Journal of Industrial Engineering and Management

JIEM, 2014 – 7(4): 831-856 – Online ISSN: 2014-0953 – Print ISSN: 2014-8423
http://dx.doi.org/10.3926/jiem.1195

Vendor Managed Inventory: Why you need to talk to your supplier

Frederik Zachariassen, Henning de Haas, Sirle Bürkland

University of Southern Denmark (Denmark)

[email protected], [email protected], [email protected]

Received: June 2014

Accepted: July 2014

Abstract:

Purpose: The purpose of this paper is to investigate the concept of Vendor Managed
Inventory (VMI) from an inter-organisational perspective. Extant literature on VMI tends to
investigate the concept from a focal perspective, even though VMI has originally been born as
a collaborative arrangement.

Design/methodology: The paper is based on a literature review and an empirical study. It

provides a comprehensive literature review on VMI and an illustrative case study of a supplier
and a buyer jointly implementing VMI.

Findings: The findings of this paper are twofold. First, a literature review uncovers that
contemporary research has delimited the analysis of VMI to a focal company perspective as
current VMI cost models tend not to capture the picture of the complete supply chain.
Second, it demonstrates through an illustrative case study that adoption of an inter-
organisational approach to VMI is vital if companies are to optimize their buyer-supplier
relationships.

Research limitations/implications: Future research should test the implications proposed in

the empirical section, as this piece of research can be seen as exploratory case study research
with the aim of analytical generalizations.

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Practical implications: The inter-organisational VMI cost perspective in supply chains should
be emphasized in purchasing departments since such a perspective significantly raises the
awareness of the costs incurred in a supply chain.

Originality/value: Existing research has not explicitly focused on inter-organisational costs

incurred by companies implementing VMI. This study seeks to bridge this research gap.

Keywords: Supply Chain Management, VMI, inter-organisational relationships, total cost, purchasing

1. Introduction

In recent years the disciplines of supply chain management and logistics have gained
considerable increase in scholarly attention. Such attention is due to the fact that both areas
focus on creating top- as well as bottom-line improvements by streamlining the flow of
material and information across the supply chain (Christopher, 1992). One of the methods for
obtaining such advantages is the use of automatic replenishment programs (ARP). ARP is used
in exchange relationships between buyers and suppliers, where the seller restocks inventory
based on information provided by the buyer (Daugherty & Myers, 1999). Examples of these
are continuous replenishment planning (CRP) and vendor managed inventory (VMI) (Disney
Potter & Gardner, 2003; Borade & Bansod, 2009) with the latter being occasionally referred to
as consignment inventory (Dong & Xu, 2002). Of these two examples, VMI is a unique
approach, in that VMI stresses the responsibility of vendors in inventory management. Benefits
emanating from this concept include but are not limited to higher selling space productivity,
increased sales per store for retailers and an improved control of the bullwhip effect (Waller,
Johnson & Davis, 1999; Angulo, Nachtmann & Waller, 2004).

Research on inventory management in general and on VMI in particular has intensified during
the recent decade (Williams & Tokar, 2008). Despite this increased focus and VMI’s ostensible
benefits, the concept has, however, not gained the popularity that was expected since its
successful introduction and application in US retail stores, such as Wal-mart and K-mart in the
early 1990’s (Blatherwick, 1998). It has even been noted that “most of the accounts [of VMI]
are anecdotal providing company-specific examples. Little empirical work has appeared in
academic publications” (Daugherty & Myers, 1999, pp. 63) with others stating that convincing
people to engage in VMI adoptions has proven to be a “monumental task” (Pohlen & Goldsby,
2003, pp. 566). Further, Tyan and Wee (2003) claimed that out of 10 companies only 3 to 4
achieved VMI success, with the rest of the companies forfeiting the project, while Dong, Xu
and Dresner (2007, pp. 356) noted that “the acceptance of VMI benefits in the trade literature
is [...] not universally positive.” Several suggestions have been made as to what causes
difficulties in VMI implementations and the subsequent use of it. These are for instance related

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to forecasting issues (Vigtil, 2007), planning nervousness (Kaipia, Korhonen & Hartiala, 2006)
and obtaining accurate estimates of production lead-times (Disney & Towill, 2002).

The majority of the extant literature on VMI has investigated such issues via mathematical
modeling, although it is continually stressed in these papers that such models carry several
limitations that might cause the models to be unrealistic (Småros, Lehtonen, Appelqvist &
Holmström, 2003). Others have researched the VMI concept via case studies (e.g. Holmström,
1998). Peculiarly, these papers investigate VMI from a focal perspective, which is surprising
when one notices that VMI focuses on the collaborative and therefore inter-organisational
issues of managing inventory. This has lead contemporary VMI studies to place little emphasis
on the inter-organisational, managerial aspects of VMI implementation, even though repeated
calls have been made for such studies. For instance, Pohlen and Goldsby (2003, pp. 579) has
suggested that as regards to VMI adoptions “further empirical research is required to
determine how the availability of [...] information affects management decision making” and
that “case study analyses will be required to capture cost and performance information across
supplying and purchasing firms.” In an earlier study Waller et al. (1999, pp. 198) noted that
“[...] successful implementation depends heavily on sound business processes and
interpersonal relationships, [where] a purely technical solutions without regard for the people
involved is unlikely to deliver the benefits“. In a similar vein, it has been suggested that “an
area of future research that may provide benefit to inventory management is the incorporation
of behavioral issues [...]” (Williams & Moore, 2007, pp. 228). In a review of inventory
management research Williams and Moore (2007, pp. 228) claim that “inventory management
models [...] do not adequately account for behavioral issues and the judgment and decision
making of managers. As a result, the predictive accuracy of such models may be constrained.”

