Would you recommend using Vendor Managed Inventory (VMI) or Consignment Inventory (CI)? Supply chain management professionals today are asking this daunting question with growing frequency as companies push themselves to do more with less resources. It seems that VMI means that you have to regulate the suppliers more than CI would require. CI allows you to have your inventory costs in the hands of the supplier so the inventory cost is lower for you. In other words, CI means we will buy the stuff from suppliers, but we will not pay the supplier until we actually use it. However, with CI, you still have to manage the inventory even though you will not pay the supplier until you use it. VMI means you actually pay someone to come in and manage your inventory for you. Many supply chain management professionals today find themselves frequently comparing the complex pros and cons of VMI vs CI.
Companies will often use a VMI supplier for Maintenance, Repair and Operating (MRO) items in their manufacturing facilities. Basically, it is all the indirect material and purchases used to support manufacturing (i.e., tools, gloves, hammers, oil, grease, brooms, cutters, drills, etc.). So, MRO is one type of indirect spend. Companies are so busy managing their direct material purchases that they do not want to waste their scarce resources on managing MRO and indirect stuff. So, VMI suppliers will manage it for you. VMI suppliers will literally come into your company and check your inventory and make sure you never run out of stuff. Yes, you do pay a premium for this but it also lets you focus on more value added activities such as managing your direct material and building products. Also, if you choose the right VMI supplier that has a core competency in this, they will likely do it better, faster, and cheaper than you could yourself. Usually with VMI suppliers, you pay them as soon as they replenish your inventory (who works for free, right?). So, you have to pay them as soon as they come in and restock the material. You can have them come in once a day, once a week, once a month, etc. You will have to use data analytics to figure out what makes the most economic sense for your business.
Now, many supply chain management professionals are asking about using CI instead of VMI. CI means we will buy the stuff from suppliers, but we will not pay the supplier until we actually use it. So, if we have an inventory of something in our factory, we are not going to pay the supplier for it until we actually use it. So, if it sits there for 3 weeks, the supplier will not get a check for 3 weeks. It sounds kind of greedy but it basically means companies can have an inventory of stuff, without the costs. Sounds like a great deal, right? It is, but you need lots of leverage to pull this off and most manufacturing companies get this leverage from suppliers for indirect and MRO stuff (it’s that competitive out there).
So – Why not use a VMI supplier and CI? Tell the VMI supplier to make sure that you never run out of stuff, but then also tell them that you do not want to pay for anything until you actually use it. Personally, I think you would look like a cash flow superstar if you could negotiate such an arrangement. If the VMI suppliers knows they will be getting steady long-term business from you, then they should be willing to support such an arrangement (as long as they get paid upon consumption of the material). So, you can have both a VMI and CI arrangement, but you will have to use your negotiation skills to pull it off.
Do not forget the importance of managing your inventory to your bottom line. Remember, to increase ROI (Return on Investment). ROI is Profit Margin multiplied by Asset Turnover Rate (ATR). What is ATR? Answer: Doing more with less (i.e., reducing inventory costs). So, by managing your inventory more cost effectively, your ATR goes up, then your ROI goes up, and the company’s valuation goes up.
One more time with more accounting details, ROI = profit margin * ATR. ATR = sales/total assets. Total assets = current assets + fixed assets. Current assets = ”inventory” + accounts receivable + cash. If you can widen margins and/or increase ATR, then ROI will go up. So, if you can reduce your total assets without changing sales and/or increasing sales, then ATR goes up. For example, reduce your inventory and your ATR will go up and ROI will go up. If you can do more with less, then your ATR will go up. The supply chain profession has the greatest impact on what goes into the ROI calculation and managing your inventory is a huge part of that.