Getting the best out of vendor managed inventory

Source: Technology Digital

Date :29/05/2007 13:37:24

The pressures of global competition and shareholder expectation have been driving the need for ever more efficient supply chains

By Simon Lloyd-Dickinson

Many companies have identified improved supply chain performance as a key driver of both competitive advantage and cost reduction. However, the trend towards increased outsourcing to low cost economies has made supply chains more complex and potentially more expensive. Even within the national economy consumer demand and competition means that there has been growing pressure on companies to achieve higher levels of service on shorter lead times. The risk in this environment is that improved service and lower product cost are achieved at the expense of higher supply chain cost and higher levels of inventory to buffer inefficiency.

Integrated answers

In the 1990s many companies turned to so called ‘integrated’ ERP systems such as SAP and Peoplesoft to try and control both cost and enable supply chain execution. However, there has been a realisation that a single package is unlikely to excel in all disciplines. Against this background have arisen a number of products which specialise in component parts of supply chain optimisation and execution. Some leading products include Optimiza (Barloworld), Logility and Infor SCM. Whilst major ERP providers continue to develop modules in this arena, many are also offering these niche tools within their packaged solutions.

The cost of a niche SCM optimisation tool is often cheaper and quicker to roll out than an ERP module and companies have become more cynical of the promise of full ERP integration. In particular, managers are realising that integration does not necessarily mean one system but the ability to build the right architecture between complimentary solutions. The benefits of adopting SCM optimisation tools can be significant in delivering improved service at lower cost and less inventory. A typical implementation can deliver a 10 point improvement in service and yield up to a 25 percent reduction in inventory.

The arrival of more sophisticated tools requires more data and SCM literate employees. The need for supply chain expertise is therefore growing as all businesses realise that their supply chain must be expertly planned and executed. As a relatively new discipline, knowledge, experience and talent is limited and hard to source. This scarcity has spawned a new breed of companies offering bureau services who will run this software for you and pass back optimised settings into your ERP system for execution.

Vendor Managed Inventory

The VMI concept has been around for many years under various soubriquets. It is the logical develop of consignment stock where a supplier stock is held on a customer’s premises but only invoiced when the product is consumed. The customer benefits from moving his inventory investment off his balance sheet and onto that of the supplier whilst retaining immediate access to stock. The supplier benefits from tying the customer in to a supply contract in the expectation of making increased sales and being able to make to stock rather than to order.

However, these solutions have not necessarily produced the envisaged results due to insufficient focus on understanding the supply chain dynamics. Effectively all that has happened is that the ownership of the product changed but the problems driving poor service have not been addressed. Furthermore, and this is often the case, the customer is usually significantly larger than the supplier and so its cost of capital is less. By transferring the inventory to the smaller supplier the real cost of inventory actually goes up. Once the supplier factors in the cost of inventory and of expediting orders to maintain stock the commercials of the solution cease to be as attractive.

What both parties often miss was is that the same rules apply to setting stock and reorder levels in a consignment environment as apply to their own prime or finished goods. The mechanics of stock control, delivery and reordering have become more sophisticated as consignment stock became VMI but the challenge of planning inventory in such solutions has remained.

Just like a single company

I recently worked with a large industrial distributor who provided products to large engineering companies through VMI. The concept was great for the original reasons but close inspection of the cost of inventory and service revealed low levels of profitability. The challenge was to optimise both inventory and order activity to deliver customer satisfaction at lowest cost and acceptable inventory. By applying adapted SCM tools to optimise both inventory and order activity we were able to remove surplus inventory, reduce the number of replenishments by 50 percent and improve overall service.

It sounds too good to be true, but these solutions are often hailed as a great sales success, implemented with limited data and then left to operations to play catch up and take the stick for poor service and profitability. The built in waste grows over time as the customers demand profile changes but the order points which run them stay static.

The lesson for suppliers is to run the VMI stock as if it were in their own warehouse on monthly planning cycles and make the solution increasingly profitable with fewer deliveries and less inventory.

Making VMI effective

The disciplines of logistics and inventory management seem to work in parallel rather than hand in hand. A gap has arisen between software aimed at optimising logistics and that aimed at optimising inventory. Logistics products like CAST and Paragon concentrate on transport cost optimisation without reference to inventory and SCM tools which drive inventory policy take little account of the impact on operations. In the case referenced above we ultimately built a bespoke solution (called VMI Max!) to balance both variables to deliver the optimum solution.

There also needs to be close cooperation between sales, supply chain and operations in both establishing and improving the effectiveness of VMI solutions. The need for an integrated strategy in this area is critical as departmental targets can often be set in opposition to optimal performance. For example if faced with an objective to reduce inventory the supply chain manager can easily half replenishment cycles but the unintended consequence will be a doubling of order activity which will drive up transport costs.

So, as ever in the world of supply chain the answers are not simple and require a holistic approach. In my experience companies can leverage real benefits from SCM software solutions in overcoming the challenges we have created for ourselves in pursuit of lower product unit costs. The benefits will however only accrue to companies who can articulate a clear vision and objectives to a new breed of employees who can understand and exploit this technology.