An Investigation of the Impacts of Market Demand, Forecast Error, and Profit Margin on VMI’s Benefit

Supply chain collaboration has received heavy attention from both practitioners and academic researchers because of its focus on the entire supply chain’s interest and its potential to improve operational efficiency of supply chain management. The close collaboration among the supply chain members is expected to lead to the successful outcome that is not possibly made by the uncollaborative supply chain system. Vendor-Managed Inventory (VMI) became well known to be the supply chain collaboration program that has been already applied to various industries and enables the companies to lower inventories and increase customer service levels. While the majority of past studies support the superiority of the supply chain system with VMI over the traditional system without VMI, the exact conditions and requirements to fully exploit the strength of VMI are still under the investigation. This study investigates the impact of VMI on the supply chain performance. The proposed economic model represents a two stage supply chain system with a single buyer and a supplier. The performance evaluation is conducted in two ways-through model analysis and numerical examples. First, the simple inventory management models that represent two distinct supply chain systems are analyzed under the optimal conditions. Second, the profit-based models are developed to include the revenue and detailed cost items including production, inventory holding, setup, ordering, and transportation costs, and numerical examples are used to compare the profits of two different supply chain systems under different conditions. Based on the sequential process of decision-making and information sharing activities made by the buyer and supplier, the proposed model incorporates multiple steps of the operations including purchasing, replenishment, inventory control, production, and transportation. In the numerical examples, this study examines the impacts of tree environmental and operational conditions-market demand, forecast error, and profit margin-on the VMI’s performances. Based on the results of the model analysis and numerical examples, this study examines whether the VMI system is superior to the traditional system and identifies the pattern of VMI’s performance under different operational contexts. The analytical model including only ordering and inventory holding costs confirms that VMI results in less supply chain costs than the traditional system. The numerical examples of the profit-based model, however, show that VMI does not always outperform the traditional supply chain system. The cost saving due to VMI is caused by dramatic reduction of buyer’s costs, but, in most cases, the supplier appears to incur higher expenses. This study identifies the conditions that remedy supplier’s loss due to VMI. The increased market demand causes serious damage to supplier’s profit, and consequently decreases the economic benefit of VMI for the entire supply chain system. For the supplier, the economic advantage of the VMI system is high when the supplier makes a large error in forecasting market demands in the traditional supply chain system. The numerical examples also indicate that higher profit margin of the buyer reduces the economic advantage of the VMI system for the supplier as well as for the buyer. These results imply that retaining a sufficient amount of demands and corresponding order quantity by properly controlling the sales price is critical to obtain full economic benefits from the VMI program. This study makes the contributions to business practices by providing the following valuable managerial implications about VMI application. First, this study discovers the potential that VMI can be beneficial to every participant of this program. The numerical examples of the proposed model show that, by acquiring sufficient demands and order quantity, even the supplier can be financially benefited by participating in the VMI program. Second, this study reveals the specific conditions that enlarge the cost savings due to the VMI program. The outcomes of the analysis indicate that both supplier and buyer can optimally exploit the advantage of VMI by properly managing the demand forecast and price contract.