TBS-908 Supply Chain Management

Analyzing the Role of VMI on Supply Chain

Executive Summary: In this report, we have done the analysis on VMI and the role of VMI on Supply Chain Surplus. We started by detailing how VMI came into existence and proved that it is not just a fad, launched by some corporate industries but it is here to stay. We analyzed how companies are feeling the urge to implement the VMI in their Supply Chains. VMI help the firms to achieve proper coordination among the suppliers and the retailers. It was explained how VMI helps to reduce inventory both at the Supplier's and the Manufacturer's side. Later on, we discussed the advantages companies enjoyed after implementing the VMI. We also discussed the risks and the costs involved in financing the integration of VMI. However, it was also mentioned that the implementation costs are declining by the day with the advent of high end IT systems. We discussed the obstacles and hurdles faced by companies as well. The major among them being the organizational structure and the attitude and the beliefs of the employees of the firm. We then proceeded to discuss the industries and processes affected due to VMI. It was also stated about the companies for which, VMI is not suitable. Especially, those firms which want to have firm control over the inventory and those firms which are sensitive about sharing the demand. Finally, we concluded by giving the recommendation about CPFR and the major processes evolving, which are making VMI better with each progressing day. Introduction: With the progress in the technological and process level aspects of the industry, there have been one too many fads which have come and gone. Some changed the process, some changed the technology and some the industry structure, thus creating a revolution. There were some fads, which came and went off without notice. Few of the new innovations and techniques tried to automate the complete process. Ideally speaking, there has not been a complete automated process because manual handling/intervention is required in certain scenarios like matching minimum/buffer orders, allocating capital for refilling the inventory or perhaps the actual term could be "Inventory Replenishment". Ever since time immemorial, there has always been a tug-of-war between the distributors and manufacturers. Due to dynamic nature of the consumer demand, both the Distributors and the Manufacturers get involved in the guessing game and this may result in the "Surplus" or "Stock-Out". The challenge for the Distributor lies in finding the optimum way of replenishing the inventory such that the requirements of manufacturer are met. Historical Journey of VMI: Throughout the history of Supply Chain Management, there has always been the need for maximizing the overall efficiency of Supply Chain, rather than focusing on one activity or interface of Supply Chain. Scholars and researchers of SCM had been proposing a lot of strategies of which VMI is one of the strategy to maximize the
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Analyzing the Role of VMI on Supply Chain

overall output of the Supply Chain. This strategy of Vendor Managed Inventory was first applied to the grocery industry. This was jointly developed by P & G, the supplier and WalMart, the distributor in the late 1980s. Also known as "Continuous Replenishment Strategy" or "Supplier Managed Inventory", VMI gained stupendous success after the successful implementation between P & G and Wal-Mart. Many companies from different industry verticals like GSK, Electrolux, Boeing, Nestle, TESCO etc, implemented this strategy with their suppliers and have proven records of optimizing the Supply Chain Surplus (Kazim Sari, 2007). Why is VMI Required and Its role in Supply Chain: There are two major factors in supply chain which many companies want to control. Controlling those factors has been of key importance for the success of the complete supply chain strategy. Those two factors are 1) Cost Involved in maintaining inventory 2) Level of Service offered to Customer (Matt Waller et al, 2001). Most of the companies have been running around to control and optimize these two variables to gain the most of supply chain surplus. VMI, in its principality, has brought smiles on the face of Supply Chain managers by being able to control these two factors. Let us see how VMI helps to maximize surplus by reducing the cost and improving the service level. To Reduce the Cost of Inventory: Suppliers have to maintain a level of inventory, to provide for the additional demand arising from the buyers. The level of inventory to maintain differ based on the industry. There is cost involved in maintaining the inventory. Suppliers have to bear the burnt of this cost due to anticipation of demand. So, demand volatility or demand fluctuation is the major reason for this cost accrual. This variability in demand affects the supplier the most as they have to alter their production costs, production schedules, production calendars, allocation of the labor, optimal use of the machinery etc,. Altering these variables results in increase in cost. So, suppliers are in search of some process or technique that can help them reduce all those costs involved due to demand variation. Here comes VMI into the picture. VMI helps to dampen the demand variability and fluctuation by offering better correspondence between both the supplier and the buyer. Supplier is empowered by VMI, as supplier is given freedom to access the demand pattern of the firm and adjust its inventory as per the demand. Now, the suppliers can have smaller portions of buffer or safety stock as they have an idea about the spikes in demand (Matt Waller et al, 2001). Thereby reducing the uncertainty element of the demand and so the cost involved as well.