Answering such repeated calls for research on inter-organisational aspects of VMI would,
therefore, be valuable, as it would deepen our understanding of the relevant features of VMI
and buyer-supplier relationships. Since VMI originally was meant as a collaborative approach,
in which both buyers and suppliers should cooperate in order to benefit from its
implementation, this paper, therefore, aims to “explore how the extant literature has treated
VMI and subsequently demonstrate the importance and necessity of implementing VMI from
an inter-organisational perspective.” The former part of the research question is answered via
a comprehensive literature review, while the latter is answered through an exploratory single
case study involving a focal company implementing VMI together with one of its most
important customers.

To investigate the issue at hand, the paper is structured as follows. In section two, a literature
review is carried out concerning VMI related contributions. The literature review reveals that
the existing empirical studies tend to continuously treat VMI from a focal company perspective
and ignore the inter-organisational aspects of VMI implementations. Section two also points
out three central constructs of VMI that are prevailing in the existing literature. This is done

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with the aim of positioning and comparing the findings of the case study in section four in the
light of the main constructs found in current literature. In section three, the methodology of a
single case study is presented, while the subsequent section four explores and analyses the
empirical data of the case study. Section five concludes with the findings and suggests avenues
for future research.

2. Literature review

This section contains a brief introduction to VMI and an in-depth literature review on the
subject. VMI has been researched rather intensely throughout the years with a special focus on
theoretical discussions, mathematical modeling and simulation. It was not until the 1990’s
though that significant interest in the concept of VMI developed when companies looked at
their supply chains to gain competitive advantage. While traditionally associated with the
grocery sector, VMI has also been successfully implemented in a number of other areas,
including the steel and electronics industries (Kuk, 2004). There are a number of benefits that
VMI brings to companies and supply chains, particularly regarding dynamic inventory control,
customer service and asset use. A more comprehensive description of the development of VMI
and its expected benefits is provided by Disney et al. (2003).

A key element in VMI implementations is that the supplier is in control of the customer’s
inventory to ensure that predetermined service levels are maintained. Hence the vendor makes
all replenishment decisions, dispatching a quantity of product that may be fixed or variable
according to the control system used (Waller et al., 1999). In this respect, the customer
effectively takes a passive role in the supply chain. From the literature definitions of VMI, it is
not clear, however, whether VMI is a measure that should be taken collaboratively or if it is a
solution imposed on the supplier by the customer (retailer) with only providing an effect on the
latter. In the next section, this question of VMI as a focal or an inter-organizational measure
will be explored.

2.1 Review of VMI literature

For the literature review of this study journals and papers have been searched in
ScienceDirect, Wiley-Inderscience, Emerald and EBSCO HOST’s databases Business Source
Complete, Business Source Premiere, Academic Search Premiere and Academic Search
Complete. The databases were systematically searched for the key terms “Vendor Managed
Inventory” and “VMI”, so that they could appear either in the title, abstract or keywords. The
reference lists of the identified papers were carefully analyzed in order to include all literature
that has revolved around the concept of VMI. Through the initial literature search, 70 papers
were identified, from which five were excluded, as they only contained limited or sporadic
references to VMI (e.g., Potter, Breite, Naim & Vanharanta, 2004). To this reduced list of 65

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papers, six additional papers (e.g., Cooke, 1998; Achabal, Mchintyre, Smith & Kalyanam,
2000; Cetinkaya & Lee, 2000; Kuk, 2004; Toni & Zamolo, 2005; Blackhurst, Craighead &
Handfield, 2006) were deemed relevant and therefore added to the list, making a total of 71
VMI-related papers identified.

The results of the literature review are presented in the below table 1. From table 1 four
different methodological approaches to the study of VMI can be discerned:

• mathematical simulation modeling,

• literature reviews/non-empirical discussions on VMI,

• quantitative data analysis and

• qualitative data analysis.

Additionally the papers can be categorized as having either a focal or an inter-organisational

approach. We define a focal perspective as a research approach that investigates the concept
of VMI by focusing on only one side of the buyer-supplier relationships, namely the buyer’s
side, thereby not explicitly investigating the suppliers side. An inter-organisational approach
stresses the need for addressing both sides of the relationships either via mathematical
modelling or empirical data analysis to investigate the impact of the use of VMI on both
parties.

