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A standard agreement for vendor Vendor managed

inventory
managed inventory
Francesco Zammori, Marcello Braglia and Marco Frosolini
Dipartimento di Ingegneria Meccanica, Università di Pisa,
Nucleare e della Produzione, Pisa, Italy 165
Abstract
Purpose – The purpose of this paper is to define the standard structure of a vendor managed
inventory (VMI) agreement, which can be used as a guideline for the early definition of the agreement.
Design/methodology/approach – Starting from an industrial application of relevance, the
information flow and the technical details, which are to be defined before the operation startup, are
identified and discussed. These data are used as the key points for the definition of the basic frame of
the agreement. A particular emphasis is given to the ‘‘Technical Specification’’ and the ‘‘Service Level
Agreement’’ sections.
Findings – It is shown that a VMI agreement should be arranged into parts dealing with the generic
and legal sides of the agreement, whereas the technical aspects and the relation-specific topics should
be addressed in the annexes. This increases the flexibility of the agreement in that, as the VMI
relationship evolves over time, changes will affect only the annexes leaving the main body of the
agreement unaltered.
Practical implications – The proposed agreement has a flexible structure and can be easily adopted
by the personnel involved to correctly define and implement VMI in several industrial fields.
Originality/value – By approaching VMI from a practical point of view, this paper identifies the main
issues that must be covered in the agreement to fit the needs of both parties and to assure benefits on
both sides.
Keywords Agreements, Service levels, Supply chain management, Vendors, Inventory management
Paper type Case study

1. Introduction
In recent years, the supply chain management has proven that companies can achieve a
sustainable competitive advantage whether they compete as part of the supply chain
and not as single entities (Ellram, 1995; Cooper and Ellram, 1997; Beamon, 1998).
Hence, they must focus on their core competencies and keep together the expertise of
external partners (i.e. suppliers and logistic providers) in order to manufacture and
deliver the products that customers demand (Hines and Rich, 1998). In this regard, the
outsourcing of logistic functions has been a great opportunity for many companies,
which cite the operational efficiency, a greater flexibility, an enhanced service level and
a better focus on their core business as the main benefits that can be obtained
(Rabinovich et al., 1999; Göl and Çatay, 2007). The biggest paybacks have been
exploited by those companies which outsourced an integrated set of logistic processes
using a third party logistic provider, as this increases the involvement of the provider
himself and facilitates the integration of the entire supply chain (Boyson et al., 1999;
Bolumole, 2001; De Boer et al., 2006).
By the early 1990s, the awareness of the economic opportunities offered by the
logistic outsourcing has led to the development of several partnership initiatives (i.e.
automatic replenishment programs, ARPs) which have been successfully exploited to Strategic Outsourcing: An
coordinate the logistic flows and to match the customer demand as close and quick as International Journal
Vol. 2 No. 2, 2009
possible (Daugherty et al., 1999; Mason-Jones et al., 2000; Sabath et al., 2001). pp. 165-186
Nowadays, among the ARPs strategies there is a spike of interest in vendor # Emerald Group Publishing Limited
1753-8297
managed inventory (VMI), which is a great example of a value added logistic process DOI 10.1108/17538290910973376
SO being outsourced (Ferrozzi and Shapiro, 2000). Although literature on this subject is
extensive, it is somewhat surprising that the number of practical and technical works
2,2 on VMI is relatively small. Indeed, most of the papers deal with VMI in a mere
theoretical way, by proposing optimization models that can be rarely applied in
industrial situations (see for example Goyal and Gupta, 1989; Braglia and Zavanella,
2003; Disney et al., 2001; Disney and Towill, 2003; Grubbstrom and Zanoni, 2004; Boute
et al., 2007). Just a few works discuss interesting practical applications (see for example
166 Eisenhardt, 1989; Holmström, 1998; Kaipia et al., 2002; Valentini and Zavanella, 2003;
De Toni and Zamolo, 2004; Danese, 2005), but these as well are of little help for
personnel involved, since the discussion focuses on the performance of VMI and
neglects the technical details which must be defined before the operation start up.
A similar situation also characterizes the outsourcing literature, since the majority
of the works deal exclusively with the grounds, the benefits and the drawbacks of
outsourcing (Sohail and Sohal, 2003), while just a few contributions propose practical
prescriptive models to support the outsourcing decision making process (McIvor, 2000;
Momme and Hvolby, 2002; De Boer et al., 2006). Moreover, all these frameworks focus
on strategic decisions, while no mention is bestowed on the operating issues that must
be addressed to develop a logistic partnership.
The lack of operating contributions is an important gap in technical literature
because, although VMI offers several benefits (Daugherty et al., 1999; Angulo et al.,
2004; Dong et al., 2007), if the technical details of this agreement are not correctly
defined and covered in a legally sound contract (Yang et al., 2003) its adoption could
even compromise the logistic performance, especially on the supplier’s side (McBeath,
2003; Pohlen and Goldsby, 2003; Hemilä et al., 2007).
Considering the above mentioned issues, this paper proposes a comprehensive
structure of a VMI agreement, which can be adopted by the personnel involved as a
useful guideline to correctly implement VMI without missing any technical detail. This
agreement has been developed starting from the expertise originated in an industrial
application, within which all the technical issues that must be accomplished to support
VMI have been identified.
In accordance with its operating aim, this paper briefly pinpoints the legal issues of
the agreement, and focuses on the technical features and the service level agreement
(SLA). Additionally, considering that VMI is a long lasting relationship, a consistent
effort has been made to protect the flexibility of the agreement and to enhance its
adaptability over time. Indeed, an agreement which can change as the relationship
itself evolves is preferable and more effective than an agreement that is fixed and
thoroughly defined (Lynch, 2000).