TBS-908 Supply Chain Management

Analyzing the Role of VMI on Supply Chain

Figure 1: Overview of VMI

The above paragraphs dealt with why Suppliers are attracted to VM. Now let us focus on why buyers are aligning towards VMI. We will discuss the problems, constraints the buyers face then we will try to showcase how these obstacles, hurdles and constraints can be over come by employing VMI. There are two key parameters to gauge the functionality of the buyers. First is, End of Month level of inventory, second Customer service level. These two parameters are key performance indicators for any company. The performance of managers is calculated based on these two metrics. To maintain high customer service level, the inventory should be high. But traditionally, it is being practiced to keep high inventory at the start of month to attain high customer satisfaction and End of Month inventory level metric at the end of month is maintained to drop down to achieve the goal of low inventory. These two parameters seem to contradict each other. Lower the inventory, lower is the cost. The higher the inventory, the higher customer satisfaction is achieved. Because of the nature of these parameters, suppliers experience peak in demand during the start of month and a slump in demand at the end of month. Managers need to optimize these two conflicting parameters to maintain low costs and at the same time achieve higher customer satisfaction. After implementing VMI at the buyer's end, the demand gets smoother because replenishment becomes more frequent and is monitored and done by the supplier and so is duly aware of fluctuations in demand. This smoothness in demand affects both the parties, suppliers and buyers. Suppliers can better schedule and use their resources at hand, effectively plan their production jobs, minimize the buffer stock. These factors help the suppliers achieve economies of scale. The scenario at the buyers end also changes with the inventory level, legitimately lower not just at the end of the month but rather through out the month. This way, the customer service level increases during the month ends, converse to the traditional decline. The transportation, warehousing, distribution and promotional activities will be taken care of by the vendor, so the manufacturer or buyer can focus on optimizing the business processes.
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Analyzing the Role of VMI on Supply Chain

Figure 2: Four Stages of VMI (Source: Matt Waller et al, 2001)

Ideally speaking, the suppliers want the orders from the buyers to be distributed. But in the real time, this is not the case always, rather the order are sporadic and uneven. The sporadic and uneven distribution of order results because of the retail planning calendar. Normally, there are three ways by which the retailers divide the calendar. One way is to divide the complete year in to thirteen months with each month comprising of four weekends. This segregating period is helpful to compare key performance indicators as they range over the same period. The second way is to divide the thirteen months in to quarters consisting of four-five-four week months and the third way is to divide them as four-four-five week months (Matt Waller et al, 2001). The buyer who has employed four-four-five week month per quarter, orders 25% for the third month of each quarter and there are chances that the supplier may interpret this as an increase in demand and start producing more than required and increase his buffer stock. By employing VMI, such errors can be mitigated. Normally, suppliers in a supply chain receive orders from various buyers. Sometimes it may happen that they receive orders from the same buyer but for various distribution centers. And it may not be possible for the supplier to fulfill all the orders on time without sacrificing on the quality or service provided to the users. VMI also helps in such scenarios by helping to create better co-ordination between buyers, and their various distribution centers. Now, speaking of transportation costs, if the VMI is implemented properly, it helps to reduce the transportation costs by co-coordinating among the orders in such a way that the suppliers can send the more of fully loaded trucks than sending Less than truck load of shipments as and when the order is received. One more strategy to
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Analyzing the Role of VMI on Supply Chain

reduce the transport costs is by dedicating a separate truck which can replenish the inventory for all the nearby buyers which come under its sphere of distribution. VMI Block Diagram:

