MANUFACTURING AND
WHOLESALE DISTRIBUTION INSIGHTS
Forward Thinking Thought Leadership
Making a Vendor Managed Inventory Strategy Work for Your Company
Vendor Managed Inventory (VMI) programs can present an effective way for
all parties in a supply chain to manage inventory needs. If handled correctly, VMI
programs can lead to reduced risk, lower costs, and greater profitability.
An effectively managed VMI program offers increased visibility into a business’s supply
chain and typically results in a better-managed inventory. VMI customers benefit
from reduced administrative and personnel requirements and, in a consignment
arrangement, realize freed-up capital that would otherwise be absorbed by inventory
costs. VMI vendors benefit from being able to attract and retain long-term customers
under contract, resulting in a steady and predictable flow of income.
Above all, both the customer and the vendor reap the benefits of increased profitability
when a VMI arrangement is well executed. How? Primarily, a well-executed VMI
arrangement results in lower inventory carrying costs, more effective inventory placement,
fewer out-of-stock scenarios, and, oftentimes, joint decision-making regarding targeted
sales-promotion activities that can help boost sales.
In addition to reaping the above benefits, many businesses are taking VMI to the
next level, employing creative reverse logistics strategies to facilitate returns, with VMI
vendors operating return or repair centers on behalf of customers. For example, one
prominent jeans manufacturer, faced with the return of 40,000 pairs of damaged
denim jeans from two of its major retail customers, turned to its VMI partner for a
solution. The VMI vendor took responsibility for receiving the merchandise and finding
alternative uses for the damaged goods – in this case sending the fabric to a cotton
mill for recycling. Similarly, a major cell phone provider has outsourced repair work to
its VMI vendor. Now, when customers return damaged cell phones, the VMI vendor
handles the repair or replacement of the phones while ensuring a seamless experience
for customers.
Types of VMI Programs
MANUFACTURER-TOMANUFACTURER SETTING
Original Equipment Manufacturer (OEM)
provides needed parts or products used
in customer’s assembly process
OEM delivers products in order to
meet customer’s production schedule
or demand forecast
WHOLESALE
DISTRIBUTION SETTING
Manufacturer monitors inventory in
customer’s warehouse
As inventory is depleted, manufacturer
(supplier) replenishes it at client site
Making a VMI Agreement Work
An effective VMI program requires strong processes, controls, and supporting technologies,
notes David Rubin, principal, CohnReznick Advisory Group, and National Director –
Risk and Business Advisory.
“As we have seen in practice, all too often, processes and systems are disparate and
incompatible, bridged by antiquated technologies that undermine the value of a VMI
program,” says Rubin. “In such scenarios, the cost impact can be substantial. What
looked like a reasonable cost of doing business when the VMI contract was first struck
is suddenly inflated because of factors such as order delays or materials not arriving
on time due to communications-related errors. Thus, the importance of evaluating how
well both the customer’s and vendor’s respective systems and processes are aligned,
and taking steps to accomplish such alignment if needed, cannot be overemphasized.”
RETAIL SETTING
Customer provides point-of-sale and
inventory information to manufacturer
Based on customer input, manufacturer
or distributor replenishes retail location
When negotiating a VMI agreement, it is important to clarify each party’s expectations
by considering all possible scenarios that can arise and reaching consensus up front on how issues will be handled through the use of
comprehensive Service Level Agreements (SLA) whereby all parties agree to mutual service standards. Some considerations include:
• VMI Model – Selecting the correct VMI model to implement is critical (see “Types of VMI Programs” sidebar). Each party should understand
how each model works and agree to a specific model that best meets their respective goals and objectives.
• Level of inventory – The partners should determine, realistically, what level of inventory should be carried. This is especially critical in a
consignment agreement, where the supplier is carrying the inventory costs. While the customer may view a large consigned inventory as
an inexpensive buffer against stockouts, it is in the interest of the supplier to determine the level at which it can provide goods profitably.
Both sides need to recognize these competing needs and come to mutually agreeable terms.
• Information sharing – While it is understandable that the customer would not want to share proprietary information, some meeting of the
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minds needs to occur with respect to how much information will
be shared. It is important to remember that a necessary level of
information is critical to the success of an auto-restocking program.
• Inventory Turns – Both parties should consider who will bear
responsibility for slow-moving inventory. Therefore, negotiations
should consider which party will monitor inventory turnover and
how slow moving goods will be handled (e.g., returned to the
supplier or the responsibility of the customer).
• Damaged or lost inventory – Usually the customer bears responsibility
for damaged or lost inventory on their premises, but this is something
that needs to be addressed during negotiations.
