ASSIGNMENT 3 DUE BY: WEEK 18-23 NOVEMBER

Vendor Managed Inventory

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QUESTION 2: QUESTION 3:

VendorManagedInventory
Richard McCluney, November 29, 2010 http: !!!"e2open"com blog article vmi#vmr#$mi#getting#it#$traight
Part 1 in a multi-part series on vendor managed inventory Whenever I talk about the topic of VMI (which seems to be more and more frequently), I am asked about the various acronyms associated with inventory management, such as VMI, VMR, and SMI. In this blog, I will offer my definitions of these terms and then share some rules of thumb for When to do VMI. First, lets try and get the terminology straight. The key differences I am seeing between various demand-driven replenishment models used across manufacturing verticals are:

VMR Vendor Managed Replenishment. In this model, the customer owns inventory and the supplier is responsible for replenishment to pre-agreed, demanddriven min-max quantities. VMI Vendor Managed Inventory. In this model, the supplier owns the inventory and replenishes based on pre-agreed min-max quantities. The customer owns the inventory once it is pulled, and typically has liability for inventory not yet pulled. SMI Supplier Managed Inventory. Same as VMI. Used in many companies because they dont want to call their supplier a vendor. The key point to remember about VMI is that the delivery is demand-triggered, not forecast-triggered. Inventory is allocated based on customer forecast and replenished based on customers actual demand. Since the replenishment is driven by the supplier, but inventory liability still belongs to the customer, it is essential that the VMI goals and terms be clearly defined in the program. Good contracts spell out not only the basic termssuch as minimum order quantity, min/max inventory levels, and delivery response timebut also clearly articulate flexibility and liability parameters based on forecast at a part number level. The point being that the contract may spell out different levels of liability for a chipset versus a standard capacitor. In a separate blog I will go into more detail on inventory liability and freshness. While working with customers up and down the value chain, one question I am often asked is: what symptoms typically signal the need for VMI? While there are no hard and fast rules, below are threecommonscenariosthat maymeanits timeto take a closerlookat VMI.

1.

You are losing sales due to shortages or poor on-time delivery performance by a supplier. In this case, a VMI program may be

just the ticket you need to higher service levels. 2. Provisions for excess and obsolete inventory are greater than 0.3% of materials spend. Inventory turns on key parts have dropped below 10. These particular parts may be prime candidates for VMI.

3.

Do any of these scenarios sound strikingly familiar? Interested in learning more about best-practices surrounding VMI implementation

Part 2: Forecastcollaboration:The first stepto implementinga VMI program

In part 1, I provided an overview of vendor-managed inventory (VMI) and described a few of the most common symptoms signaling the need for VMI. In this post, I will focus on forecast collaboration, which is an important first step for designing and implementing an effective VMI program. Why share forecasts, the big win-win When suppliers dont have ongoing visibility into your demand forecast, they manage inventory based on agreed-upon safety stock and min-max inventory levels, historic purchase patterns, or simply the ability to fulfill a PO once it arrives. In order to accommodate changing demand patterns and meet service levels, suppliers often increase their own finished goods inventory, which means additional finished goods locations and higher overall inventory costs. Ultimately, these costs are passed on to you in the form of higher prices. Forecast collaboration allows you to improve the efficiency of your current inventory management program, and also puts you in a good position to set up a more sophisticated VMI program. Heres how:

By providing your suppliers with real-time visibility into your demand forecast, they are able to more effectively schedule operations and plan capacity usage in order to meet your current requirements. This means: lower costs across the board with fewer manufacturing changeovers; an increased percentage of low-cost, full truckload shipments; and the ability to replenish based on minimum economic order quantity.

By gaining visibility into your upcoming sales promotions, suppliers are able to make and ship additional quantities during predefined promotional periods minimizing last-minute rush shipments and reducing the risk of stock outs. Visibility into promotions also allows suppliers to register (promotion-based) increases in demand as one-off events, preventing distortion in average demand calculations, which often leads to unwarranted increases in safety stock. Gaining visibility into your demand forecast also allows your suppliers to coordinate replenishment orders and deliveries across multiple customers in order to improve service. For example, a non-critical part delivery can be diverted for a day or two to another customer who needs a critical delivery without putting you at risk. Similarly, a smaller-than-usual replenishment to you may enable a larger-than-usual shipment to another customer in dire need, without disrupting your service levels. What goes around comes around. By being able to balance the needs of various customers, suppliers are able to improve the networks overall performance without jeopardizing the service levels of any particular OEM (original equipment manufacturer) or customer. Without demand forecast visibility, suppliers dont have the timely, accurate information necessary to prioritize customer shipments effectively. If you are thinking about implementing a VMI program, forecast collaboration should be a top priority. Here are a few things to get you started:

