Maximizing the Use of Vendor-Managed Inventories while Minimizing Internal Headaches
Carolyn Farr Sly, CPIM
Carolyn Farr Sly, CPIM, President, Charlotte Chapter of APICS, Charlotte, N.C., 704/825-4730, BDSly@aol.com
Mary Ann Mauldwin, CPIM
Mary Ann Mauldwin, CPIM, President, Charlotte Chapter of APICS, Charlotte, N.C., Materials Manager, Thor Lo, Statesville, N.C., 800-438-0286, Mmauldwin@thorlo.com
86th Annual International Conference Proceedings - 2001
Abstract. This session will introduce the concepts of supplier partnerships through vendor-managed inventories (VMI) and subsequent implementation strategies for different types of VMI. This presentation will outline how to identify potential possibilities for commodities, services or supplies to source using VMI, creative sourcing strategies, and recommendations for a change process for implementation.
In the past several years, Mary Ann and I have been involved in implementing several different forms of vendor-managed inventories. (VMI) Today we will walk you through several of our experiences, and share some of the successes and pitfalls of vendor-managed inventories.
VMI can take on many different forms. We have defined it in four different ways:
- The vendor provides the software to manage the inventory decisions surrounding the product they supply. The customer uses the software to execute inventory decisions, owns the inventory, and manages the inventory.
- The vendor is on the customer site, executing inventory decisions on behalf of the customer primarily for the product they supply. The customer owns the inventory, but the vendor manages the inventory.
- The vendor is on the customer site, executing inventory decisions primarily on the product they supply on behalf of the customer. The vendor owns and manages the inventory for the customer until some point of usage occurs on the part of the customer. The APICS Dictionary defines consignment as "the process of a supplier placing goods at a customer location without receiving payment until after the goods are used or sold." This is a form of consignment.
- Goods are placed on a customer site by the vendor. The vendor does not stay on the customer site, but instead periodically monitors the inventories at the customer location. When inventory replenishment is to occur, the vendor places the new inventories on site. This situation is similar to that outlined in 3), but the vendor does not stay on site. This is another form of consignment, as defined by APICS.
For those of you who have not begun employing the strategy of using VMI, there are many reasons why manufacturing and service companies would be interested in this process.
- In the past ten years there has been more consideration of the vendor as a downstream work center to manufacturing facilities and as an extension of existing offerings to service industries. With that trend, there have been logical outflows of vendors providing software, inventory, warehousing or labor resources in many customer companies.
- There has been a movement toward narrowing the total number of suppliers in many companies, and developing long term partnerships with the remaining suppliers.
Those long term partnerships have also created many situations where vendors supply more than the traditional product or service they have in the past. Vertical integration of the supplier, at the customer, has caused more trending toward VMI.
- There has been a significant shift in the composition of product cost in the United States, where 60 to 80% of product cost is comprised of material. This is practically the converse of product cost composition in the 1940's and 1950's, where labor represented the vast majority of product cost. With this considerable shift, there is far more outsourcing of product and processes. If it does not make practical sense to physically outsource the product or processes, it may be a better decision to keep the product or process on the customer site, but let the vendor manage it.
- There may be situations (such as volume of the product being purchased, technical skills required to handle a product, or quality issues) where the product is unmanageable from a customer standpoint, and instead the vendor is in a much better position to handle the inventory and associated logistics with replenishment. A particular expertise on the part of the vendor may provide the necessary reason to implement VMI. This expertise could include knowledge, software, logistics equipment, trained personnel, etc.
- It may be less expensive in some situations to let a vendor manage a product or process instead of hiring and retaining personnel to manage it on a customer site.
- There may not be internal funds at the customer locale to handle products or processes that can be converted to VMI.
- Vendors are independent of internal politics which may prohibit the correct products being stocked and replenishment decisions made promptly and properly.
- A vendor who is focused on particular products or processes can objectively review inventory that is being stocked at a customer site. They can determine if there are opportunities for consolidation or standardization of products, make recommendations about inventory levels and replenishment points, streamline the processes to handle inventory, and provide onsite training to those who specify and consume the inventory on how to best utilize the VMI program.
The possibilities are limitless for choices on types of products or processes for VMI implementation. Originally most VMI implementations were for maintenance, repair and operating supplies (MRO), and the most common MRO implementations were for office supplies, safety and industrial operating supplies.
As more organizations have been successful in their VMI implementations, and more companies have seen the potential in VMI, there has been more integration into materials that are used in finished products, and more service and process implementations. Practically any product or process is a good opportunity for VMI.
How does an organization begin the process of implementing a vendor managed inventory program? We recommend the following steps in most situations:
- Select a commodity or service that you feel is an appropriate candidate for VMI. Likely candidates include commodities or services that represent a large majority of the purchasing costs, commodities that have been made or handled inside that are no longer economically or logistically feasible to continue internally, or to items with considerable control issues, such as inventory outages, inventory shortages, handling or damage problems, etc.
This selection process can be handled by purchasing personnel, but is often better served by being the decision of a cross-functional team of people empowered to target commodities or processes for VMI implementation. Team members can include representation from any functional area in the organization, but typically include purchasing, materials, manufacturing, accounting and engineering. Receiving inputs from many departments allow the team to leverage the knowledge of each function, which is critical to the success of VMI.
