Global Brief on Vendor Managed Inventory.

Introduction
Golf is a backwards game. You cannot swing too hard to hit the ball a long way. You have to hit down on the ball to make it go up. And you have to miss the ball completely to get it out of the sand. Golfers take it all for granted, and once you have been doing it for a while it even seems natural.

Something else that seems backwards at first, but is starting to feel more natural for a great many companies is vendor managed inventory (VMI). In VMI the normal trading relationship is reversed. Instead of the customer managing its own stock and deciding when and how much more to buy, the supplier does it. For many of the companies that have tried it, VMI has produced remarkable results: sales, service and profitability are better by turning the tables on which trading partner does the supply planning.

Today there is a sharp spike of interest in VMI. We surveyed a cross section of large Canadian companies at all stages of their supply chain and found that more than 75% are keenly interested in VMI. They are either doing it already, about to start, or looking at it closely. In fact, the interest in VMI is world wide - KPMG offices are reporting strong interest in Europe, the U.S. and the Asia Pacific region.

In a business world that can be influenced by fads, we set out to examine the facts about VMI. What has the case experience really been? When does VMI make good business sense? Will VMI play a permanent role in the move towards better supply-chain management? We present our conclusions in this brief.

Nothing new under the sun
What we are calling VMI today has been going on for quite a long time. Several examples:

• Frito Lay's drivers/salespersons stock the shelves for their small retail customers to keep the shelves full, the product fresh and the paperwork simple. Much fresh product moves into convenience shops in the same way.
• Hopson Oil, a home heating oil jobber, automatically schedules deliveries for fuel oil based on consumption forecasts for each customer, and has for more than 20 years. In this way they keep their order-taking costs down and keep it simple for their customers, who need not order competing fuels.
• Synergistics, a North American supplier of plastics, goes "dock to stock" with many of their customers, monitoring the contents of their raw materials silos, and automatically replenishing the right polymer to each silo.

As the examples show, many suppliers have looked after tracking inventory and ordering for customers who are too small to have inventory systems of their own, or have done it as a value added service for larger customers. The same motivations are at work today.

Motive, models and means
The current explosion of interest in VMI is happening because the three main ingredients: motive, models and means, have come together to stimulate change.

The motive for VMI is better business results, and the case experience is undeniable. Many supply chains are working much better under VMI than they did before. The gains come from three main sources:

• Retail sales can increase when a more effective supply chain reduces or eliminates store out of stocks. Supplier sales can increase sharply when the customer and supplier enter into a preferred trading relationship.
• Inventory can fall and other supply chain costs can come down when the trading partners shorten cycle times, revise ordering practices, automate and simplify the planning, ordering and fulfillment process.
• Manufacturing costs can come down when the supplier is able to optimize production plans by integrating the more timely and complete sales information that is received.

The models for VMI are many as the number of successful VMI partnerships continues to grow. The current wave of interest in VMI was probably stimulated by the highly visible arrangements between Wal-Mart and some of its suppliers, like Procter and Gamble (P&G) and Rubbermaid [3]. P&G started managing diaper inventory for Wal-Mart almost 10 years ago. Their arrangement began as a way for two large trading partners to help each other do business. As we describe in , both trading partners have reported excellent results.

The success of the Wal-Mart/P & G arrangement has been widely publicized. Today there are successful examples worldwide such as: Fasson MPD, a division of Avery-Dennison, and Worsleys, the only inter-merchant paper trader in the UK in Europe, Baxter International and a large number of hospital customers in North America, and YCH in Singapore. We show in Exhibit #2 the increase in turns experienced by those companies who have implemented VMI, the penetration (as a percent of total sales) that VMI has gained and a list of other performance measures that can be used to assess VMI's success.

Exhibit #2: It All Depends Where You're Coming From

And as for means, today VMI is relatively easy to do well. The ready availability of EDI, bar-coding, cheap computing power and good software from companies such as Manugistics, Demand Solutions and E3 means that the technical aspects can be pretty well routine.

The biggest obstacles
There are two recurring obstacles to a successful VMI program, one is strategic and the other is operational. At the strategic level, a high level decision must be made about how the company wants to position itself. Are there benefits to stronger supply chain co-operation? If so, has a high level decision been made to share the necessary information? Operationally job functions, processes, and performance measurements will all need to change in order to get the most benefit. Resistance will be felt from employees who fear change.

Strategic obstacles are the concerns most often expressed at the distributor level, that it is `not in their own best interest' to share information back up the supply chain. Why?, because the manufacturer will be in a better position to deal direct with the distributor's customers they say. We think that this is a poor argument, in most situations. In fact, the distributors that will prosper in the coming years are the ones that will give the most value to customers and suppliers. The pipelines that will be most attuned to the consumer's needs are those that have a co-operative demand chain focus on the consumer. Strategic goals must address this reality.

According to initial conclusions of the CLM's (Council of Logistics Management) study of global logistics[4] , 90% of survey respondents are comfortable exchanging information with others. Medis Health and Pharmaceuticals Inc. is a company who has opened up the information flow and is prospering.

