Vendor Managed Inventory versus Consignment Inventory Essay
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Inventory management has two very different, but effective methods: Vendor managed inventory, and consignment inventory. A company may choose to utilize either of these two methods to manage inventory. If a company is able to manage inventory, they will be better able to work the company’s capital to the fullest extent. The following paper will identify the differences between the two as well as identify what type of company is best suited for each method.
Vendor managed inventory (VMI) is a means of optimizing supply chain performance in which the manufacturer is responsible for maintaining the distributor’s inventory levels.
The manufacturer has access to the distributor’s inventory data and is responsible for generating purchase orders. Under VMI the manufacturer receives electronic data (usually EDI or via the internet) that tells him the distributors sales and stock levels. The manufacturer can view every item that the distributor carriers as well as true point of sale data. The manufacturer is responsible for creating and maintaining the inventory plan. Under VMI, the manufacturer generates the order, not the distributor. (Williams, 1996).
Consignment inventory (CI) is when the supplier places inventory at a customer’s location and retains ownership of the inventory. Payment is not made until the item is actually sold. In other words, the supplier places some of his inventory in his customer’s possession (in their store or warehouse) and allows them to sell or consume directly from his stock. The customer purchases the inventory only after he has resold or consumed it (Williams, 1996).
Set up of Program/Software.
VMI software application manages stock levels from various locations. With an endless supply of available stock, VMI software provides companies with complete list of inventory. Comergent is one of many companies which provide VMI software implementation and training (Comergent.com). On average, implementation of software and program setup can take up to 150 days.
Consignment software will help keep track of inventory on-hand that the DC (Distributing Companies) companies do not own. Should product become sold then the product must be registered into the program in order to let the supplier know that the product has been sold and that payment is due.
VMI Program set up entails a list of key items that must be followed in order to implement VMI properly. Upon accomplishing the listed items a SLA will establish acknowledging the responsibilities of both the vendor and the distributor. The following steps are typical but are usually followed in order to accurately implement VMI into a company. Consignment and Vendor managed inventory are used interchangeably in that set up and implementation procedures are followed in a similar manner. The major differential between consignment and vendor managed inventory is ownership of product.
The first step in setting up VMI and Consignment software is to have senior sponsorship. This will help the process by providing full support towards implementing the software which can be tedious and time consuming but cost effective in the end. The second step is employ acceptance. This step just assures that the employees understand the necessary steps and will help alleviate any future frustrations. The third step is to synchronize files between the manufacture and distributing company in order to correct any miscounts from the past and to set a baseline for all future transactions.
The fourth step is EDI testing. This step will help ensure that there is good communication between the DC and the manufacture so that no miscalculations are made. The fifth step is acceptance and measurement. In this step both the distributor and the manufacturer will reconcile inventory and agree on a mutual number for which it will base all future transactions upon. The sixth and final step is point-of-sale (POS) history. Essentially the distributing company will sent the manufacturer its POS history file.
Consignment Programs are much like the VMI program, consignment follows the same procedures. However, consignment is much like an interest free loan in which the DC is able to take on inventory without paying for the product until after it has been sold. The receiving company is responsible for only paying capital and taxes and the supplier is responsible for storage and material handling. This provides the DC a reduction in cost with savings from 36% to 18%. Additionally, customers of the DC are responsible for any damage or disappearance of goods on their property. Typical benefits of implementing the VMI software is increased sales, more efficient production scheduling, 5%-20% decrease in product returns, and 10%-30% increase in service levels, just to name a few (Vendor Managed Inventory, n.d.)
Recent statistical analysis of implementing VMI in the clothing industry has shown a substantial increase in sales and inventory consistency. According to the research, POS systems provided a 37% sales increase along with 37% increase in sales forecasting (Chain Store Age, 2001)
The Vendor Managed Inventory Approach.
Incorporating VMI into a company’s practices is a very prudent decision. The main goal of the program is to streamline a company’s productivity, thus increasing cash flow. Some of the benefits of utilizing VMI consist of: lowering your on-hand inventory, significantly improving the flow of information and significantly increasing your sales.
With VMI, your on-hand inventory can be reduced drastically. This can be done because the manufacturer or supplier has direct access to your inventory supply. Therefore, they are responsible for ordering your product and having it on your shelves for you to sell. “Trucks are filled in a prioritized order. For example, items that are expected to stock-out have top priority, then items that are furthest below stock levels, then advance shipments of promotional items (promotions allowed only in transition phase) and finally items that are least above targeted stock levels” (QuickMBA, n.d.).
