Agreement
In the area of supply chain management and contractual relations with vendors and suppliers, a document known as a Vendor Managed Inventory Agreement is sometimes used. These are sometimes also called Supplier Managed Inventory Agreements, or Supplier VMI Agreements for short. At its most basic level, a VMI Agreement is a contract between a supplier/vendor and a customer. The customer agrees to purchase certain inventory items from the supplier and the supplier agrees to ship the inventory following the terms and conditions of the VMI Agreement. These contracts define the basic "rules of the road" for that relationship to continue to function smoothly . In other words, these contracts are essentially templates or check-lists that are used to set out the terms of that relationship in plain language, so that all parties are on the same page. These agreements are especially important in any situations involving large inventories and ongoing managing of that inventory.
A VMI Agreement typically addresses the following contract terms as they apply to the seller and buyer relationship:
Once these terms are agreed to, one party to the agreement may begin fulfilling its obligations under the document. Generally, the supplier will begin sending shipments of the items covered by the VMI Agreement with the understanding that the customer will pay for those items once they arrive.
Essential Ingredients of a VMI Agreement Template
A robust VMI agreement template is essential to align the vendor and the buyer regarding their respective roles in the management of inventory, how performance will be measured and rewarded, and the process for addressing issues that might arise. In other words, to help the parties understand the depth of the relationship they are entering into.
A VMI agreement template should define the key roles of each party with respect to inventory and the distribution of that inventory to customers. A key element of the VMI agreement template will be determining the degree of involvement of the vendor in the day-to-day operations of the business and how the exchange of information and decision-making will work.
Performance is critical in a VMI agreement template. At minimum, the VMI agreement template should define two essential metrics that will determine if the VMI agreement is succeeding or the VMI arrangement needs to be brought back to pre-VMI terms. The first metric, obviously, is whether the volume of sales to customers has increased. The second metric, in most regards equally important, is whether the inventory is decreasing and being replaced with better product which can drive further sales. The VMI agreement template should establish the minimum acceptable level of inventory that all parties believe is necessary to continue to drive sales and provide demand of goods to customers. The parties will also need to address how the metrics will be determined (for example, should they tie to the cost of goods sold or a form of shrinkage within the industry) and how often they will be measured.
Another significant issue the VMI agreement template should address is what happens when the metrics drop below the minimum. Who determines that the metrics have dropped and what rights do the parties have to address those concerns? For example, is the vendor or buyer allowed to terminate a supplier upon any drop in the metrics? What about the vendor’s supplier exposing the buyer to a liability?
The communication protocols for a successful VMI agreement template include determining the appropriate reviewing body (such as committee) of the necessary metrics and the frequency with which that body is going to meet (I suggest at least quarterly). The VMI agreement template should also address whether the committee is going to have the ability to get its hands dirty and deal with real-time issues. For example, if a metric is declining, but the VMI agreement is prematurely terminable, does the committee have the ability to address the issue because it believes that declining inventory levels can be addressed with a minor tweak in the arrangement.
Moreover, all parties should be in agreement as to the manner in which communications are going to work, especially if the vendor has a dedicated sales team at the buyer’s location. Is the vendor going to ensure that its sales team focuses on the entirety of the product category and is not holding back product to prevent cannibalization against the vendor’s own sales? How much, if any, can the vendor’s sales team sell product directly to the buyer’s customers without reducing inventory?
Last, the VMI agreement template should address termination of the VMI arrangements. Remember, this is a significant undertaking for all parties involved. Arrangements can be flimsy but often become interdependent when thrusted into scale. The VMI agreement template should keep in mind the potential assets and liabilities the parties may acquire while seeking to implement a VMI arrangement. For example, if one party extends credit to another party to help them enter into an arrangement, what rights does that party have if the relationship unravels quickly? Is there a right to a lien on inventory and receivables?
Advantages of Implementing a VMI Agreement
When an organization uses a VMI agreement, the advantages that result from the collaboration can quickly prove to be far-reaching and significant.
In the first place, a VMI agreement can lead to improved inventory efficiency, since a supplier is often in a far better position than a purchaser to manage production and maintain appropriate levels of stock. A qualified supplier will be able to keep shortages at a minimum, thus reducing or eliminating stockouts.