Figure 3: Stages of VMI and their integration (Source: Astrid Vigtil 2007)

To Increase the level of service: Let us consider the most important element of a supply chain, the customer service level. Now, consider a situation wherein, a customer walks in to a firm and could not find the desired product. Then the sale is lost. The cost involved is loss of sale. Say, if the company is doing a promotional campaign at the same time, when the customer had to return empty handed for not getting the desired product, then the cost involved is the loss of sale as well as loss of good will. This is a very critical loss for the company and may affect the brand image of the company as well. To avoid such a scenarios, which may prove costly and in some cases fatal to the company, the manufacturer or the retailer always looks for the supplier who is "Mr. Dependable". They may reward the customer by giving him the most of the valued shelf space (Barratt 2004b). So, a very reliable supplier may reap benefits from the retailer in the form of high revenue. By implementing VMI, the retailer may avoid such scenarios in the future. VMI, as is known and has been spoken of earlier, helps to increase coordination among various players. It helps by providing better alignment between the order replenishment and
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Analyzing the Role of VMI on Supply Chain

delivery. VMI due to its trait of alignment and coordination, may enable the supplier to divert the replenishment towards a customer in dire need and delay the replenishment for a non-critical customer. This way, the performance of overall supply chain can be increased. For this to happen, the supplier should assure the retailers at the start, before entering the agreement, that the most attention will be shown on the customer with the more critical need and that they may charge the retailers depending on the responsiveness level they require. VMI helps in prioritizing the customers, i.e., the customer with more than usual order can be given more priority than the customer with the less than usual order. In this way, the supplier can help to improve the system and make it more efficient as well as responsive. Thereby, giving more response to tending to the needs of the critical customer without harming the interest of other customers. Furthermore, the horizon of service can be extended thanks to the integration and coordination by VMI. We can extend the service by balancing the inventory and cooperation amongst the customers. This extension of service amongst the customers is called "Rebalancing". In this, the option is open for the costumer to return a product it does not require, back to the supplier, which can be delivered to the customer in need of that product. In the time of crisis, to make up for the shortage in stock, suppliers may involve the practice of stock balancing, by virtue of which, the stock can be moved or balanced amongst various retailers/costumers (Barratt 2004b). With the improvement in service, it is less likely that crisis occurs and if it occurs, then it is not expected from customers to inflate the orders to obtain much of stock in advance to avoid going stock less in the crisis. With the troubles removed, retailers can concentrate on new processes like early to market by bringing their products on shelf much sooner than their competitors, improve their competencies to become market pioneers, invest the costs saved in research and development etc,. Factors that contribute towards successful implementation of VMI on Supply Chain: Barratt (2004b) researched about the factors that can prove vital for the successful implementation of VMI. He interviewed 32 managers across various industry verticals to identiy those factors. All of his research can be summarized into two main spheres of success. i.Relationship ii.Information Barratt emphasized about the pivotal role played by the "relationship" factor in the success story of VMI. All the major factors like Mutual dependency, commitment, trust, transparency, honesty, the level of involvement, the frequency of involvement, credibility and integrity come under the sphere of 'Relationship'. One more important factor which comes under the realm of 'Relationship' and which needs to be mentioned separately is the 'Commitment'. Commitment can be long term, short term, commitment from the management, from the various levels of the organization. Research suggests that long term commitment has major impact on the success of VMI, so is the commitment from both the management as well as commitment from the intra-organization.
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TBS-908 Supply Chain Management

Analyzing the Role of VMI on Supply Chain

The second sphere of success is 'Information'. Reliability , effectiveness, correctness, completeness, consistency, timeliness and accessibility come under the strata of information. Barratt (2004b) has also concluded, after surveying the traits of purchasing managers, that VMI would be more effective and responsive if the transaction and interchange of information is done by Information Systems rather than depending on the conventional methods of information sharing. Researchers have also pointed towards two modes related to sharing of information. One is the 'Extent of Sharing' and the second is the 'Quality of Sharing' of Information. Extent of sharing depends on the traits like trust, transparency, commitment and credibility. Whereas Quality of sharing depends on consistency, effectiveness, timeliness and the optimal Information Systems used to integrate the supplier and the buyer.

