1. Introduction

What’s the biggest nightmare of any business?

Having orders in line but not having enough inventory to fulfill them. 

One of the main reasons for this is not having a particular or poor inventory management system in place. Around 43% of small businesses either use manual tracking for their inventory or don’t track their inventory at all, which leads to operational challenges like stockouts, overstocking, longer lead times, order delays, etc. Fixing this alone can reduce up to 10% of businesses’ inventory costs. 

Therefore, businesses always strive to find ways to fulfill their orders by minimizing the issues related to inventory. One approach that businesses use in this scenario is vendor managed inventory (VMI), in which the vendor is responsible for managing the inventory of the retailer or buyer. Due to its multiple benefits, businesses have shown tremendous interest in this. The VMI market is projected to grow from $3.9 billion in 2023 to $6.3 billion by 2030 at a 5.6% annual growth rate. 

Let’s see if this approach is suitable for your business or not.

What is vendor-managed inventory (VMI)?

Vendor-managed inventory (VMI) is a system in which a vendor or supplier is responsible for inventory management for a retailer or buyer. This means the buyer doesn’t place orders, but the vendor restocks the inventory based on demand forecasting.

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How does vendor managed inventory work

Vendor-managed inventory doesn’t work like a traditional supply chain, where a buyer makes a purchase order PO, sends it to the Vendor, and then the vendor sends the goods. 

In VMI, the buyer doesn’t make the purchase order; the vendor manages all the buyer’s inventory independently.

Let’s understand how it works.

• Suppose a retailer is following the VMI approach.
• His vendor manages all his inventory.
• Buyer shares his inventory data with the vendor
• The vendor monitors the real-time stocks for the retailer
• The vendor sees that the retailer’s inventory level is dropping. He will now restock it before it runs out.
• The retailer will receive the goods before the stockout and fulfil his orders.

All this has been managed flawlessly because of clear visibility into the procurement process and overall supply chain.

What data does the vendor access

In a VMI setup, the buyer (like a retailer or distributor) shares specific real-time data with the vendor so they can manage and replenish stock effectively without the buyer having to place manual orders.

The key data the vendor gets access to includes:

1. Stock levels (Inventory on hand)

• This tells the vendor how much of their product is currently in the buyer’s warehouse or store.
• It helps them know when stock is getting low and needs replenishment.
• If inventory falls below a set minimum (e.g., 100 units), the vendor knows it’s time to ship more.

2. Sales data 

• Vendors see how fast products are selling.
• This helps them forecast demand and adjust the supply accordingly.
• If 500 units were sold last week and only 200 the week before, the vendor can prepare for rising demand.

3. Purchase and delivery history

• With this metric, vendors analyze past purchase orders and delivery patterns to predict future needs.
•  If a store orders more before the holiday season, the vendor can pre-stock accordingly.

4. Stock thresholds (min/max limits)

• These are agreed-upon limits (like safety stock or reorder points) that trigger auto-replenishment.
• When inventory drops to the minimum threshold (e.g., 80 units), the vendor restocks up to the max (e.g., 200 units).

5. Returns and damaged goods data

• This metric helps vendors improve quality and manage reverse logistics better.
• If a product has high return rates, the vendor can investigate and act accordingly.

Vendor-managed inventory KPIs

For the better planning of inventory, in VMI we set certain KPIs – that make it easy to track the stocks and help both parties make informed decisions.

1- Inventory turnover rate:

How fast is the inventory sold in a particular period (1 month, 6 months, 1 year).

2- Stock-to-sales ratio:

How much stock is in hand compared to the sale volume? This metric helps optimize inventory levels as needed.

3- Backorder Rate:

Percentage of orders that cannot be fulfilled due to delay or stockout. 

4- Sell-Through Rate:

The percentage of stocks sold in a particular period compared to the total stock received.

5- Supplier quality index – SQI

This is the indicator of how well the vendor is performing in terms of material and quality of goods, replenishment process, lead times, communication, etc. 

Above 5 are the primary metrics used to track VMI’s performance. Below are the additional indicators.

Inventory carrying cost:

Cost associated with holding and storing inventory. 

This metric helps both vendor and buyer hold only the required inventory to minimize extra costs related to storage, insurance, and opportunity costs.

Order status and stockouts:

In which stage is the order in its fulfillment cycle? And how many more goods are available in the stock

This metric helps prevent stockouts with timely replenishment.Fill rate:

Orders that can be fulfilled with the available inventory.
Lead time:

The time it takes for a vendor to fulfil the order placed by the buyer.

Forecast accuracy:

How well has the demand been managed without facing stockouts and overstocking?
Inventory accuracy:

Physical Inventory available in stock as compared to the recorded inventory in the system.

How VMI Works in the Supply Chain

VMI impacts the supply chain in the following manner;

1- Shared KPIs 

With the shared KPIs, both the vendor and the buyer can see the real-time progress that makes the supply chain leaner. With metrics like the stock-to-sales ratio, the vendor can replenish inventory before a stockout, which saves significant time in creating POs, along with reducing lead times and approval cycles. 

2- Real-time data exchange 

Most businesses following VMI use a real-time data exchange via EDI or cloud platforms that keep everything transparent between the two parties, making the supply chain shorter with fewer discrepancies. 

3- Automated replenishment by suppliers 

Most of the delays in the supply chain happen not during the steps but between them, like creating an order, transportation time, and approvals. But when the vendor is directly responsible for planning the inventory, it cuts through all these unnecessary steps that cause delays, and suppliers replenish inventory in a timely manner.

