Evaluating The Financial Benefits of VMI – Part 1

Whether used in manufacturing, subcontracting or maintenance repair operations (MRO), vendor managed inventory drives efficiencies while delivering significant benefits to cash flow and capital requirements. VMI is an indispensable element in many companies’ demand-driven supply chain programme because it aligns business objectives and streamlines supply chain operations for both suppliers and their customers.

In the case of the consignment inventory, the customer hold vendor-owned inventory on-premises and purchases stock only as it is consumed. Consigning stock to the local warehouse reduced inventory risk and repetitive operational costs while smoothing out the effect of uneven demand flow. Ownership of the inventory stays with the vendor, production lines focus on their core missions, businesses manage cash and capital better and still gain benefit from supply chain management.

Consignment frees up significant amounts of working capital for the customer, while the supplier retains complete control over replenishment and is unencumbered by a traditional order cycle.

How do we fully quantify the long- term business benefits of a closer, more efficient working relationship between customer and supplier? Actually, we really can not. VMI is a rising tide that lifts both boats, a win- win partnership that delivers many non- tangible benefits based on mutual good will, enlightened self interest, smarter planning and most- favoured status.

So how do we quantify the value of a vendor managed inventory programme? Well, in fact there are several important financial impacts that deserve close examination. Let’s look at these areas.

Take as an example a hypothetical company we will call: Far & Wide International. Fair & Wide is a major discrete manufacturer with the following profile in relation to one of its major suppliers:

Inventory on Hand: $1.0 Million

Number of Inventory Items from Supplier: 5, 000

Warehouse Space: 5,500 SF

Warehouse Space Cost/SF: $3.10

Shortages per Month: 50

Obsolescence rate: 8%

PO Lines Created per Month: 150

PO Changes per Month: 85

Off- contract PO’s created per month: 95

% of Inventory Converted to VMI: 50%

Please note that Far & Wide estimates the percentage of inventory to be converted to VMI at 50%. We must remember to do our estimates based on this available VMI inventory only.

VMI changes the traditional order process; instead of sending purchase orders, customers electronically send daily demand information to the supplier. The supplier generates replenishment orders for the customer based on this demand information. The process is guided by mutually agreed upon objectives for the customer’s inventory levels, fill rates and transaction costs.

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