First, understand the need for a trustingrelationshipbetween you and your suppliersmarked by openness, frequency of interaction, and commitment. Second, ensure that you have the mechanisms and technologies in place to share inventory and demand forecast information with your suppliers that is accurate, timely, and complete. I will discuss these mechanisms/technologies in more detail in an upcoming post. Third, work with your suppliers to ensure that they understand the importance of responding to forecasts in a timely manner. Supplier commit to forecast is required to ensure delivery to an open PO. If VMI is on your companys agenda, forecast collaboration is a good place to start. Whether youre a seasoned user of VMI or just getting your company started, Id love to hear your thoughts, questions, or concerns. Im all ears.

Part 3: WhatmakesVMI work?

In the previous sections, I discussed forecast collaboration as the foundation for any successful VMI program. Today Id like to focus on a broader set of key characteristics, which helps to answer the question, what makes VMI work? Over the course of my career, I have had the privilege of helping to implement and manage a number of effective VMI programs. Heres what they all had in common:

Commitment:The hallmark of every successful VMI program is the commitment of senior management at both the customer and supplierto make the program work. OEMs (original equipment manufacturer) and suppliers alike need to understand the business value of a VMI program, and should consider it a key component of their overall strategy to enable a demand-driven supply network. Both sides should also have clearly defined program owners, including personnel in an operational role responsible for the daily execution. SupplierAgreement:Suppliers and customers should define a VMI contract at the part-number level that clearly defines expectations, service levels, and risks. Information spelled out in the contract should include:
o o o o o o o

Current manufacturing lead time (in weeks), and standard minimum order quantity Number of weeks of forecast demand used for planning replenishment levels Minimum inventory level required by the customer(typically shown in Days of Supply) Delivery response time requirements measured in hours Upside percentage and the availability period for that upside as well as upside replenishment lead time Total liability window (i.e., the number of weeks for which the customer is liable for forecast, not to exceed standard PO cancellation terms) Freshness (i.e., the agreed upon amount of time for which inventory remains under the title of the supplier)

Forecastand Response:The customer should agree to provide electronic forecasts to its suppliers, and the suppliers in turn must agree to respond (positively or negatively) within a stipulated time period. This is critical in order to enable timely customer visibility and action. Waterfall Chart: The waterfall chart is an important tool to show a clear record of transactions and inventory positions, as well as to identify the customers liability based on the supplier agreement and validation of supplier liability claims (based on freshness parameters). Integrationwith Backend Systems:Forecast responses and inventory levels from suppliers/3PLs should be integrated into backend ERP systems so that they become a part of standard business reports, including site shortage reports. ERP integration also enables the release mechanism to be directly linked to actual demand, including work order releases and changes in inventory levels. ClearFrameworkDefined:In addition to the contractual terms, the objectives of the VMI relationship should be clearly defined, along with any financial and non-financial incentives. The framework should be clearly communicated at all levels of both organizations in order to facilitate streamlined execution. From my perspective, these are the key attributes of any successful VMI program. Next week, I will dive deeper into liability and freshness, which are critical aspects of

successful customer-supplier relations within a VMI context. That being said, please drop me a line with additional functionalities that you have found important to your own VMI implementations. Did I miss anything?

Part 4: Liabilityand freshness:The hiddenside of VMI

Picking up on a topic I raised in my last blog post, I want to discuss one of the hidden (and potentially costly) issues facing OEMs, contract manufacturing service (CMS) provider, and suppliersnamely, financial exposure from excess inventory. As companies implement programs such as vendor-managed inventory, they delay taking ownership of their inventory, and as a result, carry less inventory on their books. However, while they are carrying lower inventory on their balance sheets, they are not necessarily facing lower inventory liability risk. How is this possible? If you look at the contract terms of a CMS provider, it is likely to say something like this: The customer is liable for the cost of the non-standard materials and components that we have ordered to meet the customer's production forecast but which are not used, provided that the material was ordered in accordance with an agreedupon procurement plan. When OEMs implement a VMI program, they dont carry the inventory on their books or incur any payments until the inventory is pulled from the buffer managed by their supplier. However, the OEM still takes on inventory risk when it communicates its demand forecast (a VMI input), so long as the CMS provider uses that forecast for procuring additional components within contractual guidelines. This is because the forecast is viewed by the CM provider as a trigger to commit supply in the future. In exchange for this implied commitment, the OEM typically agrees to liability for excess inventory resulting from procurement practices aligned with its forecasting practices. In other words, giving a supplier a VMI forecast within the liability window is essentially the same as sending the supplier a PO that covers requirements for that same time period. The question, then, is does your company have the necessary controls in place to reduce this financial exposure? Freshness is one way that companies attempt to control the risks associated with inventory liability. Freshness is the amount of time that the supplier inventory (built in support of the minimum inventory levels) remains under title of the supplier before the customer takes ownership. As a result, freshness parameters can be used to put an end date on when an outstanding liability needs to be either resolved or pulled by the customer. VMI contracts should define freshness as clearly as possible in order to reduce fuzziness around who will be kept holding the bag when the music stops. By creating dashboards that provide visibility into the value of expired freshness, a company maintains continued visibility into its liability.

