Consigned inventory can pose special transactional challenges for customers who maintain VMI stock

Most of us know that consigned inventory, commonly referred to as vendor-managed inventory (VMI), can provide significant advantages in terms of cash flow and material availability.  But what if we implement VMI for raw materials or finished goods? -- the kinds of items that aren’t amenable to being disbursed through vending machines?  In many cases, the implementation of VMI for inventory items such as these creates new challenges.

At the heart of these challenges is the fact that inventory has two lives:  It has a “financial life” marked by financial transactions such as invoices and payments and it has an “operational life” marked by physical inventory transactions such as shipments, receipts, and transfers.  We are used to both of these views of inventory proceeding in lockstep.  VMI, however, disrupts regular business practices by temporarily disassociating physical inventory from its financial effects.

The resulting timing differences can lead to informational deficits and a number of manual workarounds designed to overcome them.  Here is a brief summary of these challenges:

Manual Inventory Transactions

The hallmark of VMI is that the supplier owns the inventory and you pay for items taken from this inventory only after they have been consumed or sold.  This is the definition of “consigned inventory”.  The challenge is that a reliable method must exist to transfer the ownership of inventory from the supplier at the right time.

For indirect materials, the situation is greatly simplified since they are usually non-inventory items that can be expensed after the fact whenever a replenishment order is issued.

However, for direct materials and finished goods, the situation is more challenging as the ownership transfer must be triggered when the item is used by production or sales.  This is where manual coordination, manual transactions, and deviations from standard procedure often arise to preclude unwanted financial effects.  This extra work sometimes can sometimes mitigate the perceived benefits of VMI.

Manual Replenishment Ordering

A common approach is for suppliers to set up web portals where their customers can place replenishment orders as needed.  Some suppliers even employ staff to visit customer sites on a regular basis to place the orders themselves on behalf of the customer.  This works out well for the supplier since a purchase order can be immediately submitted from the point-of-use.

However, these approaches have some limitations for the customer, particularly for direct materials and finished goods.  Firstly, a purchase order may not immediately exist in the customer’s system to facilitate receiving.  This also hinders material visibility and the ability to match receipts against AP invoices.

Also, having a different web portal for every VMI supplier may become tedious for employees to manage if multiple VMI vendors are employed.  This makes it hard to scale the use of VMI.

Limited Stock Visibility

Consigned inventory is often not visible in your ERP, although some systems do have special functionality to achieve this.  For those users that do not have this special functionality, the lack of physical inventory visibility coupled with the absence of replenishment POs in your system may prevent you from easily knowing exactly what is on order and what is in stock.  VMI therefore sometimes produces a management blind spot.

Disconnected Demand Planning

An analysis may have been performed initially to set up a VMI program and its associated stock levels.  However, conditions can change over time.  Seasonality, monitoring actual usage, and market forecasts can and should play a role in adjusting target stock levels as part of an actively managed VMI program designed to prevent shortages or overstock.

The problem is that inventory demand planning is usually not practiced consistently, effectively, or efficiently.  In our consulting practice, we’ve seen situations where significant effort is expended in forecasting and planning, but VMI nevertheless becomes difficult to manage and brings about unwanted operational risk.

Limited Supplier VMI Support

Not all suppliers offer a VMI program, maybe because of the executional challenges described here or because they have a fundamental predisposition against holding their customers’ inventory.

Solutions for Achieving Practical and Effective VMI

Altemir Consulting can help implement a VMI program for suppliers or consumers that is practical, efficient, and effective.  Our goal is to maximize the use of your existing systems and practices to make VMI easy and effective.

Contact us to learn how we can help you achieve VMI 2.0.