A VMI agreement can also enhance the relationship with a supplier. Because the supplier is retained as a partner in what is ultimately a cost-conscious supply chain, the benefits of the agreement can be mutually shared and leveraged. In other words, the favor a purchaser extends by acquiring a large volume of supplies at a discount rate will typically result in a highly-satisfied vendor willing to return the favor by passing on savings realized through even more streamlined and efficient production.
Pitfalls of a VMI Agreement
While vendor managed inventories (VMI) can provide benefits to both buyer and the supplier, determents and pitfalls have also been widely reported. Naturally, these issues can arise when there is no written agreement or an informal agreement governing the VMI relationship. However, these issues can also arise with a written VMI agreement. The following section highlights some of the common challenges in VMI agreements.
Data Sharing Accuracy and Reliability
One major area of dispute in VMI programs has been what data needs to be shared and the reliability of the data being shared. Generally, the accuracy, reliability and proper-handling of the data is the supplier’s responsibility. However, if there are disputes, each party is responsible for their own respective data handling. A VMI agreement can help to set a framework regarding data handling. For example, the agreement can set a reasonable expectation of what type of data needs to be collected. This is especially important for new product launches. The agreement can also establish a process for accurate record keeping, error-checking and data management. Finally, the VMI agreement can allocate the costs of storing, managing and transferring data.
One important consideration in a VMI agreement is that the parties must agree on an appropriate metric for measuring the accuracy and reliability of the various reporting and data systems. These criteria should be defined at the beginning of the relationship to avoid disputes later.
Disputes Resolved By the VMI Agreement Versus Statute of Frauds
A dispute that may arise in a VMI agreement is whether the agreement is governed by the Uniform Commercial Code ("UCC") or the Statute of Frauds. UCC § 2-201(1) provides in relevant part: "a contract for the sale of goods for the price of $500 or more is a contract within the statute of frauds and hence not enforceable unless there is some writing sufficient to indicate that a contract has been made for sale of goods and signed by the party against whom enforcement is sought". The UCC also has several exceptions, including partial performance and acceptance of goods. The Statute of Frauds contains many exceptions as well.
While the UCC provides rules based on contracts for the sale of goods, there are alternative filings with the secretary of state that set forth filing procedures for a variety of commodities. For example in California, a warehouse operator can file a UCC financing statement to perfect its security interest in inventory. The Secured Party can serve a notice of lien by sending a letter to relevant parties implementing CN GETTING VMI AGREEMENT TEMPLATE & DRAFTING TIPS these procedures.
Confidentiality
VMI programs rely in part on the disclosure of sensitive commercial information, such as pricing and product forecasts. In this respect, VMI agreements are similar to NDAs. For example, in a VMI program the customer and the supplier will need to share technical data such as information in the database regarding current and future materials. If either party is too eager to share too much information, these disclosures could lead to disputes.
Another key area of concern is ensuring that the customer/supplier have appropriate safeguards in place to efficiently and securely transmit data. The transmission of sensitive data over a network should be designed by IT professionals to ensure information security. A VMI agreement can set a standard for such data transmissions. For example, a VMI agreement can require that the customer/supplier must comply with a standard for data security practices such as ISO 27001 ISMS.
Trust and Relationship Termination
A major consideration in creating a VMI relationship is the degree to which the parties trust each other. However, trust can also result in problems. For example, if the customer/supplier create a VMI system without discussing the details, it may create a system that does not accurately reflect the desires of either group. This could cause frustration and ill-will between the parties. Also, the VMI system could be difficult to change if an issue arises.
Disputes can arise if the relationship terminates. For example, the parties may have disagreements on how to unravel the arrangement, payment of outstanding debts, taking an inventory, and other matters.
These issues and others that may arise in VMI programs, can be reduced or eliminated with a well drafted VMI agreement.
How to Craft a VMI Agreement Template?
A VMI agreement template serves as a draft or skeleton version of an actual VMI agreement. The purpose of this document is to help a company create a legally compliant and complete VMI agreement. Drafting normally starts with a basic VMI agreement that incorporates a company’s local laws and regulations, terms, definitions, roles and responsibilities, and additional clauses, such as termination and dispute resolution. However, not all templates are created equal and companies are nevertheless advised to tailor their VMI agreements while collaborating with relevant stakeholders and legal counsel.
