Vendor-managed inventory in the retail supply chain

Journal of Business Logistics, 1999 by Waller, Matt, Johnson, M Eric, Davis, Tom

Vendor-managed inventory (VMI) is one of the most widely discussed partnering initiatives for improving multi-firm supply chain efficiency. Also known as continuous replenishment or supplier-managed inventory, it was popularized in the late 1980s by Wal-Mart and Procter & Gamble. VMI became one of the key programs in the grocery industry's pursuit of "efficient consumer response" and the garment industry's "quick response." i Successful VMI initiatives have been trumpeted by other companies in the United States, including Campbell Soup and Johnson & Johnson, and by European firms such as Barilla, the pasta manufacturer.

In a VMI partnership, the supplier, usually the manufacturer but sometimes a reseller or distributor, makes the main inventory replenishment decisions for the consuming organization. This means the vendor monitors the buyer's inventory levels (physically or via electronic messaging) and makes periodic resupply decisions regarding order quantities, shipping, and timing. Transactions customarily initiated by the buyer (such as purchase orders) are initiated by the supplier. Indeed, the purchase order acknowledgment from the vendor may be the first indication that a transaction is taking place; an advance shipping notice informs the buyer of materials in-transit.

In this relationship, buyers relinquish control of key resupply decisions and sometimes even transfer financial responsibility for the inventory to the supplier (whether by the letter or spirit of their agreement). The arrangement transfers the burden of asset management from the consuming organization to the vendor, who may be obliged to meet a specific customer service goal (usually some sort of in-stock target).

Various published accounts have described VMI benefits that range from cheaper new product introductions to reduced returns at product end-of-life, but the literature often fails to explain just why these benefits have resulted from VMI. As with many new management theories, it is sometimes difficult to distinguish the achievable results from the hype, just as it is difficult to determine how these results might be replicated elsewhere.

We provide fresh insights into the approach, along with plausible answers to these questions. We start by explaining why savings so often accrue from VMI. We then describe some underlying technologies required to make the arrangement work. Next, we introduce a simulation model that examines VMI quantitatively in order to understand the effect of key variables. Finally, we address several less than ideal conditions often found in the consumer electronics industry in order to assess the robustness of the approach.

WHY VMI?

Success in supply chain management usually derives from understanding and managing the relationship between inventory cost and customer service level.2 The most attractive projects yield improvements along both dimensions, and this is certainly the case with VMI. To begin, we examine how each partner in a VMI relationship reduces costs and improves service.

Reduced Costs

Demand volatility is the key problem facing most supply chains, eroding both customer service and product revenues. In traditional retail situations, sales fluctuations are made worse by management policies. Ordering patterns may be aggravated by demand uncertainty in general, conflicting performance measures, planning calendars used by buyers, buyers acting in isolation, and product shortages that cause order inflation.

Many suppliers are attracted to VMI because it mitigates uncertainty of demand.3 Infrequent large orders from consuming organizations force manufacturers to maintain surplus capacity or excessive finished goods inventory, which are very expensive solutions, to ensure responsive customer service. VMI helps dampen the peaks and valleys of production, allowing smaller buffers of capacity and inventory.

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-ofquarter incentives are tied to financial reporting. The combined result of this behavior is a monthly order spike to the supplier.

With VMI, the frequency of replenishment is usually increased from monthly to weekly (or even daily), which benefits both sides. The supplier sees a much smoother demand signal at the factory.

This reduces costs by permitting better resource utilization for production and transportation; it also reduces the need for large buffer stocks. The vendor can make replenishment decisions tuned to operating needs, and also has heightened awareness of trends in demand. The consuming organization benefits from legitimately lower cycle stocks, notjust low end-of-month inventories intended to mislead the reward system. Even if the buyer has surrendered ownership to the supplier, many benefits arise from improved transportation and warehouse efficiencies. Moreover, service levels will go up at the end of the month or quarter.