2. Basic concepts of VMI

VMI is an inbound logistic strategy based on the concept that the supplier should be in
charge of managing customer’s inventories by using the demand information provided
by the customer himself (Hall, 2001). This eliminates a step in the information chain
and creates a better demand visibility for the supplier, who can synchronize his
manufacturing process to the actual demand (Kaipia et al., 2002) with the result of
having less inventories and lower logistic costs. Additional advantages are listed in
Table I (Daugherty et al., 1999; Angulo et al., 2004; Dong et al., 2007).
The most relevant feature of VMI is a shift of decision making as the supplier
manages inventories and triggers replenishment on behalf of the customer. In doing so
he can make decisions on the shipment frequency and on the replenishment quantities,
and at the same time he becomes responsible for keeping the quantity stored at the Vendor managed
customer warehouse between a minimum ‘‘s’’ and a maximum ‘‘S’’ level and he is liable inventory
for any stock-out related costs. In turn, the customer must share sensitive and timely
data to help the supplier with the production planning and the inventory management.
Since the availability of accurate data is essential to formulate realistic order
proposals (Cophra and Meindl, 2001) information sharing is the core of the process and
it is typically based on the two transactions shown in Figure 1 (Hall, 2001; Pohlen and
Goldsby, 2003).
167
The first one is the advance ship notice (ASN), which is sent by the supplier to the
customer as soon as a shipment is made, and contains detailed information about
the content and the destination of the freight. This notice facilitates the updating of the
inventory records and permits to reduce the fixed cost of receiving.
The second one is the product activity record (PAR), which is periodically sent by
the customer to the supplier and contains all the information that are useful to schedule
production and to decide whether a new shipment is needed or not. The current stock
level (of the customer) is the most valuable information and should always be provided
to the supplier. Other data of the PAR largely depend on the stage of the supply chain
where VMI takes place. As a general rule, when VMI is established between a
manufacturer and a wholesaler, the PAR should also contain point of sales data and/or
incoming orders. Information concerning stock withdrawal could also be transferred
for control purposes. Conversely, when VMI is established between inner tiers of the
supply chain (i.e. manufacturer to manufacturer VMI) both the master production
schedule (MPS) and the stock withdrawals should be transmitted to the supplier
(Vigtil, 2007). In this case, due to the manufacturing lead time, the supplier is forced to
schedule production using a time phased planning procedure and so the accuracy of
the data contained in the customer’s MPS becomes paramount. In particular, the MPS
should be split into two portions (Braglia and Zammori, 2006): a frozen horizon (FH),
containing fixed orders, and a planned horizon (PH), containing provisional orders

Supplier benefits Customer benefits Shared benefits

Bullwhip effect reduction Stock-out reduction Reduction of data entry errors

Lower reliance to forecast
Reduction of order
modifications
Production planning
simplification
Financial costs reduction
Purchasing process
simplification
Increase of sales
Improved speed of the process
Stock level reduction
Improved service level Table I.
Main advantages of VMI

Figure 1.
Information flows in VMI
SO which can be modified by the customer only within a maximum range of variability
  percent agreed both by the customer and the supplier. Only in this way the
2,2 supplier can improve his ability to match the actual customer demand without relying
on significant stock.

3. Methodology
Legally speaking VMI agreements are private subscriptions and, although they have
168 been recently typified by the industrial praxis, they are not regulated by any legal code
of practice and there is not a codified structure to conform to. As a consequence, the
design of a standard VMI agreement is an original subject which has not yet been
deeply explored.
As usually happens when not much work is available in technical literature ( Jaiswal
and Kaushik, 2005), the authors approached the agreement definition through a case
study research methodology.
To select a potential candidate to be taken as the reference point, the authors started
from the assumption that, whereas the legal and generic issues of VMI partnerships do
not depend on the operations performed by a factory, most of the logistic issues
covered in the agreement are site specific and can be hardy generalized. In other words,
only by designing/modeling the logistic operations it is possible to specify the technical
parameters which must be covered in the agreement.
For this reason, the authors chose to start from a complex problem to include in the
basic agreement almost all the technical issues that can be encountered during
the development of a VMI partnership. This, in turn, increases the flexibility of the
agreement and its ability to be applied to different industrial fields. Indeed, a
comprehensive agreement can be used by the personnel involved as a sort of checklist
and/or as an operating guideline to select the topics that must be tackled to correctly
implement VMI, without overlooking any technical detail.
As a result an Italian plant, which manufactures superconductors coil windings for a
word wide corporation that produces magnetic resonance imaging machines, was chosen
as an optimal candidate. The identity of this plant must remain screened and in the
following of the paper we will refer to it as superconductor manufacturer (SM). As
previously mentioned, this choice was motivated by the complexity of the manufacturing
process and by the opportunity to analyze a manufacturer to manufacturer VMI, which
is certainly the most complex form of VMI. Indeed, to implement VMI within SM, several
operating problems concerning logistic and manufacturing issues had to be tackled thus
enabling the authors to understand in more depth the technical issues that must be
covered in a comprehensive VMI agreement.

