It’s a conundrum, isn’t it? On one hand, managing inventory for e-commerce can be complex, and it would feel awesome to hand off that responsibility to someone else. On the other hand, handing over all your inventory needs to an external third party? That feels like a risky move.

Both viewpoints have merit. However, a properly executed vendor managed inventory (VMI) strategy can earn you a competitive advantage by maintaining steady inventory levels to prevent against stockouts and excess stock.

But we’re getting ahead of ourselves. Let’s start at the beginning with the obvious question: what is vendor managed inventory?

In short, a vendor managed system is where the supplier – often the manufacturer – of the goods you sell assumes responsibility for optimizing your inventory levels. In doing so, they also take on responsibility for the reordering cost, while the retailer (that’s you) simply takes ownership of the stock and covers the associated holding cost.

Let’s take a deep dive into how vendor managed inventory works and some pros, cons, and best practices so you can see whether it might be a good fit for your business.

How a vendor managed inventory system works

As it’s a collaborative approach to optimizing stock levels, vendor managed inventory is all about working together to keep your processes in check and your customers happy. Here’s the lowdown on how it works.

Step 1: Establishing the VMI agreement

First, you enter into an official partnership. Both sides ink up a supply chain agreement that clearly lays out the who, what, when, and how. Agreeing to data sharing is a must, as each side will have to spill the beans on inventory and sales data for covered products. Once the rules of the game are set, it’s go time!

Step 2: Keeping tabs on stock levels

This is where the data-crunching magic happens.  Your supplier whips out some fancy software with sophisticated demand forecasting algorithms to assess sales patterns, trends, and seasonal spikes. Based on the findings, they determine optimal reorder points for each product in your catalog.

Step 3: Ordering and restocking

When inventory levels hit those magic reorder points, your supplier springs into action to generate purchase orders and optimize shipments so stock gets replenished across your warehouses and retail outlets exactly as planned.

Step 4: Inventory reconciliation

Both the vendor and your team will run regular stock checks to ensure everything is where it should be. If there are discrepancies, you both roll up your sleeves to fix them. Once any issues have been ironed out, it’s time to settle up. You’ll typically pay based on either actual inventory levels or consignment inventory terms, depending on the details of your VMI agreement.

Step 5: Continuous improvement

Neither party gets to rest on their laurels. To make the agreement work long-term, both supply chain partners must continually review the inventory management process and adjust for improved efficiency. For example, your vendor’s VMI specialist might tweak reorder points based on market shifts and demand forecasting reports.

A summary of vendor and retailer roles

A vendor managed inventory system only works when both parties know exactly what’s expected of them. And while collaboration on all fronts is advantageous, critical roles do vary between you. Let’s take a look at the primary responsibilities of retailers vs. VMI vendors to establish precisely who does what.

Suppliers’ VMI roles

• Inventory management – Your vendor is the data maestro, continuously crunching numbers, setting optimal reorder points, and ensuring your stock levels are sufficient to meet customer demand.
• Order fulfillment – When it’s time to restock, your vendor ships inventory directly to your door, ensuring your shelves stay full (but not too full – receiving excessive inventory is a telltale sign of poor vendor performance).
• Cost management – The supplier handles the reordering costs, lightening the load and saving you from financial stresses related to paying for excess stock/ excess storage space.

Retailers’ VMI roles

• Data sharing – While you needn’t do much of the heavy lifting yourself, you need to be a good data buddy by providing timely info about sales patterns to facilitate accurate demand forecasting.
• Inventory ownership – You’re the owner of the physical stock. So, it’s your responsibility to cover the usual supply chain bills for storage, insurance, etc.
• Performance review – It’s on you to actively participate in reviews and play improvement detective. After all, providing feedback that makes inventory management processes even slicker benefits you the most in the long run.

Key components of vendor managed inventory

OK. Now we’ve got a handle on how vendor managed inventory planning works and who’s in charge of what, let’s get down to the nuts and bolts.

When it comes down to it, there’s just three core components of any successful VMI program:

1. Inventory management.
2. Reordering and stock control.
3. Information and data sharing.

Let’s delve a little deeper into the specifics of each.

Inventory management

With the help of your trusty new stock whisperer sidekick, you’ll be able to find that sweet spot where you hit the Goldilocks economic order quantity every time.

No more drowning in excess inventory.

No more unsold inventory clogging up your valuable storage space.

No more dead stock and inventory shrinkage woes.

