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Vendor Managed Inventory (VMI) – How It Works

In a vendor managed inventory (VMI) arrangement, the service provider creates the orders for the customer based on data provided by the latter.  The inventory levels that must be maintained, fill rates and costs, among other agreements, are stipulated in a contract that binds both parties.  The arrangement is intended to improve the client’s supply chain performance by reducing on-hand inventories while at the same time ensuring that stock-out situations do not occur.

Inventory information is exchanged between vendor and client through Electronic Data Interchange (EDI).  Based on the EDI data obtained, the vendor then specifies the quantities to be delivered to the customer through normal distribution channels.  The entire VMI process can be summed up in three main EDI transactions – product activity record (or transaction 852), purchase order acknowledgement (855), and advance ship notice (856).

  • Product Activity Record – This is also called 852 and contains pertinent sales and inventory information for each item such as movements and forecasts.  The information includes quantity and amount sold, on hand, on order, received, and forecast.  The EDI information is usually sent to the vendor on a weekly basis.  However, this may be done more often in the case of high volume businesses.

Based on the 852 data received, the service provider makes an order decision.  The order details must conform to the provisions of the existing agreement between the vendor and the customer.  Most vendors utilize a Vendor Managed Inventory (VMI) software for this purpose, which may be part of a full ERP package like SAP.  It may also be a stand-alone system such as LevelMonitor, Blue Habanero, NetVMI, or other similar products.

The software validates the accuracy and relevance of the order data.  Based on pre-determined information, it will compute the reorder quantity for each inventory item.  Customer-provided information like promotional offers, seasonal products, and new items will also be considered.  On hand quantities will then be compared to the reorder points for each location on a per item basis.  This process will determine if an order is required and what quantity is needed for each item.

  • Purchase Order Acknowledgement – Also known as 855, information on this EDI transaction is sent to the customer once an order for stock replenishment is placed.  They include purchase order number, date, line item, item number, item description, quantity, price, freight information, and shipping date.
  • Advance Ship Notice (ASN) – This EDI transaction is also called 856.  Vendors provide clients with an ASN to make them aware of an incoming shipment.  This document is different from the purchase order acknowledgement both in terms of content and timing.   While the purchase order acknowledgement is transmitted upon placing an order, the ASN is sent once it is confirmed that the goods are already in transit.

One of the main benefits of a Vendor Managed Inventory (VMI) arrangement for a client is the elimination of the need to monitor and maintain stock levels.  Lower inventories mean significant savings in terms of warehousing and manpower costs since the maintenance of a big warehouse space for materials and supplies is no longer required.  Likewise, the purchasing department is no longer burdened with the task of liaising with various suppliers and the preparation of voluminous purchase orders.  Less manpower will then be required to monitor orders and deliveries since much of the work has been delegated to the vendor.