Scope
Focal Inter-organisational
Methodology
Achabal et al. (2000), Cetinkaya & Lee Daugherty & Myers (1999), Chan
(2000), Disney & Towill (2002), Dong & Xu Cheung, Lee & Kwok (2006), Yu, Liang
(2002), Disney et al. (2003), Småros et al. & Huang (2006), Nachiappan,
(2003), Yang, Ruben & Webster (2003), Gunasekaran & Jawahar (2007), Zhang,
Angulo et al. (2004), White & Censlive Liang, Yu & Yu (2007), Yao & Dresner
(2006), Reddy & Vrat (2007), Sari (2007), (2007, 2008), Almehdawe & Mantin
Wilson (2007), Nagarajan & Rajagopalan (2010), Darwish & Odah (2010), Sue-
(2008), Southard & Swenseth (2008), Yu, Ann, Ponnambalam & Jawahar (2012),
Mathematical modeling
Liang & Huang (2009), Yu, Wang & Liang Yao, Dong & Dresner (2012), Chen
(2012), Yu, Hong, Zhang, Liang & Chu (2013), Sadeghi, Mousavi, Niaki &
(2013), Chen, Lin & Cheng (2010), Yu & Sadeghi (2013), Sadeghi, Sadeghi &
Huang (2010), Lee & Ren (2011), Dong Niaki (2014a, 2014b), Xiao & Xu
Dresner & Yao (2013), Hariga & Al-Ahmari (2013), Lee & Cho (2014), Pas&ideh,
(2013), Hariga, Gumus, Daghfous & Goyal Niaki & Niknamfar (2014), Rad, Razmi,
(2013), Hariga, Gumus & Daghfous (2013), Sangari & Ebrahimi (2014)
Nia, Far & Niaki (2013)
Literature review/ Barratt (2003), Pohlen & Goldsby (2003), Blatherwick (1998), Cooke (1998)
non-empirical Williams & Tokar (2008), Zammori, Braglia &
discussions on VMI Frosolini (2009)
Kaipia, Holmström & Tanskanen (2002), Toni Waller et al. (1999), Kuk (2004), Dong
Quantitative data
& Zamolo (2005), Claasen, van Weele & et al. (2007)
analysis
Raaij (2008), Borade & Bansod (2010)
Walton (1996), Tyan & Wee (2003), Kaipia et Holmström (1998), Dorling, Scott &
al. (2006), Elv&er, Sarpola & Mattsson Deakins (2005), Blackhurst et al.
Qualitative data
(2007), Tanskanen, Holmström, Elfving & (2006), Dorling, Scott & Deakins
analysis
Talvitie (2009), Guimarães, Carvalho & Maia (2006), Vigtil (2007), Kauremaa,
(2013), Stanger (2013) Småros & Holmström (2009)

Table 1. Results of the literature review sorted by methodology and scope

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Below, it will be shown by carefully commenting on the papers in table 1 that VMI studies have
only to a limited extent provided an empirical account on the use of VMI as a collaborative
initiative. There is a lack of research that investigates how both the buyer and supplier are
actively involved in coordinating and cooperating with each other in VMI settings, even though
empirical accounts of these relationships have repeatedly been called for in the literature.

The majority of papers (a total of 44) identified through the literature review deal specifically
and meticulously with mathematical modeling of VMI, as for instance Wilson (2007) and Yao
and Dresner (2008). Most common approaches use mathematics in order to arrive at models
that could predict deterministic or stochastic demand on inventory (e.g. Lee & Cho, 2014).
Others use empirical data in order to describe VMI related aspects via simulation models (e.g.
Southard & Swenseth, 2008). Although such articles are relevant inasmuch as they contribute
to highlighting how certain variables behave under fixed circumstances, they carry certain
limitations in that they are only able to take into account a limited number of variables. Almost
all researchers approaching the issue of optimizing VMI relationships admit that this is a
limitation of these studies. For instance, Småros et al. (2003, pp.351) noted that: “[...] more
case studies focusing on companies that have implemented VMI and studying the benefits they
have attained as well as the problems they have faced in practice are needed. This is the only
way to get reliable information on the actual processes employed by the companies as well as
on the important relationship issues that are so critical to the success of collaborative
approaches such as VMI.”

A smaller part of the extant literature (a total of 6 papers) consists of literature reviews or
normative discussions which are used to ponder various aspects of VMI. For instance,
Blatherwick (1998) and Cooke (1998) discuss the diffusion of the VMI concept and its possible
effects and success factors in practice. A third paper, Barratt (2003) calls for further research
on verifying the actual economic benefits of VMI, while Pohlen and Goldsby (2003) investigate
the managerial barriers as to why VMI is not implemented more often in firms. They conclude
that further empirical research is needed on VMI application. Williams and Tokar (2008) carried
out a literature review of inventory management research in major logistics journals, pointing
out that further research is needed on more complex VMI settings that so far have not been
modeled by mathematical means. Zammori et al. (2009) discuss how the use of standard
agreements can be applied effectively in VMI settings.

