One of the most common questions that arise when it comes to inventory management is what the actual differences between vendor-managed inventory and consignment inventory are, in practice, and what the benefits and drawbacks are for each.
To keep it simple: The core difference between VMI and consignment inventory boils down to a question of ownership. In terms of what strategy is appropriate for your business, this central differentiation between the two may help solve that debate right away.
At its most basic level, vendor-managed inventory is when you sell or “vend” inventory the supply of which is managed by the producer of the product in question. This process is typically governed by predetermined inventory levels as well as minimum inventory levels that automatically trigger stock replenishment shipments.
Consignment inventory is when the vendor “vends” product directly from the stock of the supplier and pays for it after a sale or the product is “consumed.” VMI allows for a constant level of a frequently purchased item to remain on hand whereas consignment inventory draws upon a source of product that is paid for after the fact.
Consignment inventory allows vendors to shrink their capital outlay in order to keep inventory on hand but it does not eliminate the costs associated with managing and storing it. The consignment model is thus ideal for products that are not regularly consumed, that are capital intensive, or both. Budgetary constraints combined with demand uncertainty makes the consignment model appealing for a variety of reasons but it might not be the best option for products that are frequently consumed.
Given this distinction, the advantages of VMI are reduced to four major components: Customer service efficiencies, demand stabilization, reduced inventory requirements, and cost rationalization.
Customer Service Efficiencies
VMI offers vendors the ability to respond to customer demand fluctuations without having to actively manage the supply of products on hand. That’s because VMI makes sure that a minimum level is maintained at all times and eliminates the administration and overhead associated with traditional stock replenishment methods. This further establishes you as a reliable vendor for said goods and builds consumer confidence (as well as encouraging repeat business) in the process.
Because VMI responds directly to customer activity as well as adheres to a set minimum level of product on hand, businesses do not have to worry about meeting market needs and can focus on other areas of administration. VMI largely eliminates the need for massive orders (and the expenditure associated with them) in order to meet unexpected demand from customers.
Reduced Inventory Requirements
Because inventory is largely predetermined and managed according to a range of parameters, suppliers do not need to buffer their own stock in order to accommodate unexpected spikes in demand.
In many industries, VMI allows for the company that deploys it as a strategy to harmonize processes between their order fulfillment and distribution center thus allowing for cost savings in administration and capital required to keep inventory on hand.