One way to reduce potential liability, then, is to identify the process and technology improvements needed to maintain visibility into inventory freshness. With VMI programs, the buyer-planner role becomes integrated, requiring buyers to get used to the fuzzier areas of planning. Investing in training around liability and freshness is one way to enable your buyer-planners to make intelligent decisions to lower inventory liability. Another key investment area is around technologies that enable the buyerplanner to collaborate with suppliers, and to provide them with clear visibility into consumption, forecast, and inventory positions. Other initiatives such as planned rampdown and a reduction in the number of engineering change orders (ECOs) can also play a role in reducing inventory exposure. So while you are enjoying lower working capital costs from your VMI initiatives, it is critical to monitor your inventory liability and make the right decisions. What is your company currently doing to control inventory liability and financial exposure? How effective have you found your current methods? Our readers would love to hear your story.

Part 5: ImplementingVMI: The final checklist

Its been a long haul, but were finally herepart 5 in my five-part series on VMI. I wish I could cap off my VMI tirade with something exceedingly cool and exciting, but Im afraid Ive left the least sexy part for last...internal system requirements. Sigh. Well, it has to be done. After all, VMI is pretty much useless if you dont have the right software and systems in place to support it. So here goes. First, lets take a look at software requirements. In order to set upand maintainan effective VMI program, you should invest in a supplychainsolutionthat offersvisibility, collaboration,and controlacrossall relevanttradingpartners . Heres a more detailed checklist:

Enables near real-time inventory visibility across sites, hubs, suppliers, and in-transit inventories; Calculates projected inventory positions and potential supply-demand imbalances and communicates them to OEMs (original equipment manufacturer) and suppliers; Enables OEMs to share forecasts with suppliers, and to receive near real-time responses; Enables exception-based configurable alerts, so that all stakeholders are notified of potential issues and projected inventory violations;

Provides audit trails for visibility into transaction history for liability management and dispute resolution; Provides B2B integration options that allow you to integrate with 100 percent of your supply basefrom sophisticated multinational companies to mom-and-pop shops; Provides a rich set of reports and decision analytics that give a 360-degree view of the entire inventory management processto ensure that suppliers are replenishing inventories at required levels to meet fluctuating demand. Key reports include:

Execution versus plan reports, which track how well actual pulls compare with forecasts Trend reports, which track inventory trends and calculate how closely they stay within defined minimum-maximum levels Waterfall reports, which show a clear record of forecast transactions and inventory positions, as well as identify liability with alerts for impending freshness Performance metrics, which track key metrics necessary for effective inventory management, including inventory turns, aging, and valuation

I know its a long list, but VMI is a pretty sophisticated process. And to make matters even more complicated, our software checklist needs to be complemented with a second critical component: a streamlinedsupplieron-boardingprogram . In my experience, this is the most significant area of unplanned risk for companies implementing VMI. By failing to account for the significant costs/efforts associated with supplier on-boarding, many OEMs (OriginalEquipmentManufacturers ) run out of budget and resources before a working process is in place. For this reason, I recommend considering the manyadvantagesof an on-demand(or SaaS) softwaremodel as opposed to more traditional on-premise solutions. On-demand providers typically have extensive experience enabling B2B connectivity with suppliers, and are able to provide the relevant training and technologies needed to get them up and running quickly. As a result, your overall solution is less expensive to implement and maintain for both you and your partners. Finally, on-demand solutions allow your organization to shift focus to inter-company collaboration (a cornerstone of effective VMI) and away from procuring, installing, and maintaining those pesky hardware and software systems internally. So its pretty simple (sort of). VMI requires software that offers real-time visibility and collaboration plus a streamlined on-boarding program. With these two areas under wraps, youre pretty much ready for takeoff. So what are you waiting for? Drop me a line with additional questionsor feel free to offer our readers your own perspectives on successful (or not-so-successful) VMI enablement.