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The following video outlines five ways that vendor managed inventory (VMI) works. Simply put, VMI is when a vendor manages the physical inventory counts at the customer's facility.
There are several ways this is done.

First, the vendor can position an employee at the customer's facility to manage the inventory. The employee is employed by the vendor but stays at the customer's facility to manage the vendor's inventory.

Second, a physical inventory replenishment in vendor managed inventory agreements includes an individual bringing inventory with them and physically replenishing stocking levels. You'll see this in small stores, or a 7/11 when someone comes and replenishes the beer, chips, coke etc.

The third approach is when a vendor has access to the customer's inventory system. In this case, they manage the customer's inventory counts from their own office by reviewing inventory counts through the customer's MRP or ERP system.

The fourth approach involves the barcoding the inventory and providing a summary of usage to the vendor. The vendor then replenishes the inventory based on the usage provided by the customer. A simply solution might also include providing images or photos of the inventory and or a summary excel sheet. The excel sheet is best used in conjunction with an image. This approach is best used by small and medium-sized enterprises.

Finally, the last strategy includes the vendor renting out physical warehouse space from the customer and or renting out space adjacent to the customer's facility.

Ultimately, the benefits of this type of arrangement for the vendor are that they are able to remain the incumbent supplier. They are assured of getting the customer's business. As such, they reduce their lost sales cost of inventory.

Another benefit is that they help their customer plan better. In fact, a vendor managed inventory agreement is ideal for customers who can't plan.

However, the drawbacks include carrying costs and the issue of a customer who suddenly wants to return product. How is this handled by the vendor?