Last month, we began our discussion of vendor-managed inventory (VMI) programs listing possible advantages and disadvantages these programs present for both customers and suppliers. We also presented some advice for determining which products should be included in a VMI program. This month we will discuss system features that must be in place to ensure a “win-win” outcome. These features include:

  1. The supplier must be able to monitor the status of inventory at the customer site. In order to determine when products should be replenished as well as the quantity that is needed, the supplier must have current information as to how much of each product is being consumed at the customer site, when stock receipts arrive, and other transactions that affect on-hand quantities. This is often accomplished by sending electronic data interchange (EDI) transactions between the supplier’s and the customer’s computer systems. Automated dispensers (similar to vending machines) can also be utilized to record material consumption.
  2. Replenishment parameters for each item maintained at the customer site are recalculated at least once a month. These replenishment parameters include:For items with recurring usage:These are products that are sold or used on a regular basis. The anticipated demand of each product between deliveries and the safety stock quantity must be calculated by the supplier for each product. Larger safety stock quantities require a greater investment by the customer, but will help avoid stockouts of products whose actual usage is hard to predict. Good replenishment software can show the customer different inventory investments and the resulting service level – that is, a realistic estimate of the percentages of requests that can be completely filled from stock inventory. Here is some data from a recent VMI implementation with 838 items with recurring usage:
Safety Stock Safety
1-Week Supply $48,288 $80,377 95.7%
2-Week Supply $96,577 $128,666 97.7%
3-Week Supply $144,865 $176,954 98.8%


The average inventory investment is the sum of the safety stock investment along with the average value of inventory that will be on hand between deliveries from the vendor. Notice that a much greater investment is needed to increase the service level by a small percentage. This is due to the fact that weekly usage of most items with recurring usage will follow a “bell curve.” In most weeks, a “normal” or a “typical” amount of inventory is consumed. But a lot more safety stock is needed to fill orders in the few weeks when a very large quantity of the product is requested. How much is the customer willing to invest in order to avoid stockouts in these few weeks with high usage?

For items with sporadic usage: These products are used infrequently and are typically maintained based on a multiple of the normal order quantity that should be able to be filled from stock inventory. The normal order quantity is the number of pieces typically sold or used at one time. For example, if the item is sold by the dozen, the normal order quantity would be 12 pieces. Typically, one normal order quantity will be maintained for each of these items, but two normal order quantities may be maintained for very critical parts. Again, this depends on the amount of money the customer is willing to invest in this type of inventory.

Next month, we will conclude our discussion of VMI programs by determining how often inventory should be replenished, as well as setting up metrics to measure performance. A well-structured VMI agreement has the potential to provide benefits for both the supplier and the customer. If each partner concentrates on their core competencies, both firms can increase their productivity and profitability.