• Communication – It is important to keep communication channels
open throughout the partnership. How will the parties communicate?
Consider these scenarios: Does the customer anticipate a greaterthan-normal inventory need in the near future? Is the supplier
expecting a large order from another customer that may have
an impact on supplies? This is information that needs to be freely
communicated between the parties. Many VMI partnerships have
failed on this challenge alone.
VMI Benefits at a Glance
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Increased profit for both parties
Reduced inventory on both sides
Faster stock replenishment
Fewer stock-outs
Enhanced inventory turns
More space for production needs or to house other stock
Better customer retention/cash-flow certainty for supplier
Less administrative burden for customer
Enhanced customer satisfaction rates on both sides
What Does CohnReznick Think?
In response to the global economic downturn, many companies
have found that collaborating with key partners via VMI is
helping them reduce costs, improve efficiencies, and gain
greater certainty and visibility into their supply chain operations.
While VMI has proven effective in achieving these goals, it is
critical to do the groundwork. This includes making sure the
ERP systems between customer and vendor are appropriately
aligned to communicate effectively. It also is important to realize
that the parties in a VMI arrangement are, indeed, partners
in every respect. Open communication, a willingness to share
critical information regarding inventory and consumption, and
an understanding that the benefits of VMI must be equally
shared are all key to making a VMI partnership work.
This is the third article in a five-part series, “How Manufacturing and
Wholesale Distribution Companies Can Maximize Performance and
Profitability,” prepared by CohnReznick Advisory Group and the
Firm’s Manufacturing and Wholesale Distribution Industry Practice.
Contact
For more information on VMI, please contact David Rubin, principal with
CohnReznick Advisory Group, and National Director, Risk and Business
Advisory, at [email protected] or 973-871-4021, or Alan Wolfson,
partner and Manufacturing and Wholesale Distribution Industry Practice
Leader, at [email protected] or 646-254-7416.
For more information on CohnReznick’s Manufacturing and
Wholesale Distribution Industry Practice, visit www.cohnreznick.com/
manufacturingdistribution.
Applied VMI: A Case Study
A Vendor Managed Inventory solution has worked well for one
company, a distributor of electrical materials, which embraced
VMI five years ago. Now, approximately 25% of the company’s
inventory is managed by its VMI vendor, a key supplier. Today,
when a customer places an order, the order flows directly to
the VMI vendor, where it is quickly fulfilled. Since entering this
VMI partnership, the distribution company has seen its sales
increase by more than 40%. The VMI solution has also allowed
the company to manage inventory levels more effectively and
to achieve higher inventory turns, two important goals. Indeed,
although the company’s sales have increased dramatically and
it has nearly doubled the number of distribution locations it
maintains, the required in-house inventory to support this rapid growth
has only increased by 18%. In addition, inventory turns have
increased by 20%, which is well above the industry-wide average.
• Consignment. In this type of arrangement, the supplier keeps and
manages inventory on the customer site and actually owns the
inventory until the customer uses it. It is important to note that VMI
and consignment are two different inventory strategies, often
used together but which also can be used independently. VMI
describes the tasks involved in maintaining an inventory, while
consignment has to do with ownership of inventory.
• Kanban. In a Kanban arrangement, the customer defines how
much inventory will be carried. When an inventory unit is pulled,
a signal is triggered telling the supplier to replace the unit. Signals
may include an empty container shipped back, the transferal of
point-of-stock data, a phone call, or a re-order card sent, etc.
Types of VMI Programs
• Breadman. In this arrangement, named for the grocery-store
inventory restocking process, the supplier visits stockpoints regularly
to review inventory levels, replace damaged or expired goods,
and restock according to predefined levels.
VMI actually describes a family of auto-resupply mechanisms.
The more popular among these may include:
• Material Requirement Planning. This involves a computer-based
signaling system that alerts a supplier to the need to replenish stock.
About CohnReznick
CohnReznick LLP is one of the top accounting, tax, and advisory firms in the United States, combining the resources and technical expertise
of a national firm with the hands-on, entrepreneurial approach that today’s dynamic business environment demands. Headquartered in
New York, NY, and with offices nationwide, CohnReznick serves a large number of diverse industries and offers specialized services for
middle market and Fortune 1000 companies, private equity and financial services firms, government contractors, government agencies,
and not-for-profit organizations. The Firm, with origins dating back to 1919, has more than 2,700 employees including nearly 300 partners
and is a member of Nexia International, a global network of independent accountancy, tax, and business advisors. For more information,
visit www.cohnreznick.com.
© 2014 CohnReznick LLP
This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information
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