4. Major sections of the VMI agreement

Lynch (2000) and Heffernan (2004) noticed that, to promote trust and to assure the
continuity of a logistic partnership, parties must agree upon all the conditions which
must be respected during the ongoing of the relationship. Once the basic conditions of
the partnership have been stated in a contract, both parties exactly know what to
expect from the relationship and future controversial can be avoided. However, in the
definition of the agreement a first problem arose because the acceptance of a contract
intrinsically contrasts with the need of flexibility that must be granted when dealing
with long lasting relationships. Since it is impossible to foresee all possible future
scenarios, the agreement has been written in a flexible way, thus allowing the
agreement to be modified as the partnership itself evolves over time. With this aim the
agreement has been divided into independent chapters which cover the legal and the Vendor managed
generic sides of any VMI agreement, whereas technical details and specific issues are inventory
discussed in the technical specifications and are recalled in the chapters when needed.
In this way, any future changes can be easily introduced leaving unaltered the main
body of the agreement.
The general structure of the agreement and the basic links between the chapters
and the annexes are shown in Figure 2.
169

Figure 2.
Structure of the
VMI agreement
SO As can be seen, the VMI agreement developed in collaboration with SM is based on the
following sections:
2,2
. preamble;
. whereas clause;
. scope of work;
170 . terms and conditions;
. SLA; and
. annexes.
The preamble is a heading, where the customer and the supplier declare their intention
to enter the relationship and to subscribe the contract. Company names, registered
head offices, tax codes and other significant data of both the parties are also provided.
The whereas clause gives an outline of the overall framework of the agreement and
underlines the willingness of both parties to undertake a relationship based on trust
and reciprocal support. It also shows the services to be performed and the agreements
of both parties with respect to the covenants and the conditions afterwards reported.
The scope of work enlightens how the customer and the supplier are expected to
behave, making reference to the annexes for technical details. To avoid dissimilar
interpretations, claims and/or misunderstandings, this part specifies what is effectively
‘‘in’’ or ‘‘out’’ with respect to the scope of the relationship. In particular, it includes some
parts concerning the service performed by the supplier and the information released
by the customer to support it.
The terms and conditions section covers the legal issues of the agreement and is
made up of a number of subsections. The first part defines the terms of the relationship
and explains the termination options and the corresponding causes/conditions. The
parts detailing the causes of rescission refer to the SLA, where the expected
performances as well as penalties and effects of covenant infringement are discussed in
further details. Considering the collaboration spirit and the long-term duration of a
VMI this section also contains a set of possible renewal options.
The second part of the terms and conditions covers the responsibilities of both
parties in the case of
. industrial accidents;
. damages caused to stored items and/or equipment; and
. theft and/or unexplained loss of stored items.
All the applicable insurances and the eventual waiver of subrogation have been
included in this section. Another important element included in the terms and
conditions deals with the financial aspects of the relationship. Briefly, some chapters
have been included to cover
. the price of the items;
. terms and methods of payment;
. start up cost; and
. penalties.
Finally, a chapter dealing with the confidentiality of data has been added, in which
both parties agree to keep any shared information in strict confidence.
 The SLA is a characteristic section of any logistic agreement (i.e. performance- Vendor managed
based agreement) where the customer and the supplier commit themselves to attain a inventory
predetermined level of performance. This part defines the service which is expected to
be supplied by both the customer and the supplier and includes a list of key
performance indicators (KPIs) used to quantify and to assess the achieved level of
performance. For this reason, KPIs have been tied in with penalties and/or benefits, in
order to define congruent bonus-malus incentive system. Furthermore, a chapter has 171
been included which gives the possibility of making periodic inspections to check the
preservation of the operating conditions and/or of the quality standards defined in the
agreement.
The Annexes section defines in further details some of the technical topics briefly
cited within the body of the agreement. The technical specification is certainly the most
important part of the annexes and carefully details all the technical features which are
situation-specific and which could evolve over time. Technical aspects which have been
tackled concern:
. product characteristics;
. plant and premises;
. equipment;
. information systems;
. data type; and
. operating procedures.
Additional details concerning the main topics covered in each section of the agreement
are given in appendices 1-4.