For those interested in creating their own VMI agreement, the following steps are recommended . First, focus on the underlying legal compliance requirements and the business needs of various departments, such as finance, supply chain, and sales. Second, consult with relevant stakeholders. These parties may include sales, finance, risk management, procurement, IT, and accounting personnel. Third, draft the VMI agreement with the goal of increasing efficiency and revenue. Fourth, obtain input and sign off from all relevant stakeholders, including those in finance, risk management, legal, and other departments. Fifth, distribute the VMI agreement template to relevant partners and clients and train other relevant departments accordingly, such as logistics and warehouse personnel. Finally, review and update the VMI agreement template regularly, to ensure that it remains accurate and complies with all applicable laws and regulations.
Tips for a Productive VMI Agreement
To maximize the potential of VMI agreements, it is essential to have a clear understanding of the legal parameters of such agreements to avoid potential legal pitfalls. In addition, regular monitoring and updates to the VMI agreement can help to ensure that both parties are adhering to its terms and can help to identify potential issues before they become a more serious problem. A successful VMI agreement should include provisions for regular reviews of its terms as well as specific procedures for how disputes between the two parties will be handled. In addition, it is important to maintain open lines of communication between the parties to a VMI agreement to help facilitate any changes that may be needed to the agreement over time.
For example, if a company and its VMI supplier begin marketing a new product to a new audience, the volume of purchases may change significantly as a result. In that instance, both parties should review the terms of the VMI agreement to determine whether any updates are needed to better reflect the realities of the new arrangement. If the parties anticipate that the supply levels of the items in the VMI agreement will fluctuate significantly during the life of the agreement, it may make sense to include terms to that effect in order to avoid conflict or confusion in the future.
Agreement vs. Traditional Inventory Plan
VMI represents a fundamentally different approach to managing inventory than traditional methods. For one, with traditional inventory management, the customer purchases its own inventory and then hires a VMI vendor to manage that inventory for them using a traditional VMI Agreement. However, even when the VMI vendor owns the inventory and is controlling what is being purchased, the customer manages the process, schedules and makes the purchase decisions. The stock level and other decisions are still mostly in the hands of the customer.
Under a new VMI relationship, the VMI vendor will have delegated authority to manage the inventory and make purchases, such as in a vendor managed consignment scenario. This does not mean, however, that the customer no longer has any say in things. In fact, because these arrangements can be so complex, often the best way to implement a VMI agreement is to create a protocol for discussing and addressing issues or questions as they come up. The goal is for everyone to have a greater understanding at the outset of how the process will work.
The difference between VMI and the traditional approach is the timing and authority to control inventory. With traditional inventory systems, inventory is loaded into warehouses, shipped, stored until sold and then picked, wrapped and shipped as needed. Traditional replenishment is based on demand and, as a result, inventory management is reactive.
On the other hand, VMI is preemptive or predictive and inventory is proactively managed based on forecasts of what inventory will be needed. VMI is a more reactive system in that VMI numbers continue to grow , but basic requisites are in place. Each party still has its own roles and responsibilities but has the ability to have greater influence over things than the other party would in a traditional system.
VMI is also much more efficient to the point where a vendor will sometimes build a whole business around it because of the effectiveness of VMI. VMI is valued because it reduces the costs of the management of inventory, which is approximately 25% of the cost of goods sold. And typically, once a company has implemented VMI, they won’t go back. The ROI is just too great.
Traditional inventory systems and vendor managed inventory systems can be somewhat synchronized. Using Inventory Optimization, there is the ability to create a hybrid model where triggers are set in the VMI model to move the right items at the right time and at the same time rely on predictive analytics to determine which items need to be stockpiled. That means VMI takes care of some inventory, but once the next session of predictive analysis is done, the hybrid model has allowed the inventory team to optimize the VMI strategy for the entire enterprise at a higher level than could be accomplished without the Hybrid system.
As a general rule, if a company has inventory greater than $1 million and moves it at least once per day, VMI will probably work well for them. For small and medium sized businesses, VMI is probably still a good option, but they should have an idea of their processes and what they want from the relationship before they start working with a vendor. The key with any vendor today is to find someone who really understands the process, how to make it work and who will follow through on their promises.