Miller Says:

The true value of VMI comes through the creation of a pull-based system that supports a lean supply chain, which ultimately provides tangible value to the end customer. What do you say? Send us your comments here

Vendor Managed Inventory (VMI) programs are one of the most powerful tools for creating a lean supply chain. These programs leverage the strengths of lean organizations and eliminate the waste associated with detailed forecasting and scheduling processes.

One challenge with VMI programs is to get beyond the narrow focus of internal cost reduction and move to the big benefits available through a holistic view of the complete supply chain. The following article, from Jamey Miller, Sr. Director, Supply Chain for Copan Systems, provides an excellent description on moving beyond the narrow focus of VMI as a cost reduction tool to how organizations are earning the big pay-offs from crafting a lean supply chain.

The True Value of Vendor Managed Inventory, Part 1

When most supply chain professionals discuss VMI, they often quote the benefits as it relates directly to their company. Although these benefits are valid and provide great value to a company, the true significance is often overlooked with this narrowly focused view. The real benefits of VMI relate to driving a lean supply chain that is centered on creating an end-to-end pull system, based on end user demand that cascades through the supply chain. The purpose of this article is to provide an overview of the obvious benefits of VMI and outline the true value that VMI provides within a supply chain. In a follow-up article, I will discuss some key steps to implementing a VMI program as well as items to be cautious of when establishing a VMI relationship.  

OBVIOUS BENEFITS OF VMI

The obvious benefits of VMI can largely be grouped into two general categories: cost and delivery. Below is a brief summary of these benefits.

Cost

• In a VMI relationship, the supplier holds inventory onsite or near the customer, allowing the customer near instant access to the inventory. This immediate access allows the customer to pull inventory as needed and only pay for that which is consumed, thus reducing inventory investment and increasing inventory turns.
• In most VMI arrangements, the supplier has the responsibility for replenishing stock, which would include ordering the inventory, managing the logistics to ship the material, and counting the inventory.  By passing these costs normally managed by the customer on to the supplier, the customer is able to reduce the overall cost of their product and increase their margins.  

Delivery

• By having the inventory onsite or near the customer, it enables the customer to pull inventory quickly and efficiently based on their production needs, effectively reducing the lead-time to next to nothing.

THE TRUE VALUE OF VMI

As mentioned earlier, the aforementioned benefits are obvious ones that most defer to when discussing VMI. However, the true merit often times goes unnoticed due to a company’s myopic view of their supply chain. The true value of VMI comes through the creation of a pull-based system that supports a lean supply chain, which ultimately provides tangible value to the end customer. These benefits can also be grouped in a similar fashion to the ones outlined above, with the addition of one critical dimension – quality.

Cost

• Although many people look at all inventory as bad, the inventory in a VMI program is often an asset worth investing in because it decouples upstream and downstream supply chain partners from random order fluctuations, forecast inaccuracies, and other variations in demand and supply. Inventory in a VMI program can be positioned at the best place for quickly responding to variation in the supply chain and removes the need for each supply chain node to maintain their own buffer of inventory. This can significantly reduce the overall supply chain inventory and the associated costs of maintaining such inventory.
• VMI allows the customer to pull inventory in the quantities needed to meet their customer’s demand, thus eliminating minimum order quantities.  The supplier may choose to replenish the VMI inventory based on pre-specified minimum order quantities internal to their company; however since the inventory liability largely resides with the supplier, they have more of an incentive to eliminate such requirements that push unneeded inventory and cost into the supply chain.

Delivery

• VMI helps to compensate for the lack of system integration between supply chain partners by allowing inventory to reside within the supplier’s ERP system, until pulled by the customer.  By keeping inventory within the supplier’s system, it provides a more accurate input into the material requirement planning process, as well as provides a more accurate demand history that can be diluted by minimum order quantities and/or other planning variables.  This, in turn, enables the supplier to more accurately predict customer demand and improve delivery performance.
• Since inventory is at or near the customer, VMI provides a more reliable mechanism for delivery compared to traditional ordering approaches such as discrete POs.  By providing such a reliable delivery mechanism, VMI removes variability from the delivery process, thus allowing the customer to improve the delivery of their product to their customer.  For example, assume you have a product that contains 200 components and each of those components must be physically in hand to start the production of the product.  If each of the 200 components used within a product has an on-time delivery performance of 99%, the overall product delivery performance would only be 13.4% (.99200).  In order to achieve a product on-time delivery performance of 98% or greater, the delivery performance at the component level must be 99.99% (.9999200).  The only way to achieve this type of delivery performance is through the use of VMI.

Quality

• As previously discussed, VMI facilitates a pull-based approach that helps prevent excess inventory from being pushed into the supply chain.  By reducing the inventory levels within the supply chain, it drives both the customer and supplier to more quickly identify quality issues in the material and/or product because they are using inventory close to real-time relative to the production date.  In addition. there is not excess inventory available in the channel to allow production to continue, which traditionally helps mask quality issues.
• VMI also promotes a quality conscious culture because the inventory resides on the supplier’s books until pulled by the customer.  Whether people like to admit it or not, a supplier will be more responsive in addressing and resolving a quality issue if the inventory is on their books.

VMI IMPLEMENTATION

The benefits mentioned above will not be realized unless a VMI strategy is properly planned, implemented, and controlled. Although VMI seems somewhat simplistic in nature, there are a few critical steps that need to be taken to ensure success for both the supplier and customer. We will discuss an implementation approach and a case study of a success in our next report on lean thinking from SCDigest.

In the meantime, send your ideas and comments to feedback@scdigest.com.