Another part of the literature (a total of 7 papers) uses quantitative data to test various
hypotheses. Waller et al. (1999) theoretically explain why savings potentially can accrue from
VMI for both suppliers and buyers; nevertheless, they do not provide an empirical support for
this. Kaipia et al. (2002) use a simulation approach based on quantitative data on inventory
demand to analyse the benefits of VMI from the viewpoint of managing the replenishment
process of the entire product range. They claim that “there are numerous case examples of
successful VMI implementations”, although the studies that they point to (e.g. Cooke, 1998

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and Holmström, 1998) do not contain empirical proof for successful VMI implementations. Kuk
(2004) found that a lack of trust can be a major barrier to effective VMI adoption, while De
Toni and Zamolo (2005) use a simulation model on the basis of quantitative data to argue that
VMI can be a successful initiative. Their approach is purely technical, making only a minor
reference to inter-organizational aspects of the VMI relationship between the buyer and
supplier. On pp. 73, it is stated that “the change from the logic of traditional replenishment to
VMI approach has provided significant advantages for all involved in distribution and supply
chain.” Nevertheless, their empirical account only focuses on the benefits of VMI on the focal
company with no attention or empirical data given as to how suppliers reacted or benefited
from it. Dong et al. (2007) tested various determinants of VMI adoption, while Claasen et a l.
(2008) investigated performance outcomes of VMI via structural equation model focusing
mainly on the buyer’s side. Similarly, Borade and Bansod (2010) conducted a survey for
drivers and obstacles to VMI in an Indian context while focusing exclusively on the buyer’s
side. In conclusion, the analyses conducted in these studies provide fruitful insights on VMI
adoption but do not investigate an active inter-organisational involvement between buyer and
supplier.

The last group of studies relies on qualitative data (a total of 13 papers). Most of these studies
limit their analysis to a focal perspective with some brief references to inter-organizational
issues. For instance, Walton (1996) briefly mentions VMI in relation to electronic data
interchange, while Holmström (1998) mentions some inter-organisational issues without
showing an empirical evidence on these. Tyan and Wee (2003) studied an adoption of VMI
between two companies in the Taiwanese grocery industry. However, they focus on the focal
company, not providing an account of how the VMI implementation affected the supplier’s cost
structure. Dorling et al. (2005) and Dorling et al. (2006) studied key determinants of VMI
projects in the New Zealand food industry, developing an organization-level framework for VMI
implementations. Kaipia et al. (2006) investigated the connection between the bullwhip effect
and planning nervousness in VMI related situations, while Vigtil (2007) specifically focused on
the type of information exchanges that firms utilize in VMI projects. Tanskanen et al. (2009),
Guimarães et al. (2013) and Stanger (2013) all investigated VMI benefits from a focal
perspective with Elvander et al. (2007) categorizing different types of VMI systems via
dimensions as for instance inventory locations, sourcing policies or shipment decisions.

Among the above-given list of papers, few papers can be found to involve some analysis of
inter-organisational aspects of VMI. Blackhurst et al. (2006), for instance, analyse the gaps
between the expected and the actual effects of two VMI initiatives. The authors audit the
processes of two supply chains and suggest that shortcomings in collaboration between the
partners caused material shortages and low levels of inventories in both VMI initiatives.
Another study that sheds light on inter-organisational relationships is by Kauremaa et al.
(2009). They provide a snap-shot picture of five different VMI dyad and report the shared
benefits between suppliers and buyers. While these studies point to the importance of

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collaboration and the benefits of VMI on both parties in a supply chain, they do not provide
data on the change that VMI implementation brings and collaboration between buyers and
suppliers on their common goals, cost analysis and the performance of the resulting supply
chain. The present paper aims to fill this gap.

In summary, the 71 papers reviewed provide mathematical modelling and empirical data
mostly from a focal perspective, being limited in grasping inter-organisational relationships.
The few studies that take an inter-organisational perspective on VMI implementations (e.g.,
Blackhurst et al., 2006; Kauremaa et al., 2009) show the effects of VMI on both the buyer and
the supplier, but lack evidence on change processes of the VMI implementation that involves
mutual goal setting and various offsets in costs and benefits of the changes across the sites of
the buyer and the supplier.

3. Research method

An exploratory single case study is used to investigate VMI implementation in a focal company
together with one of its key suppliers. The case study is exploratory in nature as it is used to
investigate a phenomenon that lacks detailed prior research and pre-defined hypotheses (Yin,
1989). A qualitative research method was chosen since it has been suggested to be useful in
complex real-life settings where the boundaries between phenomenon and context are not
clearly evident and where the investigator has little control over the events (unlike an
experiment), (Yin, 1989, Ellram, 1996). A VMI implementation in a buyer-supplier relationship
provides such a complex setting. Barratt (2003, pp. 61-62) has also noted that “in order to
gain a deeper understanding of collaborative planning, qualitative case-based research would
seem to be the answer” and that “the long-term implications of collaborative planning suggest
the use of longitudinal research”.