Just efficient inventory turnover with enough product availability and safety stock to ensure customer satisfaction on every order.

Bada bing bada boom! Tiptop inventory planning, here you come!

Reordering and stock control

Imagine never having to worry about running out of stock or manually placing orders again. And consider all the time you’d save and the pesky human errors you’d avoid in the process. That’s the beauty of a VMI contract.

As soon as inventory levels hit a predetermined “reorder point,” bam! Your supplier’s automated workflow system kicks in to automatically generate a purchase order.

But, what happens if a product suddenly becomes a best-seller? Easy. They simply adjust the reorder point based on real time data to ensure you’re still well-stocked.

The bottom line? Less work for you and more time and cash flow freed up to spend on core business activities.

Boom! Exponential business growth coming right up!

Information and data sharing

The ability to make data-driven decisions is critical to the growth of your business. And leveraging the power of two supply chain brains (or, more likely, two snazzy computer systems) is better than one.

We already know that by sharing inventory data with your vendor, you can forecast demand more easily – even in the face of changing sales patterns and market shifts.

But, an efficient VMI inventory model does much more than that. Outsourcing analysis to an external party ensures there’s no bias or guesswork in your inventory figures. Just pinpoint statistical accuracy, paving the way to more strategic decision-making across your entire organization.

All those juicy insights with minimal data analysis effort on your part? Result!

Pros and cons of vendor managed inventory

It’s all sounding pretty good so far, isn’t it? And for good reason. Vendor managed inventory can be a game-changer for retailers. However, it does come with some trade-offs that you should be aware of. Let’s take a look at a comprehensive list of pros and cons.

VMI system benefits

Reduced inventory costs – By optimizing stock levels and avoiding excess inventory, you stand to save big on transaction costs, storage fees, insurance, etc.

Lower stockouts – Say goodbye to those dreaded digital “out of stock” signs. Timely stock updates ensure you have the right products on hand at the right time to meet customer expectations.

Stronger customer relationships – When your inventory management system is optimized and you’re hitting those order fulfillment and delivery deadlines every time, you’ll attract a loyal following of brand ambassadors.

Streamlined operations – With your supplier handling much of your inventory reordering, you can focus on streamlining other aspects of your business, like marketing and customer service.

Improved cash flow – With more accurate demand forecasting, you’ll need less inventory, which frees up more cash to inject into research, development, and expansion.

Detailed inventory data insights – Chances are, your vendor has some high-tech software that can pull out way more insights about customer expectations and preferences than you’d be able to muster on your own.

Improved supplier relationships – Vendor managed inventory enhances supply chain management by building trust. It’s like having a business partner who’s always got your back with guidance about everything from in-stock performance and inventory turn targets to how to manage third-party sellers.

Better contracts – Never be afraid to push the envelope and ask for a few juicy partner benefits! Vendor managed approaches often offer loyalty programs with additional perks like bulk discounts on inventory shipments.

VMI system limitations

Loss of control – When you hand over the inventory management reins, you might feel your vendor suddenly has more control than you do. From inventory shipments to how physical space is used in stockrooms and warehouses, you might feel like you’re giving up the driver’s seat in your own car. But who knows? Maybe your supplier will turn out to be an even better driver than you.

Data security risks – Sharing sensitive sales data raises security and confidentiality concerns. You don’t want all your valuable inventory data to end up in the wrong hands, and there are multiple vendors out there to choose from. So, you must do thorough due diligence to select a reliable partner with advanced data security measures and protocols.

Supplier dependence – Becoming overly dependent on your supplier’s tech stack and systems could lead to operational problems if there’s ever a hiccup with their software. Not to mention, it makes it harder to switch suppliers. Plus, there’s always a chance an unscrupulous vendor takes advantage of your reliance by instigating a pattern of unnecessary ordering. So, maximum vigilance is essential.

Implementation challenges – The initial setup of a VMI solution can be a bit like untangling a Gordian knot. You’ll likely face a few obstacles while you’re aligning processes – and expectations – with your vendor managed systems. The resulting disruption could temporarily affect your day-to-day operations and overall supply chain management.

Limited flexibility – Vendor managed inventory operates based on predetermined rules and algorithms. While that’s great for consistency, it can limit your ability to pivot quickly if how much inventory you need changes unexpectedly.

Vendor managed inventory best practices

If you’re ready to test the waters and take your VMI game to the next level, the following list of best practices will help to ensure your VMI agreement runs like a slick, well-oiled, profit-boosting machine.