5. Analysis of the industrial application

The following subparagraphs discuss the main issues which have been addressed and
included within the technical specifications and the SLA. As previously discussed, most
of the elements included in these sections of the agreement deal with the operations
performed by the customer and the supplier. To give evidence to this fact, this
paragraph focuses on the planning, control and scheduling issues which have been
addressed and shows how only by designing/modeling such operations the parameters
of the contract can be clearly specified.
To facilitate the comprehension of these topics, a brief description of the
manufacturing process performed within SM has been included herein. Coil windings
are made up of the so-called Type II superconductor wires, made of tiny filaments of
niobium-titanium alloy embedded in a matrix of solid copper. Superconductor wires are
manufactured through the restacked drilled billets production cycle, which is based on a
sequence of hot extrusions and cold-drawing operations which permits to turn a three-
layer billet (of niobium, titanium and copper) into a wire of 0.825 mm in diameter.
A twisting machine twists wires with a different pattern of the internal strands to
obtain the Type II superconductor. This is a vital step of the process, not only because it
allows the electro-dynamical decoupling of the filaments, but also because it
differentiates (i.e. customizes) the end product. This aspect plays a fundamental role in
the part of the technical specifications concerning production planning and scheduling.
SO Finally the wires are chemically cleansed and tinned. After that, wires are checked
by an electronic device which analyzes their structural integrity and are finally winded
2,2 on coils and packed.

5.1. Length of the FH and PH

The possibility to easily integrate the MPS of the customer in the MRP of the supplier
is a prerequisite to assure a win–win VMI relationship (Vigtil, 2007). To this aim the
172 MPS of the customer should be divided into an FH and a PH. The splitting of the MPS
is probably the most critical decision to be made and, in the present study, this choice
was supported by the structure exemplified in Figure 3.
The figure shows an MPS that covers a time frame of ‘‘Z ’’ weeks, divided into an FH
of ‘‘T ’’ weeks and a PH of ‘‘Z-T ’’ weeks. The same figure also displays the
manufacturing process, characterized by a total lead time of ‘‘K’’ weeks. In addition, the
bended arrows highlight the parts of the manufacturing process that are covered by
the FH and the PH, respectively. For instance, the FH covers the shipment, the
assembly phase and a portion of the activities of the third department, while all
the other steps of the process relate to the PH. This means that only the shipment and
the assembly phase can be pulled by the fixed orders of the FH, while the other
manufacturing steps must be pushed in accordance to the orders of the PH. In other
words, the subdivision of the MPS in two portions allows the implementation of a
push–pull production system with a separation point which, in the example of Figure 3,
corresponds to the assembly operation.
Therefore, whenever possible, the length of the FH should be greater than the
manufacturing lead time of the supplier, since this allows to manage the production
process in a make to order way. Otherwise, at least the PH should be longer than the
manufacturing LT, to allow the supplier to synchronize his productive activities in
accordance to the provisional orders released by the customer. Note that this condition

Figure 3.
Information integration
in manufacturer to
manufacturer VMI
is suboptimal because in order to protect production from the variability of the PH Vendor managed
orders it is necessary to keep safety stocks. However, it is essential to avoid the inventory
condition where the lead time of the supplier exceeds the length of the customer’s MPS
because to schedule production the customer would be forced to generate his own
demand forecast and most of the VMI benefits would get lost. These considerations are
exemplified in Figure 4.
In the case of SM, the production lead time was equal to four weeks and therefore we 173
easily realized that the MPS released by the customer had to be greater than this time
lapse, to be of any help for SM. On the other hand, the decision to split this period into
an FH and a PH was not so trivial since we had to identify a practicable separation
point to deploy a hybrid push–pull production system. An optimal candidate was
found at the twisting operation, for it presents two valuable characteristics:
(1) It is the point where the customization takes place.
(2) It comes immediately after the restacked drilled billets production process,
which, due to technological constraints, cannot be split into segments.
Then, the decision concerning the required minimum length of the FH was
straightforward. Indeed, since the production lead time from the twisting operation to
the shipments is equal to one week, the minimum acceptable condition was an FH
covering exactly one week. Using these considerations as a starting point to negotiate
the contract, an agreement with the customer was reached for an FH and a PH of two
and four weeks, respectively. The extra week of the FH allowed SM to cope with the
variability of the production lead time and with any contingent issues.

5.2 Maximum degree of variability

The FH covers a period shorter than the total production lead time, and this is a
suboptimal condition for SM. Actually, the restacked drilled billets production process
must be scheduled using the variable orders contained in the PH and safety stocks are
needed to protect this part of the process. Therefore, the next step consisted in the
definition of the maximum tolerable variability (± percent) of the planned orders.

Figure 4.
Effects of the FH
and of the PH on the
supplier’s schedule
SO With this purpose, we first decided the way to schedule production and then we
simulated the process in order to assess its ability with respect to a tolerable variability
2,2 of demand.
As shown in Figure 5, the standard MRP time phased planning procedure was
opportunely modified following the procedure recommended by Braglia and Zammori
(2006).
Briefly, to fulfill the demand ‘‘D’’ of the customer, orders are inserted in the MRP at
174 the maximum possible value Dmax (i.e. Dmax ¼ D  (1 þ )) and, since the customer
will not always order the maximum quantities, to avoid a continuous stock
accumulation, a closed-loop control system is introduced as an integrating part of the
planning procedure. Concerning this last point, any time the customer updates his MPS
and the oldest planned order is frozen, a check is made to compare the cumulative
value of the frozen orders with the quantities which are already available in stock and/
or which are scheduled to arrive from the production pipeline. If these quantities
exceed the cumulative amount of the frozen orders, a rectifying value R is computed
and used to adjust the quantities which have been scheduled at week 5. Note that
acting on these quantities is not an arbitrary choice. Indeed, since the lead time used to
anticipate production is equal to four weeks, the orders scheduled at week 5 have not
yet been launched into production and therefore if they are modified the stability of the
productive plan is not compromised.
Furthermore, to minimize the safety stock needed to protect the production from the
internal variability, a constant work in process system (CONWIP) was developed.
Indeed, this is one of the best ways to keep low the lead time variability, by limiting the
total number of jobs allowed in the restacked drilled billets production system
(Spearman et al., 1990). The designed CONWIP system is schematized in Figure 6.

