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VMI - Vendor Manage Inventory Best Practices

What have organizations been able to gain as a direct result of incorporating both the strategic and technical elements of VMI in their oper... thumbnail 1 summary
What have organizations been able to gain as a direct result of incorporating both the strategic and technical elements of VMI in their operations?  From our research, VMI can have a number of benefits, including lowered investment in the supply chain (due to better forecasting), JIT delivery and less overstocking) and greater inventory turnover.  Its primary benefit, however, is improved customer service due to fewer stockouts and more optimal product mixes. Mfg/vends also stand to benefit from VMI, as it allows them to schedule production and transportation more efficiently (including ordering raw materials), to observe end-user consumption and general market trends more closely, and to develop closer ties with their customers. In summary, the benefits are as follows:

Typical Benefits to Mfg/Vend
Typical Benefits to Dist/Ret
·         Lower inventory investment (raw and
·         finished)
·         Better scheduling and planning
·         Better market information
·         Closer customer ties and preferred status

·         Fewer stock‑outs with higher turnover
·         Better market information
·         More optimal product mixes
·         Less inventory in channel (transfer costs)
·         Lower administrative replenishment costs

            As previously mentioned, it is clear that a number of critical components must come together to form a successful VMI program.  If these components are present the results can be dramatic:

·         At K-mart, customer service measures have gone form the high 80s to the high 90s.  Inventory turns on seasonal items have gone from 3 to between 10 and 11, and for the non-seasonal items form 12-15 to 17-20.

·         ACE Hardware, the large hardware cooperative, has seen fill rates rise 4% to 96% in the past few years.

·         Fred Meyer, the 131-unit chain of supercenters in the Pacific Northwest, reduced inventories 30% to 40%, while sales rose and service levels increased to 98%.  This was due to a VMI program implemented with two key food vendors.

·         Grand Union, a New Jersey-based grocery retailer with more than 100 stores and three DCs, improved inventory turns by close to 80% and achieved 99% service levels.  This significantly improved sales by eliminating out-of-stock conditions and dramatically reduced warehousing costs.

·         Oshawa Foods, a $6 billion Canadian food distributor and retailer, had tremendous success with Pillsbury, Quaker and H.J. Heinz with turns improving from 3 to 9 times, while achieving customer service levels of 99%.  This, however, came after some initial adjustments in the program because of the hasty nature of initial implementation.

·         Panduit, one of the largest manufactures of components for the electrical industry with 60K skus was able to leverage its market position to develop a new computer system to reduce replenishment costs which were squeezing profitability out of the entire supply chain.  Because its distribution network didn't see cost savings in the incorporation of VMI, Panduit developed a new turnkey VMI/EDI system called Qualified Supplier Program (QSP) created by an external vendor Advantis specifically in support of a tailored approach for its industry.  As a result, Panduit claims that their distributors are providing better service to their customers, out of stock conditions have been reduced to a minimum, and its customers are tightly linked as long-term stakeholders in its business ensuring long-term supply chain stability.

            The reasons these highlighted organizations have been able to achieve dramatic improvements are widely varied, but center around a strategic approach to viewing the entire supply chain. Specifically, these include:

·         Focus your Efforts
·         Trust and Partnership between Supply Chain Stakeholders
·         Highly Effective Computer Systems
·         Competent Mfg/vends and the Ability to Forecast
·         Willing Stakeholder Partners and Patience

Focus your Efforts

            As one senior principal at EDS[1] put it: "The average billion‑dollar company may have 20,000 suppliers, and you can't do EDI with 20,000 companies. . . [but if the company limits EDI to the suppliers that account for 80 percent of their purchases] then you've gone down to maybe 200 suppliers, and you can do EDI with 200 companies."  Since EDI is fundamental to VMI, the same principle applies when moving to a VMI solution.

            Another example is ACE hardware, where only 13% of the volume is handled by VMI sources. In a survey of the mass retail industry, respondents expected vendor managed programs to exceed 10% of volume in hard goods in the next three years and 7% of soft goods. Therefore, it is important to note the concept of focusing on partnerships where each participant is capable or at least willing to develop VMI competency.

Trust and Partnership between Supply Chain Stakeholders

            If the VMI program does not have credibility and is not built upon a foundation of trust, then it is useless to try to implement it.  One grocery chain, Spartan Stores, "pulled the plug" on their VMI program, and they freely admitted that a lack of trust was a main reason the program failed; or as they put it, "The buyers trusted the suppliers, but not as much as the buyers trusted themselves".  According to Spartan's director of purchasing, "Because the VMI efforts have been less than perfect, they [the buyers] did what they did before, plus they were monitoring it like crazy.  And if something went wrong, they ended up getting directly involved. There has never been enough credibility in the process alone that you could just ignore it."