Further, with the data in hand, the vendor automates the whole process by setting the inventory levels and thresholds that speed up the process.

In short, by following the vendor managed inventory, companies can;

• Make the supply chain leaner
• Cut down overhead inventory costs
• Adapt to market changes or increase responsiveness to market changes
• Prevent “Bullwhip effect” – where a small market change can impact the whole supply chain
• 

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What is vendor managed inventory in SAP?

In SAP, vendor-managed inventory typically means integrating the buyer’s data into the vendor system so the vendor can easily and transparently manage the stocks on behalf of the buyer. 

This data is shared typically using the SAP ERP system – a buyer can transfer its data via EDI to the vendor for better VMI planning. 

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Integration points

VMI in SAP connects with existing modules, including:

• Materials Management (MM)
• Sales and Distribution (SD)
• Production Planning (PP)
• Warehouse Management (WM)

Key functionality

SAP provides specialized tools for VMI, including:

• Automated sharing of inventory data 
• Advanced analytics for demand forecasting
• VMI-specific transaction codes and reports
• Integration with EDI and other communication channels

When using VMI in SAP:

1. Set clear stock level limits.
2. Enable automatic alerts for restocking.
3. Create separate access and permissions for vendors.
4. Set up performance reports.
5. Integrate with current procurement processes.

This integration will minimize receiving errors and make operations smoother.

How does vendor managed inventory benefit the buyer

VMI benefits the buyer in the following ways;

• Less inventory holding cost
• Lower cost associated with human resources to manage administrative work due to automated replenishment
• More inventory accuracy
• Fewer stockouts and lost sales
• Less overhead cost – operational cost, warehouse cost, and working capital

How does vendor managed inventory benefit the Vendor

• Better demand forecasting
• Better production planning due to more visibility
• Strong customer relationships
• Reduce return orders
• Reduced cost related to frequent and unplanned deliveries. 

Challenges related to Vendor Managed Inventory (VMI)

VMI is not an absolute way to salvation for businesses; it is also prone to errors if not implemented correctly.

Poor communication

Poor communication, both in terms of data or dialogue, can cause disruptions in the supply chain. If the system used for inventory management is not up to date with the current standards, either because it’s too slow to update data in real time or because it’s not implemented correctly, the vendor won’t be able to get proper visibility into the procurement process, which will again impact stock replenishment.

Misalignment of forecast or stock targets

When the buyer and vendor sign the contract, they agree on KPIs and plan data metrics to prevent misalignment.

If the contract isn’t clear in the first place, it can lead to incorrect demand forecasting or stock targets. For instance, a buyer sets the stock threshold to 80 when the contract is initiated, but after some time, the order demand increases, and the buyer fails to communicate the demand to the vendor. This impacts the overall procurement process and supply chain.

To prevent such situations, open communication and regular reviews between both parties must exist.

Lack of trust between the vendor and buyer

VMI is purely based on trust. If any parties involved lack trust, the system can face challenges. Both parties need to fulfil their part of the work to keep the cycle running. If one party lacks the ability or trained staff, this can lead to a lack of trust and, ultimately, poor inventory control and management.

Is VMI right for your business?

No doubt, vendor-managed inventory has more benefits than potential drawbacks, but it is still not for everyone.

If you are a business owner thinking, “Should I go for VMI? Is it safe and right for me?” Well, there is this checklist to see if it’s for you or not.

When to consider VMI:

If you are a business (like a reseller) that has multiple vendors, you get frequent orders, and it’s difficult for you to forecast demand ahead of time, or you face last-minute stockouts that can hurt your business, vendor-managed inventory might be the best option for you.

When VMI might not work well
If you deal in highly seasonal products and your demand forecasting is unpredictable, then VMI might not be the best option for you.

At the same time, if you don’t have a proper system in place for the inventory management, you do most of your work manually and have no tool to manage demand and stocks, then again, VMI might not be the best option. 

How to make VMI a success?

Well, if you think vendor-managed inventory will work for my business, then all you have to do is evaluate your vendors, see if they use tools that best align with your system or vice versa, define KPIs for better decision-making, invest in the latest tools and software, and train your team to use it accurately.

Automation works best when fed properly. Therefore, during the whole integration process, review each step and make sure everything is aligned and in the best order.

FAQs

What is vendor managed inventory?

Vendor-managed inventory (VMI) is a system in which the vendor/supplier is responsible for inventory management for a retailer or buyer. Means the buyer doesn’t place orders, but the vendor restocks the inventory based on demand forecasting.

How to implement vendor managed inventory?

Vendor-managed inventory doesn’t work like a traditional supply chain. Here, the vendor is responsible for managing the buyer’s inventory. It works this way:

• Buyer shares its inventory data with the vendor
• The vendor does forecasting
• And replenish stocks based on that

Vendor managed inventory vs just in time?

In vendor-managed inventory, the vendor manages, replenishes, and forecasts buyer inventory.

In just-in-time inventory, the buyer creates purchase orders only at the time of need or demand. Both are very different but used for the same purpose. – Minimizing inventory-related costs and better planning. 

Is vendor-managed inventory a form of outsourcing?

Yes, it’s a form of outsourcing, where a buyer outsources a vendor to manage its inventory at the buyer’s location. 

Who owns the inventory in the vendor managed inventory?

In vendor managed inventory, the vendor owns the inventory until it is sold to the end consumer, but it remains sitting in the buyer’s warehouse.