Figure 5.
The adopted time phased
planning procedure

Figure 6.
The hybrid push–pull
production process
Finally, a discrete event simulation has been carried out to assess the performance and Vendor managed
the capability of the designed planning system. By means of a statistical analysis of the inventory
simulation’s results, it was found that the system is almost insensible to a ±9 percent
variability (of the planned orders) and that it can handle variability lower than ±12
percent. For greater values, the robustness of the system is not granted as the
probability of stock out at the customer rapidly increases.
When negotiating the agreement, these values were compared with the accuracy of 175
the forecasting system of the customer. Unfortunately, the customer declared an
average root mean square error (RMSE) of 7 percent, which corresponds to the
maximal variability of the planned orders equal to ±14 percent. Indeed, by making the
approximation of the error being normally distributed with zero average and standard
deviation equal to the above mentioned RMSE, (i.e. e percent ~ N(0, 0.07)), one obtains
a 95 percent confidence interval I for the forecasting error equal to I  [0.14, þ0.14].
Since, this interval exceeds the maximal variability which can be handled by the SM
and taking into consideration the collaborative spirit of VMI (i.e. the necessity to share
risks and benefits), both parties agreed for a value of  equal to ±10 percent.

5.3 Value of ‘‘s’’ and ‘‘S’’

Another logistic issue which was addressed consisted in the definition of the minimum
and maximum stock levels to be kept within the customer warehouse.
Since it takes one day to deliver the coils from the supplier to the customer, a safety
stock ‘‘s’’ of ten coils was considered sufficient to assure the production continuity at
customer facilities. Indeed, the average demand is equal to 20 coils per week and
therefore ten coils can cover a production period that is more than twice the average
transportation time. In a similar way, 35 coils were considered a reasonable value for
the maximum stock level ‘‘S’’. This is because the supplier is expected to deliver once
per week and a generic truck carries up to a maximum of 20 coils.
Again, the feasibility of these values was confirmed by means of numerical
simulations. A meaningful sample of the obtained results is given in Figure 7, which
clearly ascertains the correctness of both the values chosen for ‘‘s’’ and ‘‘S’’, showing the
stock trend at customer warehouse, at (supplier) finished goods inventory and at
separation point between the push–pull manufacturing process of the supplier.

5.4 Messages and information system

The VMI relationship has been based on the following transactions, sent via an
electronic data interchange (EDI) system.
(1) The customer sends a PAR on a daily basis to inform the supplier about any
change in the inventory.
(2) Once the supplier has received the PAR, he updates the replenishment plan and,
if the reorder point is reached (i.e. 15 coils), a purchase order is created.
(3) The supplier sends a purchase order acknowledgment and waits for the
customer approval.
(4) As soon as the confirmation has been received, the supplier picks the orders up
and ships them and transmits an ASN to inform the customer about the
shipment.
SO
2,2

176

Figure 7.
A sample of the
obtained results

(5) When the shipment is received the customer transmits a receipt advice to
inform the supplier about the actual composition of the freight. The supplier
can match it to his purchase order to determine any problems.
(6) Weekly, as soon as the MPS is updated (i.e. weekly rolling), the customer sends
his MPS to the supplier, which is divided into a two-week FH and a four-week
PH. Once the supplier has received the MPS, he updates the MRP and generates
production orders for the line.
As soon as the VMI relationship improves, the customer oversight on the orders
proposed by the supplier will be avoided. Therefore, we decided to use the purchase
order acknowledgment for a start up period of three months and to suspend it after this
period, unless any operating problems arise.

5.5 Identification code

To facilitate the receiving operations the customer required the use of a barcode
identification system. The following information has been included within the barcode:
. identification code of the supplier;
. identification code of the production lot;
. identification number of the coil;
 . date of completion; Vendor managed
. superconductor wires typology; inventory
. nominal diameter and tolerance limits; and
. executed quality checks.
Due to the large amount of information to be coded, a 128-B (ISO/IEC 15417, 2007) code
was chosen because it allows to generate all the ASCII characters (i.e. 0-9, A-Z, a-z and 177
special characters) and it is unlimited in length.