Major Benefits and Profitableness of VMI: Reduced Customer Inventory: The first thing that comes to mind when one discusses VMI is the reduction in Customer Inventories, with the research showing that the frequency of customer inventory orders almost doubles and customer inventory almost halved after implementing VMI. This has been achieved in VMI because, of three factors. The first is that, the supplier can manouer and control the lead time required to supply for the orders, Secondly, due to larger share of responsibility, supplier is willing to provide the goods whenever required, thus reducing the Safety Stock (Matt Waller et al, 2001). The third factor is the availability of information to the supplier with which, the safety stock element of the company is decreased. These three factors contribute to the reduction of the consumer inventories. Reduced Supplier Inventory is attainable through good forecasting techniques. However the researchers caution about two points. First, the manufacturer or the distributor should not only share the normal business turnover but also the forecastable demand. Sharing the forecast-able demand better equips the supplier to over come the unforeseen or "Spikes in the demand" and results in the significant lowering of demand variability and thus achieving the "Smoothing of Demand". Second, the VMI forms a very small percentage of the business of the suppliers. It would yield better results if the suppliers can handle a major proportion of their business through VMI. So, those suppliers who have a substantial portion of their business via the VMI are able to lower their inventory by reducing the "Spikes in Demand" and by furthering "Smoothness of Demand". Reduced costs of Administration: Implementing the VMI will reduce the administrative costs of both supplier and the distributor. The time spent on reviewing, checking and placing the orders is drastically reduced on the distributor side. Supplier will be spending less time in locating the bad order, reconciling the out of sync orders and their placements and rectifying the misplaced orders on the parts which they cannot supply. All these have been achieved due to smooth streaming of information from both the suppliers and the distributors. The supplier can make up for the missed parts in one order in the next order and the
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Analyzing the Role of VMI on Supply Chain

distributor can keep a track on that. A mistake from the distributor appears on the next EDI and the supplier can take corrective action on that order accordingly.

Increase in sales: Earlier, the companies use to face the out-of-stock situations, mostly, when the surge in demand occurs and the suppliers were left with minimal time to respond to the distributors and the retailers request to increase the supply. With the help of the VMI, firms are able to avoid such situations through better inventory management. With the VMI, the supplier has information about the products which are in demand and which have good value in the market place and so they can invest their capital accordingly in those products which will result in maximum sales. The data from the surveys and the researchers say that with VMI, the "sales per dollar of inventory investment" has increased significantly. With VMI, the distributors can position the right product at the place. With the savings from the reduced costs of inventory, the distributors and the manufacturers can reinvest the saved capital to enhance their businesses. Industries and SCM domains affected by VMI Adaption of VMI bad brought immense change in the organizations. Traditional issues like bullwhip effect and ineffective order handling has been successfully sorted out. However, the major impact of VMI has been the regularization of demand forecasting and effective replenishment of products by the suppliers. Other major areas affected were "Logistics and Transportation Management", "Inventory Management". If we see the affect of VMI based on the size of industry, then VMI on Small and Medium scale Enterprises had least effect on the "replenishment" and on big industries had least effect on "Production Planning". However, research has revealed that least impact in Large scale industries on Production Planning could mainly be due to incorporation of sophisticated and very successful techniques like "Just in Time (JIT)", "Lean Manufacturing" and "Total Quality Management". Based on the above facts, scholars of SCM stated that VMI would yield more benefits for SMEs than Large Scale Industries. Critical Review: Though the review of literature on VMI, its benefits and profitableness seems to be all rosy, there are some researchers who disagree with this view. Aichlmayr (2000, p. 66), who interviewed several Supply Chain managers quotes from one of them that of every 10 implementations of VMI, three or four achieved tremendous gains, three or four had gains but not as hoped for and two or three could not get any profits to the firm.