Keeping this in mind a total of 2½ years were spent within the case company from which a six-
month period involved an active investigation of a VMI implementation process and its
consequences on the focal company and its partner. The case company was chosen for this
research project as it was about to initiate a VMI implementation project together with one of
its suppliers. One of the authors of this study worked in the company as a supply chain
manager. While working closely together with one of the firm’s key supplier the researcher was
able to oversee the implementation of VMI in detail and have an adequate access to key
informants of the study in both the focal company and the supplier. In this way the researcher
was able to get an in-depth view of the decisions and events that took place during the VMI
implementation. The other two researchers of this study remained as outsiders for the case
company, being able to analyse the data without making an impact on the empirical setting. In
this way a collaboration of three researchers helped to maintain an objective stance on the
empirical data and avoid researcher bias.

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A confidentiality agreement was signed with both companies with the parties providing
empirical data while remaining anonymous for the paper. The total hours of interviews were
split between the key purchasing personnel at the case company and interviewing customers
and suppliers that interacted closely with sales and procurement of the case company. The
former interviews were mainly conducted with a number of strategic purchasers and a smaller
number of the interviews were conducted with the heads of the purchasing division. In
addition, interviews were also carried out with the key supplier to get an overview of both
parties in the VMI arrangement. The interviews were designed as semi-structured and open-
ended to keep an exploratory nature of the data inquiry.

Data were tested and validated by several means. First, in order to increase the validity of the
study data triangulation was used in that several elements of the empirical data were
confirmed from more than one interviewee and at different times during the research project
(Eisenhardt, 1989; Lincoln & Guba, 1985). For instance a statement concerning problematic
aspects of communication between the buyer and the supper in the VMI relationships could be
reported from several respondents. Second, data was analysed by identifying categories,
concepts and patterns in the data through discussion rounds within the team of researchers.
This strategy has been recommended for improving the reliability of the study (Lincoln & Guba,
1985; Miles & Huberman, 1994, pp. 278). This process was iterative so that the occurring
elements and constructs of the study could be verified to a greater degree. Third, an abductive
data analysis approach was used in which empirical data and theory were continuously
matched throughout the research period (Kovács & Spens, 2005). The research method
employed in this study resembles the approach used by Kauremaa et al. (2009) who also used
qualitative data in their study of dyadic VMI implementations. Nevertheless, the present study
differs by taking a more longitudinal stand on the VMI setting. In sum, this approach to data
collection fits well with the complexity of the setting and the aim of investigating VMI from an
inter-organizational perspective which can only be done by successfully investigating both
parties of a supply chain.

4. VMI in an inter-organisational perspective

The case study revolved around a six month improvement project between two Danish
manufacturing companies both operating in a global setup, one supplying the other from a
Chinese to a Danish manufacturing site. The supplier and the buyer decided to initiate a VMI
implementation project that was set out as a two-sided cooperation in which relevant cost
drivers for both the buyer and the supplier were identified. The aim of the project was to gain
significant improvements in terms of delivery time, flexibility and delivery performance.

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The VMI project was split into three implementation phases:

• Initial discussions and goal setting,

• implementation,

• day-to-day operations and evaluation of the project.

In the below each phase will be reviewed and commented upon after which a section
concerning implications of the case are provided in section 4.4.

4.1 Initial discussions on the VMI project and the goal setting

The initial work between the companies was focused on setting goals for the VMI project. The
objectives of the project could be perceived as consisting of three parts:

• the mutual goals of the project,

• the objectives on the customer’s side, and

• the objectives on the supplier side.

First, the overall mutual objective for the project was that the final result should be seen in a
total supply chain cost perspective, meaning that the cost of the solution must balance as it
did before the project with savings at the customer side covering potentially added cost at the
supplier. The cost drivers considered were transaction costs in procurement and planning,
warehouse handling/space and return on capital (e.g. value of goods flow and stocks). It
should be noted that in this case study planning costs did not change significantly for the
supplier, and this cost was therefore not included on the supplier’s side. Second, objectives
from the customer’s side were to significantly improve delivery performance, reduce delivery
lead time and increase demand flexibility, free cash tied up in raw materials inventory, reduce
administrative workload in operational procurement, and save overhead costs in general.
Third, objectives from the supplier side were to secure and increase turnover at the customer,
gain access to more accurate demand data and thereby be able to achieve higher capacity
utilization at the Chinese manufacturing site.

By looking at the cooperation and the total cost of operations from a supply chain perspective,
the idea of finding a new way of operating the supply chain was fostered through a number of
meetings between the supply chain managers of the two case companies, as they both were
already faced with a similar challenge of reducing the cost of operating the supply chain and
increasing the service to the customer. A small project group was established and given the
task to analyze and document the current supply chain. The project group was also asked to

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meticulously outline two sets of goals that would be affected by the VMI implementation. The
first set of goals was related to the identification of cost drivers. This was done in order to
pinpoint what activities as regards to inventory management caused costs to vary at both the
supplier and the customer and how these activities could then be optimized in order to cut
costs and improve performance. For the supplier the primary cost drivers were freight costs,
inventory costs, 3PL costs, cash flow per due days (payment terms) and potential price
adjustments. For the customer the most important cost drivers were inventory costs,
administration, planning and monitoring supply, cash flow per due days and potential price
adjustments. Not surprisingly, freight costs and the financial cost of holding inventory were
found to be highest.