5.6 Stocking and packaging

In the specific application stocking and transportation did not show significant
problems. Anyway, some technical issues have been defined to avoid possible causes of
damage during storage and transportation.
As for the coils, they must be wrapped with a polypropylene film forming a
protective layer 5 mm thick. They can be stocked on the ground, but cannot be piled up.
Additionally, to protect the superconductive wires, the coils cannot be grabbed on the
external surface and must be maneuvered using forklifts fitted with a 1.5 m length coil
ram, which inserts through the hollow center of the coil.
Similarly, to allow a correct reading, the barcode must be stuck on the
polypropylene film and placed on a plane surface of the coil. Additionally, to avoid
collision with the coil ram the barcode must be placed in a perimetric area comprised
between 50 and 60 cm from the center of the coil.

5.7 Quality requirements

Considering the limited number of manufactured coils and their requirements in terms
of security, the customer performs 100 percent incoming quality control checks. The
main test consists of a quench test, which is used to assess the capacity of the coil to
reach and maintain a superconductive state at cryogenic temperatures. If the test fails,
the whole lot is rejected. Two failed quench tests in a row or three in a semester can be
considered as causes of rescission of the VMI agreement.

5.8 KPI and responsibilities of parties

To assess the attained level of performance a set of KPIs has been defined. These and
the corresponding threshold values are shown in Table II.
Failure to respect the threshold values is cause of penalties, while the reiteration of
this condition can lead to the rescission of the agreement.
Concerning the accuracy of the MPS, a certain level of tolerance is given to the
customer (i.e. penalties are not issued as soon as changes of the frozen orders are
made). However, in case of changes occurred within the FH, the supplier is not
compelled to fulfill the extra orders and the customer grants him a premium price if the
new requests are accomplished.

6. Conclusions and future works

This paper has approached VMI in an operating way, by proposing a standard VMI
agreement which can guide personnel involved in the initial definition of the
agreement. Although the agreement has been defined starting from an industrial case
of relevance, most of its parts (i.e. preamble, whereas clause, scope of work, terms and
conditions) concern the legal and the generic issues of VMI and can be directly applied
SO KPI
2,2 Customer KPI Supplier KPI
KPI Threshold value KPI Threshold value

Modifications frequency of <1 per month Trespassing frequency of the <1 per month
the frozen orders maximum stock level ‘‘S’’
Maximum absolute <2 coils Trespassing frequency of the <1 per trimester
178 modification of the frozen minimum stock level ‘‘s’’
orders
Average modification of <0.5 coils Maximum stock value <35 coils
the frozen orders
Extra modifications <2 per month Fill rate >99.5%
frequency of the planned
orders
Maximum absolute <15% Maximal duration of stock <1 days
variability of the planned outs
Table II. orders
KPIs included Accuracy of the inventory >99% Accuracy of the ASN >99%
in the SLA data

to different industrial sectors. Conversely, the issues covered in the SLA and in the
technical specifications are site specific and cannot be generalized: only by designing/
modeling the logistic operations it is possible to specify the parameters covered in
these sections of the agreement. Nevertheless, to some extent this paper can be useful
to define the site specific sections of the agreement. Indeed, it has the merit of listing all
the technical details which must be necessarily addressed and can be considered as an
operating guideline to correctly implement VMI, without missing any important issue.
This is the case, for example, of KPIs and information sharing. Although there are
several ways to accomplish such requirements, the paper strongly emphasizes the
necessity of selecting a structured set of KPIs and to split the MPS into an FH and a PH,
since both these issues must be adequately tackled and addressed in the agreement.
Finally, it is worth noting that this paper opens several fields of research. Indeed,
according to the authors, most of the technical parameters which must be included in
the agreement are usually defined on the basis of manager expertise or using rules of
thumb. Therefore, although this paper has offered some insights concerning the
definition of such parameters, it seems desirable to develop a methodological
framework to support the definition and the optimization of these issues before the
agreement is defined.

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Appendix 1: scope of work

Replenishment entrusting
The core of the partnership is stated as follows:
181
. The customer gives the supplier full responsibility to generate the purchase orders and to
replenish inventories.
. The customer maintains property of the warehouse and the responsibility for the
operating management of the inventories.
. The supplier is given a full autonomy concerning production and replenishment policies.
. Both the customer and the supplier agree to share all the information which are necessary
to optimize VMI.
. The supplier assures the customer of the level of performance defined in the SLA.
Most of times the duties of the supplier end as soon as goods are delivered at customer premises.
However, as for spare parts inventories, the supplier can also be in charge of the operational
management of the customer warehouse (i.e. handling, storage, picking etc.) and sometimes VMI
can even be coupled with a free pass. Therefore, in this part it is necessary to clarify which
alternative will be adopted.

Description of warehouses, facilities and premises

The physical location of the warehouse is settled and, if the warehouse is shared by products that
are not included in the VMI agreement, the minimum space assigned to the supplier is defined.
The customer assures the availability of the handling and storage facilities and assumes their
maintenance costs. The technical details and the operating performance are defined in the
technical specifications.
The supplier examines the conditions of the warehouse and of the storage facilities and states
their suitability. Furthermore, to assure the accuracy of the inventory data, the supplier compares
the physical inventory to the inventory records stored in the information system of the customer.
In case of unsuitability, the supplier defines the necessary modifications and the deadline for the
final conformations, including them in the technical specifications, as an integrant part of the
agreement.