Operationally, the sources of resistance are numerous but the overwhelming theme is change. A major change of company operations requires a cultural adjustment as well as a significant re-organization of everyday job duties.

Culturally, many companies have not yet recognized the importance of the supply chain and will not give supply chain managers the necessary authority to implement, and will not make the necessary investments. Without top level support for the program there will be little attitudinal change. For years the focus has been on pushing product farther down the supply chain and negotiating the most money out of each transaction. The new culture must acknowledge that the consumer has ultimate power, that the supply chain itself is a competitive tool, and that co-operation between trading partners is essential. This new view of the supply chain is radically different for many companies.

Along with cultural change there are issues regarding the management of change and specific job changes. Concerns such as the role of buyers and sales people in the new environment, and the new measurement systems must be addressed. Roles and measurements will change but with proper adoption of new cultural values, it will be obvious that job changes are needed. Nonetheless, confusion and resistance must be anticipated.

Those companies who see the light will reap the benefits.

Doesn't always work out as planned
Companies like to talk and write about their successes. As a result, good news gets a headline, while bad news gets a footnote at best. However, the situations that do not work out just as planned can be the most informative of all.

Here are several cases that help clarify the VMI picture:

• After 12 months of their VMI program, Spartan Stores[5] (a Michigan cooperative grocery wholesaler) decided to halt the VMI program. The results just weren't good enough. According to Jim Swoboda, director of purchasing, inventories did fall, but it was because small orders were being placed at more frequent intervals. He feels that Spartan could have done that themselves. Two main problems arose. Although the vendors took on the task of forecasting, the vendors' decision makers did not all do as effective a job as Spartan's own buyers. As a result, Spartan's buyers ended up doing even more administration than before. However, the bigger issue had to do with promotions. Spartan and their VMI vendors did not come up with an effective way to deal with promotions planning and pricing . What started out as co-operation ended up as conflict.
• 10/26/01:WEBMASTER NOTE: Previously, this area contained a paragraph that referred to David M. Carlson, the former CIO of Kmart. Per Mr. Carlson, the information was incorrect. We apologize to Mr. Carlson for any inaccuracy and inconvenience this may have caused..

Do good results imply a long term solution?
Although many companies have seen dramatic results with VMI, some have the insight to see that this type of relationship is only a short term solution for them. As paradoxical as this may sound, in this age of continuous change it should not be surprising. An excellent example is Oshawa Foods [8, 9, 10.] Oshawa is a large Canadian grocery distributor and is owner of Canada's most advanced, and most successful VMI program. However, Oshawa is openly preaching that VMI is only a temporary solution and that they expect to eventually move towards sophisticated retail managed inventory sometime in the future.

Does VMI make good business sense?
We think there are many situations where VMI does make good business sense, and, in fact, presents a tremendous opportunity. You can move to VMI as a part of a broader business relationship between trading partners or simply as a stand alone process change that both partners agree on. The general posture that we counsel is: pick your spots and do it right.

A supply chain partnership between large-volume trading partners will normally have two driving objectives. With the overriding goal of maximizing value for the end customer, the partnership wants to increase sales and reduce operating expenses in the supply chain. VMI can contribute to both goals: The customer provides the information, the supplier does the planning, and between them they increase supply reliability and reduce supply costs.

As a stand alone arrangement, VMI is a way for a supplier to improve the supply process for small, unsophisticated customers, or a way to add value for a larger customer by absorbing administrative chores.

In exhibit 5 we show the main pros and cons of VMI. You should weigh these in the balance as you decide whether to begin a program.

Exhibit #5: The Pros and Cons of VMI

Here are some other key points to consider.

From the vendor's point of view:

Consider VMI as a first step in forging a supply chain partnership.

Aim for preferred trading relationships that can produce large increases in sales volume.

Plan to negotiate practical alternatives to current forward buying practices.

Do it right: put in the necessary support systems to ensure you actually improve supply chain forecasting and planning.

Plan to make use of the information that you will receive in order to reduce your own operating costs.

As a manufacturer, be prepared for a one-time volume hit as the excess stock is withdrawn from the supply chain

From the customer's point of view:

Recognize that VMI can be a fast way to set supply chain improvements in place while you are working to improve your own systems.

Be prepared to share sales and inventory information with the supplier. This is a corner stone of the arrangement. Handle promotions as special cases.

Only move to VMI if the vendor can actually make better decisions than you, and only stay with VMI as long as that continues to be the case.

Finally, recognize that you will need to deal with several management issues that arise for the changes that you are making. In particular, you may need to review and revise staffing and organization arrangements, and alter pricing practices.

This article has been reprinted with the permission of:
Alan Saipe, Partner, (416) 777 3137
Jeremy Geiger, Consultant, (416) 777 8068

KPMG Consulting
Toronto, Canada
August 1996

Logistics  |  KPMG Canada

Note to users: This information is of a general nature. Although we endeavor to ensure its accuracy and timeliness, no one should act upon it without appropriate professional advice after a thorough examination of the facts of the particular situation.

© KPMG 1997 all rights reserved...

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