- Start analyzing current volume of purchases and composition of that volume. That can be a very daunting task if you have used multiple vendors for the same commodities, or if your organization, for instance, has not been standardizing the part numbering or description of purchases in your purchasing software. When attempting to analyze data that has not been part numbered or described consistently, you may be making an "educated guess" as to what the composition of your volume has been. Often the best resort is to ask your vendors what they have supplied to you, and to have them provide the usage data.
You will need to attempt to filter any demand that is not forecasted to repeat, and include any new demand that is forecasted to occur. Explanation of current and projected volume requirements will be imperative to the vendor's understanding of VMI offerings that they will be able to consider.
- Once the volume analysis is complete, it is necessary to form a team of people (which could be the same personnel involved in the commodity or service selection) to put together vendor evaluation criteria. A checklist should be developed of necessary questions for each vendor to be interviewed for the VMI program, which should include the elements of the vision your organization has for your implementation. For example, if your organization envisions one major vendor on site handling a major commodity, and you determine that you do not want to own or manage the inventory, that definition of your vision should be included in the background information for the vendors and the vendor selection criteria checklist.
- A list of prospective vendors should be established in preparation for an interview process. The team should brainstorm possibilities for this list, and current well-performing vendors should be included. Current suppliers have some familiarity with your business, your culture, and the products you consume. There may be an existing partnership that could help facilitate the implementation of VMI.
If there are recommendations for vendors that are not current suppliers, they should be carefully evaluated, as the organization may not choose to begin a VMI process with an unproven vendor.
- Once the prospective vendor list has been created, a point person should be established to contact the different candidates. This contact person should inform the vendors of the organization's vision, talk to them about the selection criteria, and help them understand the forecasted composition, volume and specifications of the commodities or processes. It is also fair to alert the vendor about why the organization is considering VMI for these particular commodities or services, although it may mean sharing information about the types of issues your organization has had in handling these products.
You may also want to invite the prospective vendors into your organization to assess the situation. The vendors should also be informed about the use of the cross-functional team in the interviewing process, what type of preparation you will require from their organization, and the length of time for each organization to present. Typically vendors are interviewed by the team one organization at a time.
- The interviewing process (and the fun!) begins. Your selection criteria is highly dependent upon your organization's expectations about what you hope to achieve from the use of VMI, but typically includes some of the following questions:
- type of experience the organization has with VMI
- how receptive are they to VMI
- what volumes (units/dollars) do they expect
- their particular expertise in meeting specification and quality requirements
- are they large or experienced enough to handle your products/processes? Do they possess sufficient capacity for growth?
- what are the implications to our organization if their supply is ineffective, and how would this be handled
- step-by-step process of how they would handle inventories and manage inventory decisions
- does the supplier possess the skills necessary to recommend consolidation of part numbers or activities? Standardization? New or improved methods of handling and reducing waste? Recommendations for cost savings.
- do reporting capabilities exist to both inform and increase your organization's awareness of cost savings, inventory levels, dollar volumes, etc.
- recommended measurements of VMI success
- do training skills and manpower exist in the vendor's organization to support the implementation and continued success of VMI? Does a suggested training and implementation plan exist?
- are they willing to invoice one to two times per month vs. for each transaction?
- proposed technology that will support the implementation
- is there an existing culture fit between your organization and the vendor? Are you willing to share information? Does the climate for a long-term partnership exist?
- will there be a need for confidentiality agreements and can the supplier maintain that confidentiality?
- contractual and pricing requirements
- After the interviewing process is complete, the selection team will decide on vendors that require further investigation. References and financial status should be checked, and followup information may be supplied by the potential candidates. Formal vendor proposals are often supplied at this point.
- After all the existing information has been reviewed by the selection team, and all questions answered, a vendor is selected for the targeted commodity or process. Formal contracting normally ensues. A joint change plan is then developed by your organization and the vendor, which is reviewed with any functional areas that may be affected by this process change. Milestones for the change process are documented and meetings between both organizations begin to assess the change process and implementation success. Frequent communication must occur to ensure the effective collaboration between companies, and joint measurements developed for checking the success of the implementation.
In conclusion, VMI programs have resulted in significant cost savings. Some of those savings are:
- Reduced inventory.
- Elimination of expediting items included in the program.
- Reduced costs resulting from volume purchases.
- Fewer items purchased through consolidation of requirements.
- Reduced supplier base.
- Time savings resulting in additional savings as internal focus is placed on improving procurement of A and B items.
- Enhancement of continuous improvement activities as more items are added to VMI.
- Encouragement of supplier partnerships.
- Reduced risk of obsolete inventory.
- Encouragement of supplier participation in identifying best item for the application, therefore improving product quality.
- Support for empowerment principles as user becomes the communicator with the supplier as opposed to purchasing.
- Reduced number of purchase orders, invoices, receipt and issue transactions.
As the VMI process has proven to be successful, many companies have expanded their programs to include managing all C items used in production. The savings are limitless.
We are very excited to be a part of several successful programs and hope to use these experiences to continue to expand the program to include other procurement activities, including managing service agreements.