Conditions for storage

The customer assures that goods will be stored in a suitable location and will be kept physically
separated from all the items not included in the VMI agreement. The supplier grants that all
goods will be delivered to the warehouse properly marked and packaged for handling. Technical
details concerning codification, shape and dimensions of pallets and packages are described in
the technical specifications.

Information systems
Parties agree to share all the information needed to support VMI and to define the operative
means of communication. They commit themselves to conform and integrate their information
systems, through the adoption of a univocal communication standard. Procedures and
responsibilities for the preliminary analysis are also defined and a deadline for the final
integration is given. Technical details concerning the information system, the identification code
and the communication standard are detailed in the technical specifications.
SO Appendix 2: terms and conditions
Term and renewal options
2,2 In this chapter, the terms of the relationship are defined and the termination options are
described.
Note that the length of the contract can be fixed or undetermined, but in both cases it is
convenient to establish a lockup period during which neither the customer nor the supplier can
rescind the contract. When the contract has a fixed duration, one should include either automatic
182 or dynamic renewal options.
Conditions and requirements may change over time and therefore it is critical to include a fair
and equitable method to rescind the relationship. Furthermore, during the aforesaid period, in
response to a recurrent negligent behavior of the counterpart each party can interrupt the
contract by means of a written notice. Details concerning breaches of contract should be given in
the SLA. A clause which permits to correct the causes of the unsatisfactory performances,
specifying the maximum time available to make the correction, will also be included.
The current law gives the customer the opportunity to rescind the contract at any time (i.e. ad
nutum), even in the absence of contractual infringements. If the customer wants to exert this
right, he must refund the supplier of all the sustained expenses and of the lost revenue. To avoid
this eventuality a specific clause must be inserted in the contract.

Liability and limitation of damage

Parties decide who will assume the responsibility for the items from their delivery to their
consumption.
Generally, in the case of contract warehousing or warehouse lease agreement:
. The warehouseman is not liable for any loss or injury occurred to the goods stored, unless
this was due to his failure in exercising care in regard to them, as a reasonable careful man
would do under such circumstances.
. The warehouseman is not liable for damages and/or injuries which could not have been
avoided by the exercise of such care. However, in VMI partnership it is the customer who
generally assumes full responsibility for the items that are lost, stolen and/or damaged on
its premises. To avoid misunderstandings parties must formalize the kind of liability that
best fit their specific requirements.

Applicable insurance and subrogation

A chapter should be included to ensure that both parties have an appropriate insurance.
Typically:
. The supplier can agree to insure the goods until the title transfers (presumably passing on
the insurance costs as part of the selling price).
. The customer can agree to insure the supplier goods for the supplier, incurring the
insurance costs directly and presumably receiving a corresponding price discount.
Even in the case of supplier assured goods the customer is not entirely without risk unless the
contractual agreement between the parties contains a full waiver of subrogation against the
customer. Otherwise the vendor insurer can subrogate against the customer in the event of a paid
claim, citing negligence, say, for fire, theft or vandalism losses.

Prices and invoices

Details concerning the selling price are given and rules for a periodic review of the price are
defined. Indeed it is fair to provide the supplier with a reasonable increase rate.
Also the timing for issuing and paying invoices should be detailed in this section and so
parties must establish whether VMI will be coupled with consignment or not.
Property of the initial stocks Vendor managed
When VMI is coupled with consignment, solid agreements must be made about the stock that
remains within the customer, before the beginning of VMI. If, as usual, the supplier takes over the inventory
stock, the parties must define the price at which the supplier buys the initial inventory. It is
important to consider any cost which is involved in taking over the stocks, such as:
. obsolete items;
. un-salability to other customers; 183
. physical stock counts; and
. insertion in administrative stock.
The supplier must carefully estimate these costs, before making any concessions to the customer.
Actually, the costs incurred in this operation, must always be recoverable by means of the
margins stipulated in the VMI agreement, whereas credit to the customer is unadvisable and is
only allowed for re-saleable stocks.

Qualified court of justice

Parties declare their intention to make any effort to face any problem that should arise in a
friendly way. However, it is advisable to appoint an external referee chosen by the parties to
settle any controversy. If the arbitration fails, the parties shall have recourse to the court of
justice specified in this chapter.

Appendix 3: SLA
Supplier responsibilities
The supplier:
. is in charge to generate purchase orders and to replenish inventories;
. assures to constantly keep the inventory of the buyer in the range [s, S];
. assures to standardize shape and dimension of pallets and packages as detailed in the
technical specifications. Pallets will be delivered with an univocal identification code
consistent with the information system described in the technical specifications;
. is free to make decisions about his productive campaign, the reorder point, the
replenishment lot size and the shipment frequency;
. must inform the customer about the strategies adopted to manage production and
inventories;
. agrees to send a Purchase Order Acknowledgment and waits for the approval before
making a shipment; and
. as soon as a shipment is made, he transmits an ASN to inform the customer about the
exact composition of the freight.
It is advisable to define an operating procedure for the replenishment process. If the customer has
already developed a quality system, he adopts the procedures included in the quality manual and
encloses them within the agreement.