The second set of goals was related to the identification of supply chain performance
measures. In the meetings held between the buyer and the supplier a common set of
measures were agreed upon that both parties saw as relevant to concentrate on. These were
delivery service, lead time, inventory stock-outs and buffer levels, and total volume in flow. An
outline of these goals were made on a mutual basis in which a simple as-is to-be analysis was
carried out which will be presented in the next section 4.2.

4.2 Implementation of the VMI concept

From the early stages of the improvement project the supply chain concept was characterized
by a traditional buyer-seller relationship where the customer issued a purchase order and
where the customer supplied ex-works from China based on an agreed lead time. The
customer sent forecasts to the supplier, but these were only used as indications of the demand
level. That is, no procurement or production of semi-finished goods was initiated. In the below
figure 1 the supply chain concept before the VMI project can be seen.

Figure 1. The supply chain setup before the VMI change

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The mode of transportation was weekly shipment. This meant that every week the supplier
sent a container to the customer. The transportation lead time including picking and customs
and delivery was 5-7 weeks. When the goods arrived in Europe, they were stored in a third
party logistics (3PL) warehouse, from where the production at the customer was supplied
based on a Kanban pull system.

To understand the cash flow in the supply chain, it is important to notice the transaction time
line, when the costs are incurred at the supplier and when they are paid for at the customer.
The initial supply chain concept states that the responsibility of the goods and the point of
invoicing are at shipment from the supplier in China. The payment terms in this case was 60
days net. As the customer had a raw material inventory covering 140 days of demand, the
customer had to pay for the goods 135 days before usage and hold the financial value in
inventory. In urgent cases, if the customer experienced sudden increases in demand, or if a
quality issue was recognized, the supplier had to deliver new products to the customer by air
freight which of course was much more expensive than transport by sea. As the analysis will
show, the mode of transportation was chosen based on a traditional understanding of the
optimization of the cost drivers in the supply chain with focus on the focal company, i.e. that
the cheapest mode of transportation has to be ship and not based on a dyadic/supply chain
total cost perspective. In figure 2 the supply chain setup after the VMI application is presented.

Figure 2. The supply chain setup after the VMI project

As can be seen from the figure the responsibility of the supply to the customer assembly
factory was now handed over to the supplier which meant that whereas the supplier originally
had the responsibility to secure goods available ex-works from the China manufacturing plant,
the supplier was now responsible for securing the right products and volumes available at the
raw materials inventory of the customer. This change affected both the planning and
production processes at the supplier which will be discussed in section 4.3.

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A large part of the project period was dedicated to finding solutions as to how to operate the
new supply chain setup. The logistical processes of the new concept, such as forecasting,
ordering etc., were relatively straightforward to define. However, the success in operating the
new supply-chain setup depended on the ability to find solutions to the cost implications of this
new setup. As explained above, the starting point of the project was that the total cost of
operation should not increase. With this in mind, the project group defined the cost drivers
involved in operating the original setting and the new setup in order to be able to compare the
two. A major change to the cost model of the cooperation was the shift in ownership of the
goods in transit and the raw materials inventory at the customer. The cost elements in
question were the value of the inventory at the customer and the value of the goods in transit.
In the original setup, the transportation was organized by ship, leaving minimum 5 weeks of
inventory in transit. In addition, the payment terms were called into question. The timeline of
the new supply chain concept was established in order to define the cash flow of the
cooperation.

The analysis made by the two companies showed that if transportation was handled by air and
the inventory at the customer was tightly controlled, the cash flow effect of the change was
significant. An analysis was made concerning the cost/savings at the customer and the supplier
to find the cost elements changed by the change in operation. The two major cost elements
that were affected by the change for the customer were found to be a reduction in inventory
and the related savings in return on capital. Secondly, the administrative savings in planning
were affected due to the changed setup of which the supplier is handling the planning of
supply to the warehouse.

4.3 Day-to-day operations and evaluation of the VMI setup

Having implemented the VMI project the buyer and the supplier set out to achieve a stable
day-to-day operations schedule. The impact of the VMI project could be seen in terms of
financial and non-financial performance measures. The effect on the financial performance
measures are illustrated in figure 3 for the supplier and the customer.

