Vendor Managed Inventory: How long do we need this?

Vendor Managed Inventory (VMI) or Supplier Managed Inventory is one of the several business models that have been made popular by Walmart since it asked P&G to provide this service at it's distribution centers all across US. Just to make sure we are in the same page, here is a definition of VMI* (It is a family of business models in which the buyer of a product provides certain information to a supplier of that product and the supplier takes full responsibility for maintaining an agreed inventory of the material, usually at the buyer's consumption location (usually a warehouse or a DC). It is often described as a symbiotic relationship where both vendor/supplier (Procter & Gamble) and the buyer (Walmart) have something to gain from it. From a buyer (Often a retailer, but can be a Contract manufacturer) perspective, the values are rather obvious. It relinquishes the responsibility of managing the inventory at DC, cutting PO and worrying about the entire process of making sure that the desired items are available for sales or consumption. Does this come free to it! Often times it has to commit to sharing all the market insights (Forecast collaboration) of the demand to it's vendor. Of course it looses any direct control over the inventory to it's suppliers. 

Supplier in turn gets to plan the inventory based on perfect visibility to actual demand and it's own production capacity. The big "value" comes from the fact that supplier having visibility to both demand (through forecast collaboration) and supply (of it's own manufacturing capacity) can do a better job of planning the inventory than the Retailer itself. Hence the supplier having better access to all the relevant information both at demand and supply side, can manage the process optimally with lesser inventory compared to the retailer. Hence the "value" boils down to the supply chain visibility (i.e. information) that allows optimal decision making and consequently a more efficient supply chain. Now if all those desired information (i.e. visibility) is made available to the Retailer, can it get the job done with equal efficiency? I am always intrigued by this last question and would like to explore it a little bit here.

In the present environment it is rather foolish to assume that "All" the relevant information of the vendor will be available to the retailer. The existing relationship between trading partners does not allow this kind of collaboration. This is because the retailer than can use the information to its own advantage at the expense of the vendor. Since the vendors are already aware of this possibility they are unlikely to provide all the details necessary for the retailer to make the best possible decision. Both parties in fact are aware of this reality and hence we have VMI. 

Does a firm like Toyota having an excellent reputation for developing trust based relationships, need this sort of model? May be not! When businesses worldwide would improve their processes to the extent that VMI would be considered redundant, than it would be safe to assume that we have reached the pinnacle of collaboration in our extended supply chain. Until than VMI is going to stay with us.

* Note: Click here for the Wikipedia site for VMI. 

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Risk Modeling: Can we blame Analytics for the current status of economy?

Scenario analysis in business involves investigating multiple alternative events and their impact on the final outcome. For example if I am trying to predict the revenue of Motorola in US based on growth in demand for a certain high-end model, than I need to look at alternative growth figures to create several possible scenarios and predict revenues for each of those scenarios. Hence if the likelihood of revenue growth is 8% this quarter based on a 15% growth in the new model, than I must look at all other possible growth figures in addition to the 15% number.This will provide alternate figures of revenue growth. Such analysis is quite common in the industry and decision makers often look at these alternatives and plan accordingly. 

Banks and other financial institutions whose business are dependent on prices in the "real estate" market must have looked at multiple scenarios of price change. Now the question is how do we determine these alternative growth numbers? Historically the housing market has experienced steady growth (in prices) due to persistent government policy of encouraging higher house ownership tom-toming it as a sign of prosperity. If the growth number is always positive and varies for example between say 1% to 15% on average, than an analyst is going to use only these numbers in the stress test. Consequently he/she will most likely miss out the -25% drop in average price that we have experienced in the last year. 

Now any decision based on the lowest growth of 1% is unlikely to cover the risks associated with a 25% drop in price. Is this how our sophisticated analysis failed to prepare the banks adequately for the present slump in real estate price and account for the risks associated with it? I am neither an expert in this process nor aware of the exact data that are used to perform the risk analysis. However inability to visualize an event which has never occurred is really a difficult situation. It is a challenge for the analytics community to look beyond historical data in a significant way, and apply those scenarios into the decision making process. 

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Inventory Collaboration: Why Commercial Airlines are struggling to make it happen?

Commercial airlines in US are holding some of the most expensive MRO items in their balance sheet. From high-speed turbines to impellers, high-speed bearings, landing gears and other mechanical devices, the total inventory by some estimate was more than $250b in US alone in year 2000. Since there are very few OEM's who manufacturer these aircraft components, the inventories are mostly the same items. For example engines are mostly built by GE, Pratt-Whitney, Rolce-Royce or sometimes Bombardier. Moreover these spares are often located in same cities like Chicago, New York etc. which happens to be the hubs of the major airlines. One of the most obvious approach to reduce the inventory of these common parts in co-located hubs is to collaborate and pool these items. The benefits of reduced working capital and higher service level is rather obvious. The question is why it is not happening! Several attempts in the past, particularly in Europe to pool the inventory even among airlines-alliance partners did not materialize! If the investment in working capital is so huge and benefits are a no-brainer, than why airlines are struggling to make this happen?

This problem has been studied extensively in the past, both by academics and by practitioners. One of the most common causes was the poor relationship between the competing airlines due to fierce competition among the large players such as American and United in Chicago or United and Delta in Denver. Consequently they are reluctant to share their operational data, particularly in the absence of any third party MRO service provider which can potentially stock and distribute these items from a central warehouse. 

Here I want to bring two other operational issues which I think are very important and must be addressed in order for the collaboration to see the day-light. I would illustrate my point here using a very simple example. 

Let us consider we have only 3 airlines United, American and Delta operating in Chicago's O'hare and they are planning to collaborate on a Honeywell made 'landing gear'. Suppose the existing number of spares for the 3 airlines are 100, 60 and 40 respectively. When these 3 parties approached a consultant, he studied the demand variability and came up with a pooled inventory of 150 (Present inventory is 100+60+40 = 200) at a single warehouse to support the combined demand while ensuring the minimum prescribed service level. Now the question is how do we allocate this 150 among the 3 players. The simplest approach is to go for a proportional allocation. The existing numbers are in the ratio of 100:60:40 (i.e. 5:3:2); hence the new numbers can also be split in the same ratio. Hence each airlines would now pay for 75, 45 and 30 units respectively. However this does not make any sense! The smallest airlines (in this case the one with 40 units originally) is going to have 150  units potentiall available for use, a significantly large number to boost it's service level really high. However for the largest airlines, the benefits in service level (when inventory jumps from 100 earlier to 150 now) is not that high. Hence this allocation mechanism does not make sense and provides very little incentive for the largest incumbent to participate.   

Another challenge would arise when the inventory for some reason drops to say only 1 unit and right at that time 2 different airlines have the demand for that item. Now how to determine who should get the access to this last unit!

I strongly believe that unless these seemingly simple but fundamental challenges in designing a fair and equitable allocation are addressed, inventory collaboration would be rather difficult. I would propose a possible solution to this issue in my next posting. 

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