Vendor managed inventory and consignment stock: how they work

What VMI and consignment stock are

In vendor managed inventory (VMI) the supplier monitors the customer's stock and decides how much to replenish and when, within agreed minimum and maximum levels. In consignment stock the goods sit at the customer's site but stay owned by the supplier until they are consumed; only then does the customer buy and pay.

These are two different concepts that often travel together. VMI answers "who decides replenishment"; consignment answers "who owns the stock". Either can exist without the other.

Visual map: information flow and stock ownership

The map shows the data flow between customer and supplier, the moment ownership changes, and the numeric example.

VMI vs consignment: the difference in one table

The most common combination is VMI with consignment: the supplier replenishes and still owns what is on the shelf.

How VMI works: min, max and replenishment

The customer shares consumption and stock balance with the supplier through EDI, a portal or a spreadsheet. The supplier uses that data to replenish between two limits.

Min = daily usage × (lead time + safety days)

Max = Min + daily usage × replenishment interval

The minimum covers delivery time and variation; the maximum sets the physical and financial space the supplier may occupy. The safety margin is covered in safety stock, and the classic reorder point in inventory management.

In practice the supplier compares the balance with the minimum every cycle. If the balance is near the minimum, it delivers the difference up to the maximum. The customer stops issuing item-by-item purchase orders.

Worked example: a special fastener at 50 per day

Example (fictitious): an assembler uses 50 units per day of an item that costs R$ 12.00 (Brazilian reais). The supplier lead time is 2 days, safety is 1 day and replenishment happens every 3 days. The month has 20 working days.

Min = 50 × (2 + 1) = 150 units. Max = 150 + 50 × 3 = 300 units. Approximate average stock = (150 + 300) ÷ 2 = 225 units.

Before, the customer bought a monthly lot of 1,000 units (50 × 20) with 150 as safety stock. Average stock was 150 + 1,000 ÷ 2 = 650 units. With a cost of capital of 1.5% per month:

VMI cuts the customer's stock by 425 units, or R$ 5,100.00 of capital (7,800 − 2,700). With consignment the capital released is R$ 7,800.00. The R$ 40.50 per month moves to the supplier, who recovers it in the price: it equals about 0.34% of the R$ 12,000.00 monthly billing (1,000 × 12). If the supplier's gains in logistics and demand visibility exceed that, the deal works for both sides.

How consignment works in practice

• Ownership: the supplier ships the goods under a consignment shipping document; they are identified and kept separate in the customer's stores.
• Trigger for the purchase: consumption in production (or sale) is the event that transfers ownership. The sales invoice is issued then; tax details depend on the jurisdiction and the operation and must be confirmed with your accountant.
• Consumption reporting: the customer reports usage per period and the supplier invoices what was used. Discrepancies are settled with cycle counting.
• Losses and obsolescence: the contract must say who answers for damage, theft, shelf life and slow-moving items.
• Maximum term: many agreements set a deadline for the item to be consumed or returned.

When to use VMI and consignment

Continuous-use items often pair with supplier kanban or a milk run supply route. To choose partners, see supplier evaluation.

How to implement in 6 steps

1. Pick the items: start with 10 to 20 items of stable consumption.
2. Agree on parameters: min, max, replenishment cycle and lead time, using the formula above.
3. Define the data flow: frequency and format of consumption and balance reporting.
4. Set commercial rules: price, payment terms, ownership, losses and maximum term.
5. Adapt the stores: identified area, addressing and controlled access; see inventory valuation for the accounting effect.
6. Measure and review: stockouts, turnover, deliveries and stock accuracy, monthly (inventory turnover).

Sharing consumption data also helps reduce the bullwhip effect across the supply chain, because the supplier sees real demand instead of inflated orders.

Common mistakes and limitations

• Wrong customer stock data: VMI is only as good as the balance reported.
• Min and max calculated once and never reviewed when consumption changes.
• A contract with no rule for obsolescence and slow-moving items.
• Treating consignment as "free stock": the cost of capital exists and comes back in the price.
• No access control on consigned stock, so consumption goes unrecorded.
• Shifting stockout risk to the supplier without giving it the demand forecast.

Frequently asked questions

What is VMI?

It is the model in which the supplier monitors the customer's stock and decides replenishment between an agreed minimum and maximum.

What is consignment stock?

Goods that sit at the customer but belong to the supplier until consumed. The customer only pays for what it uses.

Are VMI and consignment the same thing?

No. VMI defines who decides replenishment; consignment defines who owns the stock. They can be used together or separately.

How do you calculate min and max?

Min = daily usage × (lead time + safety); max = min + daily usage × replenishment interval. In the example, 150 and 300 units.

Who pays for the stock under consignment?

The supplier carries the capital until consumption and usually recovers that cost through the price or the contract terms.

When is VMI not worth it?

With irregular consumption, expensive items with obsolescence risk, long lead times, or without a reliable stock data system.

About the author

Vagner Soares

Lean Manufacturing & Behavioral Management Specialist

Over 20 years in the automotive and metalworking industries (GM and Dana), Lean Manufacturing practitioner since 2006. SENAI instructor and mentor in Brazil’s Brasil Mais Produtivo program, delivering consulting, training and audits for 50+ companies, combining quality, productivity and people development.

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