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Figure 3. Effects of the VMI project on financial goals (source: provided by the case company)

As mentioned in section 4.1 the meetings between the supplier and the buyer resulted in the
agreement that costs at the supplier and at the buyer should not be higher after the VMI
implementation. Figure 3 highlights the achievement of this goal. At the supplier, freight costs
increased because the mode of transportation changed from sea to air. In addition the supplier
experienced a moderate increase in inventory and 3 PL costs. However these added costs were
offset by savings in cash flows and additionally the buyer assumed the responsibility of making
for the residual added cost by letting the supplier increase the price of their products. This can
also be seen on the right side of figure 3 in which the customer had an equivalent increase in
the price component. In total this resulted in the supplier not incurring more costs that were
not offset by savings in cash flows or an increased price in products. The customer experienced
a large decline in inventory costs as the customer now could receive products much faster than
before due to the change in transportation mode. The buyer and the supplier were also
together able to identify cost savings in the administrative, planning and monitoring supply
processes at the customer. With a decreased cash flow and the aforementioned price
adjustment for the supplier the net savings effect for the customer is shown on the far right of
the figure.

As mentioned in section 4.1 supply chain measures were also identified for the VMI project.
Based on input from the senior supply chain managers the project group, which consisted of
members from both the buyer and the supplier, was given scenarios that they needed to test
during the analysis of the supply chain. For example, if the financial value of goods in transit
and the large raw material inventory at the customer could finance a supply chain where all
shipments were made by air, lead time could be reduced significantly, while responsiveness to
changes could be increased. Areas of analysis were modes of transportation, payment terms,
effect on cash flow and lead time. In addition, the project group did a mapping of the business
processes in procurement and planning in the two companies to understand the hidden costs

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of the VMI setup. That is, the costs that were not directly visible in terms of inventory,
transportation and handling. The changes in these supply chain performance parameters due
to VMI are shown in table 2.

Supply Chain Parameter Before the change project After the change project

Delivery service 80 % (avg. on time) 97 % (avg. on time)

48 h. call off time
Lead time 12 weeks
12 weeks forecast commitment
Customer side: Customer side:
Raw materials: 20 weeks Raw materials: 3 days
Goods in transit: 5-6 weeks Goods in transit: 0 weeks
Inventory
Supplier side: Supplier side:
Goods in transit: 0 weeks Goods in transit: 2-5 weeks
Finished goods stock: 2 weeks Finished goods stock: 3 weeks
30 part numbers
Volume in flow (Items /Pce) Volume from 1500 pce. pr. year to Same, no significant change.
25000 pce. pr. year

Table 2. Effects of the VMI project on supply chain performance

Table 2 shows that the effects of VMI implementation were evaluated as being positive. For
instance, delivery service increased from 80 % to 97 %. Similarly lead time changed as due to
the changed mode of transportation the supplier was able to provide the buyer with a 48h call
off time. This affected inventory levels for the customer who was now able to minimize its raw
materials stock to 3 days. The supplier, however, experienced an increase in inventory levels as
goods had to be sent quickly when the customer requested an order. The added costs for the
supplier were, however, offset by the customer with the price adjustments as mentioned
earlier.

Before providing implications of the VMI implementation in the next section it should be briefly
noted that a cost driver not considered in this analysis was the risk of obsolescence in regards
to inventories. As material flow in the new setup is moving at a more rapid speed there are
fewer products in the supply chain and consequently less risk of obsolescence in terms of
product updates, engineering change orders (ECOs) and component changes. Therefore a
more detailed analysis for the risk of obsolescence in regards to inventories was not
conducted.

4.4 Implications of the study

In this section 4.4 significant implications of the buyer–supplier relationship are derived and
discussed based on the above-given case study, with the aim of showing how an inter-
organisational approach to VMI differs from a focal one. The implications are discussed on the
basis of the three constructs: communication, cost perspective and supply chain competencies.

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• Communication: Supply chain management literature often states that successful

relationships are based on effective communication (e.g. Kulp, 2002; Dong et al.,
2007). Lacking or inefficient communication is suggested to lead to conflict and
inexpedient behavior due to misunderstandings (see e.g. Su, Song, Li & Dang, 2008).
In general, it can be stated that the greater the breadth and depth of this
communication the more likely it is that the two parties in the relationship can be
perceived as having an inter-organisational approach, whereas a relationship with
lesser breadth and depth of communication can be seen as having a more focal
approach (Lambert, Emmelhainz & Gardner, 1996). Angulo et al. (2004) noted that
proper information sharing in VMI relationships is important in terms of the information
not being delayed or inaccurate or incomplete. Vigtil (2007) stated that sharing of
inventory levels and sales forecasts are the most frequently mentioned information
elements to be exchanged between buyer and supplier. The present study shows that
VMI implementation projects do not only entail communication of inventory levels and
sales forecasts, but an open analysis of the costs and benefits of the projects for both
parties. The communication between the buyer and the supplier entails a collaborative
goal setting, as well as a deeper look at each other’s costs and benefits with the
analysis of the overall performance of the supply-chain. Understanding of the demand
patterns and need for flexibility and speed from the customer side and the limitations in
production processes and procurement lead-times on the supplier side provide a
common ground from which VMI changes can be negotiated and built upon as a
collaborative project. Existing VMI literature have not focused upon this aspect of VMI
relationships to a great extent, although some authors briefly and sparingly have
touched upon the subject (Dorling et al., 2005; Vigtil, 2007).

