The Value of Centralization in a Vendor-Managed Inventory System

Abstract

In this paper, we investigate the effect of information precision and information reliability on manufacturer-retailer relationship by analyzing and comparing two inventory management systems, a traditional system and a Vendor Managed Inventory (VMI) system. We first construct a basic model and a benchmark model for both systems. Then, we analyze and compare these models. Different from the previous literature, we propose a new measure for the extent to which the manufacturer is willing to use the VMI system. Our analysis show that more precise information at the retailer's alone may hurt the performance of the traditional system, while VMI system without information sharing still dominates the traditional system. This suggests that the benefit of centralization in a VMI system is significant enough to improve the supply-chain performance regardless of information precision and reliability. With the new measure, we show that the manufacturer's willingness to implement a VMI program increases monotonically in demand variability.