            Therefore, we believe that not only is the support of top management fundamental to establishing the trust between the firms, but that operational employees must be sufficiently incentivized to support a trusting orientation.  Trust, however, is a hard thing to created overnight.  Organizations must work over time to support such arrangements similar to Japanese organizations that have formed functional departments specifically to generate closer partnership ties with suppliers.

Highly Effective Computer  Systems

            It is abundantly clear that in every company that we benchmarked in the pursuit of .understanding VMI, effective systems were a key to the successful implementation of VMI. As one executive at ACE Hardware put it, "don't entertain thoughts of faxing".  Admittedly the costs of EDI/VMI are significant and according to The EDI Group,[2] in 1995 the cost of a "Hub" (W. W. Grainger) to communicate with several suppliers was $200,000 a year and required 3.86 employees dedicated to it.  The cost of a "Spoke" for a smaller company communicating electronically with only a few firms is $20,000 a year and required 1.54 employees.  The benefit is obvious, nevertheless, the systems limitations must be overcome to support long-term strategic approaches especially considering Grainger's start-up approach.

Competent Mfg/Vends and the Ability to Forecast

            The theory upon which VMI is founded is that the mfg/vend is more competent to manage and forecast inventory than their dist/ret partners.  According to John White, one of the members of the logistics steering committee for the International Mass Retailers Association, the theory works as follows:  "Retailers are used to a trigger point mechanism, sometimes called model stock.  You try to set model stock based on forecasting, but that's a reactionary system.  Not many retailer systems are set up on DRP logic."  The extent to which the mfg/vend can better manage their own inventory and shipping based upon better information from the dist/ret, sets the limits on the success of the VMI program.  Essentially, VMI attempts to use POS data and known inventory levels to optimize production so that both manufacturing and distribution costs are minimized and customer demand is met.  This is obviously a very complex task, and Grainger has to evaluate their suppliers to judge their competencies in all of these areas as additional mfg/vend partners are selected as the pilot program is expanded.

            K-Mart, who we have cited throughout this review for their successes with VMI, has scaled back their VMI program to just 50 suppliers (from a high of 300).  This reflects the inability of many of their suppliers to effectively forecast, which resulted in higher out-of-stocks with some items.  The failure of K-Mart and the subsequent re-focusing indicates that significant investment in developing ones mfg/vend's competencies in forecasting and inventory management are a key tenet to successful VMI programs.  At some point, however, re-focusing may be necessary if its affiliate partners are unable to move on VMI effectively.

            An alternative example from K-Mart's experience is Whitehall-Robbins, who have been able to achieve success from their innate knowledge of the production facilities.  Whitehall-Robbins knows how to build inventory with K-Mart if the Advil plant is scheduled for downtime because their forecasting systems are highly integrated.  As a result, product returns have also been reduced because pre-season bulk discounts have been eliminated in favor of week to week forecasts and deliveries.

Willing Stakeholder Partners and Patience

            One standard for choosing suppliers was provided by Grand Union, who selected vendors that were market leaders in their respective categories, as well as technology and supply chain innovators.  This included the realistic perspective that no VMI program could be set up overnight.  Similarly, time was needed where at Fred Meyer management started in 1991 by implementing EDI, then in 1992 moved to computer-assisted replenishment programs.  In 1993 they finally moved to VMI. It took significant time and investment, but it paid off and continues to do so today.

            Nonetheless, some VMI programs have been set up quickly.  Oshawa Foods set up their . program with Pillsbury in 6 months, with Quaker in 3 months, and with H. J. Heinz in 3.5 weeks, in part because these trading partners "claimed" to already have varying degrees of experience with VMI.  As a result of this hasty approach, Oshawa ran into many problems similar to Grainger's initial attempt at VMI two years ago.  In the end, Oshawa was able to gain measurably, but it took a minor re-focusing.

            In total, VMI best practices can be uncovered when one understands that significant effort will yield results.  Each organization was able to "tailor" their approach based on specifics of their industry and competencies of their supply chain partners.  For some, success was negligible, for others it was significant and led to other paradigm shifting improvements.

[1] EDS is a major systems integrator that also has support of a consulting practice (AT Kearney) that specializes in assisting organizations become cost competitive with technology applications (like VMI/EDI, etc).
[2] The EDI Group supports studies on the status of EDI and is located in OakBrook, Illinois.