TBS-908 Supply Chain Management

Analyzing the Role of VMI on Supply Chain

Companies for which VMI is not suitable for: VMI is not applicable for the cases where, the retailer is very tight lipped about his stock and he wants to have tight control over the inventory. This process is not recommendable when the supplier does not have the competency to exploit the demand information obtained from the retailer or in the cases where the VMI implemented items form a very minimal percentage of the supplier's business. In such a case, even though the supplier has maximum demand information, competencies to tend to the demand, he would face financial problems for scheduling the production of such goods in case of emergencies. VMI is not advisable for the companies whose supplier does not have expertise in the logistical aspects like handling of goods, packaging of products and timing of delivery. If the retailer is not flexible regarding his inventory needs, then it creates challenges for the supplier with no mastery, skill and craft in dealing with the logistical side of business. Companies which use VMI in Dubai: The well known companies using VMI in Dubai are Al-Futtaim, Gulf Food Trade, Spinneys etc,. Al-Futtaim has employed SAP, an ERP to integrate all of its functional modules. It had a tremendous impact on the costs by decline in the Inventory. Best Practice: Al-Futtaim has outsourced the management of VMI for 13 dealers to SYNCRON, a major Supply Chain Management firm. This outsourcing of VMI to SYNCRON has helped to drastically reduce the level of inventory and at the same time improved the frequency of order cycle. Key Issues and Challenges involved in Implementing VMI: Various reasons have been suggested by researchers about the obstacles or challenges faced by VMI in SCM. The first and foremost is that the buyers are skeptical about sharing their information to the suppliers. This can be due to lack of trust, transparency or lack of mutual understanding between the required parties. The second reason given for inconsistent information sharing is the inefficient Information Technology Systems. The high level managers may be vary of spending huge amounts on the IT systems owing to the fact of the amount of business transactions involved. There had been many a scenarios where the supplier was unable to do proper demand forecasting. The company like Kmart was forced to cut down the relation it enjoyed with the suppliers because of fraudulent forecasting Aichlmayr (2000). This can be due to lack of proper forecasting tools on the suppliers side or the lack of the skills involved in this field. Spartan Stores, a grocery chain giant in supply chain had to sever its ties with the suppliers because of inappropriate handling of the promotional activities on part of the suppliers. This may have resulted because of lack of experience in the field of promotional activities. Few scholars looked at the obstacles and divided them into factors internal and external to the supply chain. Internal Factors: They came up with the factors internal to supply chain like sharing of outdated data with the suppliers - this could be due to lack of mutual understanding, lack of trust and other factors discussed above. Inconsistent Forecasting of demand and inappropriate promotion campaigns also comes
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Analyzing the Role of VMI on Supply Chain