Customer responsibilities
The customer:
. must refurbish the warehouse in accordance with the operating requirements specified in
the technical specifications;
. assumes the purchasing, the maintenance and the operating costs of the facilities;
. maintains the operative management of the warehouse, unless differently specified;
SO . assures a full visibility of the actual inventory levels;
2,2 . commits himself to transmit Sales Data or his MPS in accordance to the means defined in
the technical specifications; and
. specifies the minimal quantity that will be purchased from the supplier and commits
himself to respect the prices, the economical conventions and the invoice terms defined in
previous documents.
184 It is advisable to define operating procedures covering the operating management of the
warehouse. If the supplier has already developed a quality system, he adopts the procedures
included in the quality manual and encloses them within the agreement;

Key performance indicators

Parties agree upon the metrics that will be used to measure the performance of the service.
KPIs shall be tied in with penalties and/or benefits and parties must define the threshold values
above which economical claims can be issued. Similarly, the threshold values above which the
rescission procedure can be initiated must be established as well.
On the customer’s side, KPIs should be able to quantify:
. the frequency of the changes occurred inside the FH;
. the respect of the maximal variation of the orders;
. the accuracy of the inventory data; and
. the respect of the space reserved in the warehouse.
Similarly, on the supplier’s side, KPIs should be able to quantify:
. the respect of the ‘‘S’’ and ‘‘s’’ stock level;
. the frequency of stock outs;
. the accuracy of the ASN; and
. the inward quality.

Appendix 4: annexes
Data alignment
All the activities which must be performed for data alignment are described, giving the schedule
and the responsibilities for such activities. At least:
. parties must define an appropriate codification for items and locations;
. for each item and location, the parties must agree on the attributes that will be shared
(specifications, quality requirements, packaging format, pallet dimension etc.); and
. the parties must commit themselves to maintain data synchronization and accuracy.

Demand information
The information that will be shared to estimate the demand is defined. All the messages should
be described focusing on:
. content;
. format;
. communication standard;
. frequency; and
. responsible for the dispatch.
Possible demand information messages are:
 . stock level; Vendor managed
. stock withdrawal; inventory
. planned promotions;
. MPS; and
. point of sales data and/or incoming orders.

Purchase messages
185
The messages that will be used to trigger purchase orders are defined. A possible list includes:
. purchase order proposal; and
. purchase order approval, ASN.

Receipt and consumption messages

This section defines the messages concerning the receipt and the consumption of goods. A
receipt advice should always be transmitted to the supplier, while a consumption report can be
used to enable the application of a consignment stock business scenario.

Technical specification
Technical specifications must be drawn up after technicians of both parties have carefully
examined the actual condition of the warehouse and that of the logistic facilities. This section
contains a detailed analysis of the actual conditions of the logistic system and defines all the
technical parameters needed for a profitable implementation of VMI. The following main issues
should be addressed:
Product description. Items related information should be divided into general information (GI)
and specific information (SI), respectively. GI refer to data that do not change over time and can
be transmitted only once, conversely SI depend on the agreement and therefore it is advisable to
define a procedure for an ongoing updating. Possible GI are:
. item description and technical drawings;
. materials;
. weights;
. magnitude ‘‘MAG’’ (i.e. aptitude to be transported);
. toxicity, inflammability or other potential hazards;
. place of use; and
. place of storage.
Similarly, possible SI are:
. quality rate;
. transportation lead time;
. minimum stock level ‘‘s’’;
. maximum stock level ‘‘S’’;
. length of the FH;
. length of the PH;
. maximum admitted variability  ;
. pallet type and pallet dimension;
. number of item per pallet; and
. weight and dimensions of the complete package.
SO Premises, warehouse and handling facilities. The following elements should be detailed:
2,2 . number, dimension and location of the loading-unloading stations;
. layout and dimensions of the warehouse;
. type of shelves;
. loading capacity;
186 . number and dimensions of the storage locations reserved for VMI;
. number, length and width of the access corridors;
. security systems;
. number and type of fork lifts available and
. available implements etc.
A plant layout and all the technical drawing retained necessary must also be included in the
annexes.
Tracking system. The following elements should be detailed:
. adopted technology (i.e. radio frequency, bar code, data matrix etc.);
. codification standard;
. operating conditions;
. adopted readers;
. reading distance and
. tracking points.
If possible, one should include detailed drawings to show the precise point (on the package)
where the identification code should be inserted.
Information systems. The following elements should be detailed:
. adopted hardware;
. adopted software;
. communication standards and interface (i.e. EDI, XML etc.);
. integration of information systems; and
. ongoing synchronization.
Declaration of compliance. In this section, the supplier subscribes the adequacy of the facility. In
case of inadequacy, an adjustment design should be included in the contract.
Packaging, handling and storage procedures. All the operating procedures should be included
as integrant part of the agreement.
Threshold values. Two limits should be introduced for each KPI defined in the SLA. The first
one determines the level above which a penalty can be issued, while the second one permits the
rescission of the contract.

Corresponding author
Francesco Zammori can be contacted at: francesco.zammori@ing.unipi.it

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