Because of this, they can figure out how much you sell in a week or two weeks and only put that amount on your shelves, versus the company estimating an amount for a period of time or just ordering the same amount each time. If your company orders 100 widgets each time they order, and they only sell 28 widgets a month, then that is 72 widgets that do not need to be on your shelves that month taking up space. Especially when you have an item that is much larger that you only have room for 5 in your warehouse, and you sell 12 per month.
This leads right into our second point and third points. VMI will improve the flow of information and aid in increasing sales. Because VMI is responsible for maintaining your inventory, you do not have to worry about your employees getting sidetracked by answering the phone or going on a coffee break. VMI is designed to track what you sell, and supply what you need. Therefore, there is no middle man who may forget to order an item when you get to low or order to many and have them sit and take up space for a couple of months while you try to sell them. Having the inventory you need when you need it will only streamline your process and increase your sales. You will never have to worry about forgetting to order a product or overstocking a particular item.
The Consignment Inventory Approach.
The key benefit to CI is that the customer does not have to tie up all of their capitol in inventory. This is an extremely nice design, especially if the customer sells very expensive equipment. For example, if you sell airplane jet engines, you may not have a couple million just lying around to purchase your inventory. However, if you do not have the inventory you will not sell it. Therefore it is a win-win situation for the supplier and yourself.
This type of inventory approach would also be very useful when there is a new and unproven product that someone wants on the market. Because the product is unproven, the seller can agree to sell the product without the worry of losing their entire investment if there are no consumers.
Vendor Managed Inventory.
Once Vendor Managed inventory is established between a customer and supplier, the customer will no longer have the resources to perform this role in-house. This will make the customer more reliant upon the supplier.
Also, the customer could incur more costs in the end when a vendor managed system is implemented. The information services department of the customer will end up spending more time to be sure the data is valid that goes to the supplier. The materials management organization also spends a large amount of time ensuring the supplier performs as agreed and that any potential issues such as reordering processes and returns are ironed out (Williams, 1996).
Some of the challenges implementing vendor managed inventory can come from the parties involved. Sales forces can be concerned about loss of control, the effect on compensation if the inventory is controlled by a computerized system instead of their direct relationship with a customer. There is a concern of potential loss of jobs and concern of technical problems. Distributors are concerned that inventory will be pushed onto them, there will be less promotion, discounts with the supplier and that there is less control on the data on what the retailer want (QuickMBA, n.d.). The key to vendor managed inventory is for both parties to agree on the system that will be implemented as well as the levels at which the inventory will be replaced based on sales and demand data from the customer.
If a customer used consignment inventory, it does not mean that there will be no cost to the customer. There are still costs incurred related to storing and managing the inventory. This can make it a challenge for suppliers to get retailers to stock their product. The retailers do not want to invest the money and risk getting stuck with something they do not have the same level of confidence in as the supplier. The supplier then allows consignment of their product and creates a shared risk with the retailer. The supplier risks the capital investment associated with the inventory and the retailer risks the use of space for the product.
Consignment should not be used as a cost cutting tactic. In the end, the customer will still need to spend time reporting back to the supplier on sales and inventory and accounting tracking for when the items sell. The supplier also risks not receiving payment for a longer period than the typical 30 day net period of a standard inventory order (Williams, 1996).
Both parties also need to come to agreement on issues that may come up such as time limit to keep the stock at the customers establishment, freight policy, insurance issues, return policy, reporting procedures, and the list goes on. If the parties can not agree on these issues, it could create a strained relationship from the start. Consignment should only be utilized when it provides benefits that surpass these added costs (Piasecki, 2004).
This paper has clearly identified the differences between vendor-managed inventory and consignment inventory. Each has its benefits and its problems. VMI is recommended for companies who do not want to have unnecessary inventory, rather than in CI where there is a need for various inventory, but allows the customer to have an opportunity to sell products which are not widely known yet. If the customer is looking only to cut cost, then VMI is the recommended tool.
Datalliance (n.d.). What is vendor managed inventory (VMI)? Retrieved May 23, 2005, from www.vendor-managed-inventory.net
Chain Store Age (2001). Specialty Appearal (Inventory Management and Vendor Relations) Retrieved May 29, 2005, from InfoQuest.
Piasecki, D. (2004). Consignment inventory: what is it and when does it make sense to use it. Retrieved May 22, 2005 from www.inventoryops.com
QuickMBA (n.d.). Vendor managed inventory. Retrieved May 23, 2005, from
Vendor Managed Inventory (n.d.) Vendor Managed Inventory Setup. Retrieved May 29, 2005, from www.vendormanagedinventory.com
Williams, M.K. (1996). Making consignment and vendor-managed inventory work for you. Retrieved May 22, 2005 from www.vendormanagedinventory.com