under internal factors, as this could be due to 1)Not having proper demand forecasting tools 2) lack of understanding of IT 3) The field for which the supplier is responsible lies outside its core competitiveness etc, Aichlmayr (2000). External Factors: Not much research was done in the vitality of factors external to supply chain. Performance of the party outside to the supply chain does matter for the success of VMI. VMI will be a failure if the supplier outside to the VMI cannot supply in time to the supplier in the VMI partnership. Best supply chain results depend on the capabilities of this outside supplier. Sharing of Information in its basic form can be done by using email, phone, fax or in person. In its sophisticated form, information can be shared through IT systems, ERPs etc,. And there is a high need that the company does adequate research prior to going for a particular IT system or ERP. This decision comes from the strategic phase of supply chain. The objective goals of the firms need to be understood, visioned, interpreted and construed by the firms involved in the IT implementation Aichlmayr (2000, p. 66). These firms should 'See' the actual business needs prior to implementing the appropriate IT system. Care should also be taken to effectively integrate all the interfaces involved as reconfiguring the system would be a costly affair. Organizational Hurdles: Organizational culture also forms a major hurdle to venture into VMI. The perceptions, beliefs, values and attitude of the firms play a major role in the determination of the organizational culture. Researchers stated that the employees are not prone to accept changes favorably and that they view the latest fads/technology as a threat to their positions. They try to put up some resistance and it is the duty of the managers to communicate to the employees the benefits involved, ease of process achieved in incorporating the new technology. The senior managers should take care to inculcate proper values, develop right sense of responsibility in the firms (Kazim Sari, 2007). The managers should take steps to train the employees regarding the new technology implemented and to reduce that sense of fear in the employees that automation would result in losing their jobs. Prior to taking a decision on automating the supplier and the buyer side, the managers take into consideration the capital constraints involved, justification for the cost of technologies, understanding the functional needs and technical specifications of the business. These were few of the organizational hurdles involved in implementing new technologies in supply chain. Recommendations: Nowadays, scholars of SCM are suggesting a technique which can be said as VMI taking a step ahead. It is named as Collaborative Planning, Forecasting and Replenishment (CPFR). This is being touted as the next evolution of VMI, wherein forecasting of demand constitutes the focal point. Conclusion: VMI is a concept that most of the industries are showing interest in. We have discussed the necessity of VMI in detail in the above paragraphs. The reason why VMI is suggested to industries can be summarized into two: 1. Reduction in inventory 2.
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TBS-908 Supply Chain Management

Analyzing the Role of VMI on Supply Chain

High Customer Service level. These are the two characteristics that all the industries want to achieve. Through our analysis and the review of literature, we were able to prove how these two desired and coveted characteristics can be achieved through VMI. The advantages of implementing VMI are numerous like increase in the sales, reduced cost of administration, reduced inventory at both customer and the supplier side and that the cost saved through these, can be invested in research and development and in improving the business processes. However there are number of hurdles in implementing this technique. We were able to discuss most of them like budgetary constraint, technological constraint, Organizational constraints etc,. The good news is that the costs relating to technology are decreasing by the day and that it is becoming relatively easy to implement VMI with the advent of much sophisticated IT systems. Suppliers and Buyers are available with variety of IT related products right from very costly systems like SAP, Oracle etc, to relatively economic company specific customized IT systems. However care should be taken that the solution implemented should not be completely technical oriented without the involvement of the relevant people. Both the suppliers and retailers should involve themselves in the implementation. Failure to do so by any of them may make the implementation futile. So, the involvement, coordination and collaboration of both suppliers and retailers is of very critical nature.

References:
1. Matt Waller et al, 2001, 'Vendor Managed Inventory in Retail Supply Chain', Journal of Business Logistics, Vol. 7 No.5, 2001, pp. 365-387 2. Kazim Sari, 2007, 'Exploring the benefits of vendor managed inventory', International Journal of Physical Distribution & Logistics Management, Vol. 37 No. 7, 2007 pp. 529-545

3. Aichlmayr, M. (2000), "DC mart: who manages inventory in a value chain?", Transportation and Distribution, Vol. 41 No. 10, pp. 60-4. 4. Barratt, M. (2004b), "Unveiling enablers and inhibitors of collaborative planning", International Journal of Logistics Management, Vol. 15 No. 1, pp. 73-90.
5. Astrid Vigtil 2007, 'Information exchange in vendor managed inventory', International Journal of Physical Distribution & Logistics Management, Vol. 37 No. 2, 2007 pp. 131-147 6. Richard James et al, 2007, 'VMI: A Processual Approach', Journal of Business Logistics, Vol.8 No.7, 2007

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