distributor, monitors the buyer's inventory levels and makes supply decisions regarding order quantities, shipping and timing... However, VMI has not gained widespread acceptance in the grocery supply chain. It requires all the co-operating parties to use similar protocols and common product numbering. This has slowed down the adoption of VMI, especially in the grocery sector, where large SKU numbers and frequent transactions make implementing VMI more demanding." (Riikka Kaipia and Kari Tanskanen, Department of Industrial Management Helsinki University of Technology, 1995)

HOW VMI WORKS

VMI is thus a new supply chain management system, which can improve supply efficiency provided it, is able to get rid of the implementation challenges. A typical VMI system is not very complicated in nature or that is what appears to be the case on the surface. But the actual implementation and operation of VMI can sometimes prove problematic because of the complexity of the data interchange involved. Usually, the most important technology used for VMI is EDI or electronic data interchange. This is an ordering system, which enables suppliers to download inventory files from the distributor's computers. After carefully studying inventory data, supplier places an order for the required products or makes other kinds of adjustments. The order notification is sent to the distributor who acknowledges it and the order is then shipped on a given date. After the order has been received, payments can be made through electronic bank transfer. This is the way a typical VMI system works and most companies use specialized software to interact with remote computers. In some large supply chains where several intermediaries are involved, suppliers can provide additional services of forecasting, sales planning and product replenishment. Though technology plays a very important role in VMI system today, it was originally manual which was why it took most large companies a long time to understand or adopt this model. The article titled 'Vendor Managed Inventory' which appeared in ComputerWorld's August 1999 issue sheds light on the transition of VMI from manual to automation. Author Jacqueline Emigh (1999) has this to write about this transition:

For several decades, route salesmen for food manufacturers have taken inventory when they visit stores to stock the grocery shelves, says Tim Van Mieghem, president of The Proaction Group, a consultancy in Chicago. Makers of hospital supplies became similarly inspired, employing in-hospital attendants to count and replenish items. Department stores like Wal-Mart moved to automated VMI in the late 1980s. One of the driving factors was the difficult task of predicting how much seasonal apparel was needed, says Bob Copeland, senior manager at Atlanta-based Kurt Salmon Associates, a consulting firm in the retail arena. The apparel industry has continued to be a pioneer in VMI ever since. For example, Greensboro, N.C.-based VF Corp., maker of brands like Lee and Jantzen, has been implementing a sophisticated system that integrates retail inventory data from VMI into floor-space management at the store level. In a beta test, ShopKo Stores Inc. In Green Bay, Wis., reportedly experienced a gain of more than 20% in sales of men's jeans. Ironically, though, industries facing complex situations have been among the last to adopt automated VMI." (Computerworld, August 1999)

BENEFITS OF VMI FOR SUPLIERS AND BUYERS

Now that we understand what VMI and its key features are, we are in a better position to study its advantages and disadvantages. The biggest advantage is reduction in costs for both the supplier and the buyer. Most buyers in traditional setting choose to purchase items at the beginning of the month but let inventory size decrease by the end. They however fail to realize that lesser items in inventory can significantly hurt customer service. Due to unpredictable changes in demand for various items, there are various ways in which costs can increased in traditional management systems. For example when demand for a certain item increases, there is a chance that buyers would stock up that product in larger than required quantities. This can often lead to costs increase, as buyers are unable to sell all the items within a given period. Similarly sometimes distributors place orders for items, which are not as much in demand as the buyer has assumed. This can result in cost increase, which can seriously hurt supply chain efficiency and can also prove detrimental to customer service.

To remove these problems, vendor managed inventory system is implemented. This offers both suppliers and buyers with a chance to reduce costs and increase sales. For example, suppliers can increase the frequency of orders keeping in view the demand changes, and this leads to lesser costs and more revenues. On the other hand buyers can leave order issues to the supplier and expect appropriate quantities of required items in the inventory at all times. Suppliers are in a better position to judge demand of products and can thus change the frequency of orders placed on the buyer's behalf.

Matt Waller et al. (2001) focus on the advantages of VMI and maintain that this system, if properly implemented, can help both the buyers and the sellers in cost reduction. In their research paper on this system, which appeared in the Journal of Business Logistics, Waller and others had this to say about the why VMI could attract the buyers:

Buyers are attracted because VMI resolves the dilemma of conflicting performance measures. End-of-month inventory level for example, is a key performance measure for retail buyers, but customer service level (tracked by some sort of out-of -stock measure) is also applied. These measures are contradictory. Buyers stock up at the beginning of the month to ensure high levels of customer service, then let inventory drop at the end of the month to "meet" their inventory goals (disregarding the effect on service level measures) The adverse effect is even more pronounced when end-of -quarter incentives are tied to financial reporting. The combined result of this behavior is a monthly order spike to the supplier." (Journal of Business Logistics, 2001)

But buyers are certainly not the only ones who benefit from VMI, suppliers also stand to benefit from this system, which is one reason, why choose to render this service. Cost reduction also occurs at supplier's side and this is proved by another scholarly resource. In other words, VMI is implemented only when both parties agree on a win-win strategy where the supplier can benefit as much from the service as the buyer. For successful implementation of VMI, it is thus important for the two parties to understand how they can stand to benefit from this system or else VMI would lose its effectiveness. In a paper published by Riikka Kaipia and Kari Tanskanen, the writers explained how this system could help reduce costs for the suppliers. They maintained that a better and more harmonious collaboration between the supplier and their customers could remove friction that usually mars most supply chain business relationships. Riikka Kaipia and Kari Tanskanen write:

For suppliers, the major attraction of VMI is in mitigating demand. Large, infrequent orders from customers force suppliers to maintain inventories that enable them to respond to the uneven demand. In VMI, the supplier is able to smooth the peaks and valleys in the flow of goods, and therefore to keep smaller buffers of capacity and inventory. The supplier has better opportunities to co-ordinate the shipments to different customers. It can schedule - either postpone or advance - shipments according to production schedules, customer inventory situations and transportation capacity. Usually in VMI the frequency of shipments is increased... Buyers need not monitor the supplier performance by the service level provided by the supplier to the buyer. The only meaningful service level is from the retailer to its customers. The supplier's performance is measured by this service level and by the inventory level at the retailer. Due to the supplier's abilities to plan operations better and due to more frequent deliveries, the service level improves. This generates more sales, because product availability increases." (Riikka Kaipia and Kari Tanskanen Department of Industrial Management Helsinki University of Technology, 1996)

IMPLEMENTATION CHALLENGES OF VMI

VMI system is not very easy to implement and this is the reason why its transition from manual to automation resulted in decrease of its popularity. It is important to understand here that though technology has made it easier to pull down data from remote computers, it has nonetheless made implementation a problem. This is because as we discussed above, VMI requires similar formats and software at both ends. A difference in the software or EDI systems can result in data interchange issues that affect the speed of operations. Another problem is the number of customers that a supplier might have and the technology adopted by each. IN most cases it is impossible for supplier to benefit from cost-reduction features of VMI if it has only one customer. Therefore, he would most probably be supplying his services to numerous customers, each one of whom has different needs and different technical facilities available. Therefore implementation of this system can often present various tough challenges to suppliers as well as customers.

Customization of VMI system often seems like the only solution available to resolve these conflicts. Joseph C. Andraski, vice president for integrated logistics at the Nabisco Food Group in Parsippany, N.J says that since their company offers distributors with vendor managed inventory options, they are well aware of the complications that are involved in its implementation and operation. Apart from that there are various other problems involved such as high implementation costs and disagreements between customers and suppliers.