Negotiate an airtight contract

You want protection, as does your vendor. So, an ironclad VMI agreement is in your best interests. Your VMI contract should include provisions for:

• The scope of services – Specificity is essential because there’s bound to be some teething issues, and you don’t want to get sucked into a ‘blame game’ right at the start.
• Payment terms – Be sure to include the contracted rate, payment schedules and deadlines, any applicable performance-based deviations, payment methods, rules for automatic renewal, etc. 
• Contract breach and get-out clauses – Exit clauses specify the conditions under which you can walk away from the relationship and the protocols to follow if either party breaches their portion of the agreement.

Establish clear and regular communication

Effective communication is the bedrock of a successful VMI agreement. Here’s how to achieve it:

• Schedule consistent meetings on a daily, weekly, or monthly basis, depending on your needs. Agenda points should include discussing forecasts, shipment schedules, new inventory, and any potential/ongoing issues.
• Be transparent about your inventory data, promotions, and changes in market conditions that could affect demand. Transparency fosters trust and allows your vendor to make more accurate restocking decisions.
• Work collaboratively to find solutions. There’s no place for finger-pointing in a VMI program. Whether it’s a sudden spike in demand or a supply chain management disruption, you must communicate openly to get issues resolved.

Establish key performance metrics and KPIs

VMI suppliers need to know the goals and milestones you’re looking to hit. Some essential metrics to measure include:

• Cost savings – Measure every transaction cost to establish how much you’re saving through lower carrying costs, reduced stockouts, and optimized inventory levels.
• Inventory turnover rate – Track how quickly your inventory sells compared to the rate of replenishment. High turnover indicates greater efficiency in stock performance.
• Fill rate – Monitoring the percentage of orders fulfilled from stock on hand will help you meet customer expectations more effectively.
• Forecast accuracy – Assess how well your vendor managed inventory system predicts future demand compared to actual sales. The closer the match, the more effective your VMI solution.

Adopt additional optimized inventory strategies

Explore opportunities for enhanced supply chain management to optimize your vendor managed inventory. VMI frameworks should be flexible enough to accommodate unexpected events and quickly evolving market dynamics. This may mean leaning into:

• Lean inventory management
• Just-in-time (JIT) inventory management
• ABC inventory analysis
• Safety stock analysis

Not ready to hand over the reins? Try Linnworks instead!

Vendor managed inventory is a powerful strategy. Yet, understandably, some retailers prefer to keep a firm grip on their own steering wheel. If that sounds like you, there’s a solution that offers the best of both worlds: Linnworks inventory management software.

Linnworks’ intuitive platform provides empowerment through control. Already trusted by industry leaders globally, Linnworks offers optimal efficiency – without having to give up the driver’s seat or worry about the headaches of manual management. Here are a few feature highlights:

• Multi-channel management – Utilize one centralized platform for managing inventory across multiple sales channels to gain complete inventory visibility.
• Customizable automation – Tailor automation rules to your unique business needs. You decide when to reorder, how to allocate stock, and when to launch promotions.
• Data-driven insights – With powerful AI-driven reporting and analytics tools to track sales patterns and monitor trends, you’ll have access to real time data for optimized decision-making and strategy adjustments.
• Integration flexibility – Linnworks integrations accommodate over 100 ecommerce platforms and third-party apps, ensuring you can connect effortlessly with multiple vendors and partners.
• Scalability – There’s no need to compromise control when expanding your operations. As your business grows, Linnworks adapts to your changing needs and scales with you.

Vendor managed inventory FAQs

Q: What’s the difference between VMI and traditional inventory?

A: In a traditional inventory model, the retailer orders and replenishes stock based on forecasts and demand patterns. With a vendor managed inventory system, the retailer’s hands-on involvement is significantly reduced as the supplier takes responsibility for managing and replenishing your inventory.

Q: What is a good vendor managed inventory example?

A: The automotive industry is a classic example. Car manufacturers commonly manage the inventory of components and parts at their dealerships by monitoring stock levels and replenishing as necessary to ensure dealers always have the right parts available.

Q: What purpose does vendor managed inventory serve?

The primary goal is to improve overall supply chain management by streamlining processes and improving financial performance.

Q: How do you implement vendor managed inventory?

Start by establishing a clear agreement with defined roles, responsibilities, and data-sharing protocols. Ensure your systems exchange data efficiently, set up automated trigger points for reorders, and regularly review performance metrics.