• Cost perspective: It has been previously noted in the literature that managing costs in
supply chains is vital in order to reduce total costs (Seuring, 2002, pp. 21).When
implementing VMI, companies can either have a focal company perspective or a more
inter-organisational perspective on costs. Existing VMI literature has mentioned some
cost constructs that should be used as a guideline for the success of the implementation
of VMI, but have generally limited performance measures to questions of order
frequency (Waller et al., 1999), safety stock levels (Achabal et al., 2000) and fill rate
(Chan et al., 2006). This signals a focus on performance optimization at the focal firm,
not taking into account inter-organisational cost elements, such as cash flow changes
between buyer and supplier or possible means of sharing the total costs of
implementing VMI. The present study demonstrates how total costs can be understood
and divided among the buyer and the supplier and how this is reached via collaborative
decision-making.

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The present study emphasizes that the cost structure of a supply chain is important
from a supply chain perspective not just a focal perspective. For instance, the above-
given case study shows how in an VMI context the discussion of the mode of
transportation requires an inter-organizational view of the setting as certain modes of
transportation may be seen as unbeneficial when looking merely from a focal
perspective, but beneficial to the supply chain in general when taking an inter-
organizational perspective on the relationships. For instance, the speed in material flow
gives significant benefits in terms of cash flow. Contrarily, if the customer and supplier
are not able to identify important financial parameters and the effects of the changes in
the supply chain emanating from this, the project may likely result in a focal
perspective on VMI, where the benefits of the overall supply chain remain limited
besides the shifts in cost and responsibility from one part of the supply chain to
another. The present study also shows that besides the traditional VMI performance
measures, such as order frequency and fill rate, other measures such as cash flow
improvement and reduction in overhead rates can be beneficial to the project.

• Supply chain competencies: One of the few papers that have investigated the key
determinants of successful VMI adoption in regards to supply chain context and
organizational skills noted that understanding the industry and supply chain factors that
revolve around the implementation and use of VMI are crucial for these types of
projects (see Dorling et al., 2006). These factors can amongst others be competencies
in developing long-term relationships, the degree of investment in VMI and the
competency to evaluate industry profitability. Underlying this Dorling et al. (2006)
mention the importance of understanding the industry structure. In a similar vein
Holmström (1998) noted that supply chain competencies were important when an
introduction of a modified consignment order process at a focal firm using VMI was
made. The present study indicates that such supply chain competencies at both buyer
and supplier can result in an ability to define and measure important parameters in the
implementation and use of VMI that can entail reaching common goals and save overall
supply chain costs for both parties. Inter-organizational knowledge that both parties
share allows them to understand the functioning of the overall supply chain and the
cost structures behind the every-day interaction in a VMI setting. A lack of such
competence on both or just one side of the VMI project would likely lead to a less than
optimal solution.

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5. Conclusion

This paper sheds light on the inter-organizational nature of a VMI implementation in practice
and provides three contributions to the existing literature.

• First, it highlights the tendency of the VMI research to delimit the analysis of VMI
settings to the focal perspective of the supply chain. It is argued that in order to
improve the existing understanding of the VMI concept scholars need to take a step
further from theoretical approaches and mathematical modelling to investigate the
empirical settings of VMI implementations. To understand the actual context and the
benefits of this concept it is necessary to investigate the context, challenges and
emerging practices across both companies in the VMI setting.

• Second, the empirical case study demonstrates how the economic benefits of a VMI
setting are realized through goal setting and analysis at the inter-organizational level. It
shows how certain decisions in a VMI setting may be perceived as unbeneficial when
looking merely from a focal perspective, but prove to be beneficial for the supply chain
in general when taking an inter-organizational perspective on VMI. This is illustrated by
the cost management of a VMI project that shows the offsets in costs across the sites of
the supplier and the buyer. The case study also reports on how both financial and non-
financial drivers of performance are utilized in order to create satisfying solutions for
both parties in the cooperation. This is a novel contribution, as the previous literature
has been rather speculative on real life practices on cost changes and drivers of VMI
performance.

• Thirdly, the study discusses the implications of the inter-organizational perspective of

VMI through three constructs: communication, cost perspective and supply chain
competences. It explains how an inter-organisational approach to VMI differs from a
focal one and highlights the aspects of a VMI setting in regards to these three
constructs. It explains how setting common goals, defining costs and identifying
performance measures are reached via collaborative decision-making that requires a
broader perspective and competence than that of a focal perspective.

It should be noted that as these findings are based on a single case study, they remain
tentative and should be put to empirical test in further research. Nevertheless, this study
provides an important reminder of the inter-organizational nature of VMI and can be
considered a starting point for further studies to encompass both parties, suppliers and
customers, when investigating VMI settings. For future research it is necessary to investigate
the collaboration and working practices between the supplier and the buyer in more detail to
improve the existing understanding of the VMI concept. Research on VMI would benefit from
further investigation of issues that emerge at the inter-organizational level, such as risks, trust
issues, and different areas of conflict during the negotiations and working in VMI related

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setups. Such analyses could result in successful projects as well as failures that will bring
about more deeper understandings of the realities of VMI settings.

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