What is Vendor Managed Inventory (VMI) – How it works, pros and cons

When you think of the retail and eCommerce giants in business, selling n number of diverse products online, you could be asking – ‘How are they managing inventory of so many products?’ This is valid question and this is where vendor managed inventory (VMI) comes into play. In cases, where businesses have to manage huge volumes of product inventory often the vendor works collaboratively with the seller to stock and restock inventory to ensure there are minimal stockouts and supply always complements demand.

Inventory management has never been an easy task, and here we’ll take a look at how vendor managed inventories can enable businesses to better optimise supply chain management.

What is Vendor Managed Inventory (VMI)?

Vendor Management Inventory meaning:

Let’s start by understand the meaning of Vendor Managed Inventory. As, can be gathered from the above example, VMI or vendor managed inventory system is a B2B strategy and collaborative effort between vendors and buyers/sellers to improve inventory and supply chain operations.

In an ideal scenario, the vendors would have reasonable control over the inventory to monitor stock levels based on sales and replenish the supply of products at appropriate time to prevent stockouts.

Quite naturally, this would lead to higher customer satisfaction, better inventory management, minimal wastage, lower costs, optimal reorder quantity numbers – all adding to vendor managed inventory benefits.

It’s important to understand here that the order volumes are pre-determined. Vendors can only modify the order volume after discussing with the seller. For example, wholesale and retail businesses might order 2x the usual order volume during festival or seasonal time.

Why vendor management inventory is important – Benefits of VMI

At this point you must be piqued as to why VMI is important? After all, can’t eCommerce sellers and retailers manage their own inventory? What about the numerous inventory management software available in the market to assist with this? What’s the role of vendor managed inventories in the overall supply chain operations?

Let’s take them up at a time:

• Can’t eCommerce sellers and retail businesses manage their own inventory? Yes and no. Yes, when the business is small, local and the customer base is limited. No, when the business is global, when it’s selling 100s of diverse products, when there are multiple vendors/suppliers on the platform (i.e., when the business is functioning like a B2C or B2B marketplace or similar). That is when a VMI system is required.
• Aren’t inventory management software sufficient? Yes, they are brilliant but only when the scope of business and number of external vendors are limited. But they do not serve the same purpose. Using a vendor managed inventory system, all vendors can have inventory and supply chain visibility and manage their product stocks as per needs and customer demand. For instance, if an item is selling well, the vendor can plan to restock it in time without having the seller to intervene and place an order (based on agreement).

Vendor management inventory examples

It won’t be unreasonable to think that brands like Amazon, Flipkart, Myntra or even Walmart use VMI systems. These brands are probably the best examples of vendor managed inventory systems users and have well-structured programmes in place to collaborate with multiple vendors.

Amazon vendor managed inventory relies on a lean inventory model, i.e., enough to meet demand but not excess to overstock or waste. It also uses advanced AI technologies for data accuracy and forecasting. Amazon’s vendor managed inventory system moreover is reliant on multiple third-party vendors, whereby vendors schedule deliveries to Amazon’s warehouses and/or fulfilment centres, while the actual last-mile delivery is undertaken by Amazon’s logistics partners (i.e., Fulfilment by Amazon – FBA).

Amazon follows a metric called Inventory Performance Index (IPI) to manage FBA inventory. Scoring is based on three parameters namely:

• Efficiency in replenishing inventory for popular products
• Manage and rectify any errors in listing
• Maintain optimal inventory levels

In a nutshell, Amazon empowers its vendors to track and manage their product inventory at Amazon warehouses. (Please check Amazon’s vendor section for more information).

How a vendor managed inventory system works? Role of vendor and seller

By now the most likely question from your side is to be – ‘So, how does a vendor managed system work?’ Does the vendor monitor inventory levels and place an order? Does the seller place an order? How do vendors and sellers work collaboratively?

The first thing to understand here is that there is no one standard type for VMI systems to function. It depends on the vendor-seller relationship, the scale of orders, the access and authority provided, and the overall nature of business operations.

Let’s look at certain vendor managed inventory supply chain scenarios and types:

• Scenario 1: Vendor has maximum possible control over inventory. Vendor can view and monitor inventory levels and schedule reorders based on actual insights and demand forecasting. Seller on the other hand is tasked mostly with order inspection for quality and quantity.
• Scenario 2: Vendor has partial control over stocks and inventory. Using available tools, vendor can check, monitor and map inventory levels, and keep the seller informed of the stock levels. The seller however is tasked with placing the reorder and timing frequency.
• Scenario 3: Vendor has minimal control over inventory. Vendor may review order levels but awaits new orders from the seller. Product inspection for quality and quantity are done before shipment. The transporter is also arranged by the vendor.
• Scenario 4: Vendor tracks inventory levels and schedules shipment after all internal checks. Transportation is however organised via seller logistics partners. This is often done to reduce transportation costs, especially when there are frequent reorders.
• Scenario 5: Vendor has fixed delivery schedules based on pre-determined order levels. Though vendor has limited visibility on inventory levels, the vendor cannot schedule new deliveries before timelines. This is usually the case when working on projects where components are required in specified intervals.

As can be understood, the type of vendor managed inventory system that an organisation follows can be different. The idea is to share inventory responsibilities across relevant stakeholders to optimise the overall process.

Vendor Managed Inventory process

Before looking at the how vendor managed inventory benefits supply chain operations, let’s take a snapshot of the VMI process.

Vendor Managed Inventory advantages and disadvantages

Now that we understand how vendor managed inventory systems work, let’s look at the benefits of the VMI system for vendors and sellers.

Vendor managed inventory advantages and disadvantages are plenty and diverse. The vendor benefits in certain ways whereas the seller benefits in other ways. Let’s take a closer look at the pros and cons of vendor management inventories for each of them.

VMI benefits for vendor

VMI benefits for seller

Role of logistics in Vendor Managed Inventory

We have already looked at Amazon and other eCommerce platforms as vendor managed inventory examples. When it comes to big brands, it’s understandable that they have processes and procedures to ensure seamless operations. But what happens when working with a small business?

For instance, you are a small handicrafts seller and provide limited access to your vendor w.r.t. reordering. You know your economic order quantity (i.e., optimal order quantity) and accordingly place an order – which is now awaiting fulfilment. This is where logistics plays a vital role.

In most cases, your vendor has a trusted logistics partner in place (3PL or 4PL) who undertake the task of shipping goods in time. Ideally these logistics service providers use the latest logistics technologies e.g., AI, GPS tracker, blockchain etc. for ease of tracking, payment security, and timely updates. These providers offer appropriate packaging, use the right mode of transportation, and are usually reliable.

For a small business, this is a critical step as any slack on the part of the transporter can impact the overall consignment, and in turn inventory levels, sales and customer experiences.

Gone are the days when inventory and supply chain mapping were done manually. Today, businesses are going online and relying on digital tools for end-to-end operations. There are challenges of taking business online, but the benefits are plenty. Vendor Managed Inventory is one such system whereby partnering with vendors through digital tools, sellers are efficiently managing optimal inventory, cutting costs and providing an enhanced customer experience.

Author: Sohini Banerjee

Sohini is a seasoned content writer with 12 years’ experience in developing marketing and business content across multiple formats. At Tata nexarc, she leverages her skills in crafting curated content on the Indian MSME sector, steel procurement, and logistics. In her personal time, she enjoys reading fiction and being up-to-date on trends in digital marketing and the Indian business ecosystem.