Vendor Managed Inventory? Think twice and consider the risks!

Historically, businesses have used one of two extremes for inventory management: push-based or pull-based. Push-based inventory management uses demand forecast to manage inventory and replenish from the supply base.  Pull-based inventory management, on the other hand, uses consumption to replenish from the supply base and manage inventory.  The push-based method relies heavily on forecast accuracy and typically sees inventory swings as a reaction to forecast errors.  The pull-based method relies on the ability to replenish the “pulled” demand.  In addition, the pull-based method has a “push” component to communicate “long-term” forecast to the supply base.  Extend issues with either of these two extremes and one has the classical bull-whip effect.  Add variability due to customer demand, product and component quality, lead time, etc. and the bull-whip effect is magnified.

In the pursuit of finding a way to off-load inventory (read “working capital”) from their books, many large manufacturers are moving towards so called “Vendor Managed Inventory” systems.    The logic couldn’t be easier to follow:  “why not have our suppliers own the inventory up to the point of use?  We will pay them for the product, but getting it here is their responsibility!  Plus it saves us all of the headaches associated with logistics and that other messy stuff….”

The concept of Vendor-Managed Inventory (VMI) is defined as a supply initiative where the supplier assumes responsibility of tracking and replenishing a customer’s inventory.  This initiative comes in a number of different forms, including Synchronized Customer Response, Continuous Replenishment, Efficient Consumer Response, Rapid Replenishment, CPFR, and centralized inventory management.  To effectively assess the value of VMI, one must also consider the potential costs and risks associated with the approach, through an iterative, evaluation process that includes multiple parameters.    Patterns from multiple case studies also suggest that VMI in many instances is not motivated by bilateral efforts to improve supply chain performance, but rather by unilateral interests on the part of buyers to drive effortless purchasing and suppliers to lock in and secure sales. VMI also poses significant risks, such as when large telecoms in 2001 pushed billions of inventory onto contract manufacturers, then had to write-off this inventory through “deferred obligations” when industry volumes dropped, leaving these contract manufacturers holding the bag of material.  Other findings suggest that in a large pharmaceutical supply network, the success of an extended VMI approach was dependent on the adoption of complex central information systems allowing suppliers and plants to decide how much and when to deliver taking into account all the necessary information concerning different supply networks.  This included sales forecasts, order confirmation and changes during a frozen period, automated data capture from multiple network partners, and strong levels of coordination among purchasing, production and delivery plans.  Manual operation of inventory planning is a strong component of such systems combined with strong governance and customized performance measures.

A VMI decision was explored  within a large manufacturing approximately 6 – 8 years ago, during a period of significant growth.  The decision, in this case, was indeterminate:  it was found that 1) a universal solution for all parts was not possible, 2) evaluation of VMI vs. buyer-managed inventory had some benefits in some cases, but significant risks in others, 3) the possibility of line shut-downs in a VMI situation is a real risk, and 4) the benefits of VMI over buyer-managed inventory were marginal at best.

Other findings documented by Blackhurst et al (2006) also suggest that the implementation of a VMI initiative at a large electronics manufacturer did not produce the results expected.  In fact, as a result of the move to VMI:

– Material shortages increased, even when the appropriate inventory levels agreed on in the VMI project were maintained.

– Material expediting increased.

– Inventory levels actually increased at downstream (buyer) facilities.

– Forecast inaccuracies hindered effectiveness.

– Demand visibility was reduced, and this caused last-minute exceptions and eventually to higher inventory in the entire system.

Bottom line:  think twice before you go to a “VMI” effort.  Contrary to what many people think, companies like Toyota and Honda have moved away from VMI, and simply choose to co-locate suppliers as close as possible to their facilities.  This promotes the daily discussion, communication, and rapid response that is needed to effectively manage delivery, material handling, and logistics in a complex and volatile global environment.