What is Economic Order Quantity?

Ecommerce businesses have a lot on their plate, such as inventory management. Sellers must ensure they have enough products in stock without over-ordering, and finding that balance can be difficult. This is why 34% of sellers struggle with product availability and delayed shipments.

The last thing you want is to see a customer order a product that’s no longer in your warehouse. Sellers can combat inventory issues in many ways, including calculating economic order quantity. 

 

What Is Economic Order Quantity?

Economic order quantity (EOQ) is an inventory control method developed in the 90s. This calculation aims to find the balance between the product revenue you sell and the amount of inventory you buy. 

In other words, EOQ is the ideal amount sellers should spend on their inventory. This aims to minimize costs while holding enough items to meet demand and prevent excess inventory.

 

What EOQ Tells You About Your Business

Following the correct economic order quantity calculations will save money on every aspect of the inventory management process. This includes the expenses to buy, ship, and store your products. 

While there’s one main formula to calculate EOQ (we will discuss this later), it’s important to remember that every business’s EOQ formula will differ. For example, if you have specific order intervals or large production orders, your EOQ may differ from other stores in your niche.

How to Calculate Economic Order Quantity

The economic order quantity formula that most sellers use is √(2DK/H).

D: Number of product units purchased per year (annual demand)
K: Order cost
H: Annual holding cost

 

In other words, multiply the number of products purchased by the order cost. Then, divide it by the annual holding cost and take the square root of that figure.

If you’re not the best at math, you have other options. For example, if you’re an Amazon seller, you can access your inventory performance index to see if your inventory management needs improvement.

 

EOQ vs. Other Calculations

You may be familiar with other inventory calculations. How do these compare to the economic order quantity, and when should you use them?

 

Minimum Order Quantity

The minimum order quantity is the smallest unit of inventory a brand must purchase. This calculation is best for sellers concerned about wasting inventory that may not deliver a profit, new sellers, or stores selling a new item.

 

Economic Production Order Quantity

Economic production order quantity (EPQ) determines the ideal lot size during inventory production. This formula minimizes product storage and equipment use. Since EPQ is used for manufacturing rather than inventory ordering, suppliers commonly use it.

 

Maximum Inventory Level

This figure is the maximum number of units a business should keep in inventory while spending the least money. Anything beyond this figure risks overstocking, overspending, lost profits, and wasted inventory.

 

Benefits of Economic Order Quantity

Using the economic order quantity calculation will benefit your bottom line in these ways:

 

Minimize Inventory Costs

Extra items may seem like a good idea, but they can hurt your business; for example, you’ll spend too much money ordering and storing products. There’s also the risk that you won’t sell these items and must liquidate them.

The economic order quantity formula will ensure you buy the ideal amount of products at the ideal time to avoid wasting money.

What if your EOQ comes out at a high rate? There’s nothing wrong with ordering inventory in bulk if the products meet demand and are more cost-effective. That said, some businesses will fare better when ordering inventory in smaller quantities. 

 

Better Navigate Customer Demand

Customer demand is never easy to predict. Demand often fluctuates based on season, trends, and new items. Fortunately, the EOQ formula is flexible. 

While many sellers calculate this figure annually, you can also calculate your EOQ for every season. This way, you can better navigate the demands for that sales period.

 

Scale Your Inventory

Since the economic order quantity formula determines the ideal amount of inventory, you’re better able to scale your products. You’ll hold the amount to meet demands while not carrying excess stock.

EOQ is also a great formula when expanding markets. Scaling inventory and fulfillment will make the transition to new markets more seamless.

 

Disadvantages of EOQ

While the economic order quantity can solve many inventory management problems, it may not be the solution for every seller. Here are the limitations of the EOQ.

Not all inventory has fixed costs. Thanks to production costs and the cost of raw materials, products can vary in price over time, so your EOQ may not always be accurate. 
Doesn’t prepare for seasonal shifts. In retail, seasonal demand is too common. Whether your product demand skyrockets or plummets, you risk purchasing too little or too much inventory.
Other factors may affect inventory management. Supply chain issues and theft can impact inventory management. Unfortunately, EOQ doesn’t consider these factors. If you tend to experience surprises in your business, EOQ may not be the most effective formula.
Not the best solution for stores with a wide inventory. Most sellers use EOQ on a per-product basis. If you have a busy store with a massive inventory, calculating EOQ may be too time-consuming and complex.

Economic Order Quantity FAQs

 

Why is it important to calculate economic order quantity?

EOQ ensures sellers manage their inventory, reduce costs, and prevent dead stock. If sellers don’t calculate their inventory well, they may hold too much or too little inventory. These are serious problems for sellers since they pose either missed opportunities or wasted expenses.

 

Why does EOQ improve inventory management?

Sellers will always know the ideal number of products required to meet demand while not wasting money and resources. As a result, inventory will stay balanced, you’ll have a good ROI, save on inventory, and prevent storage limits.

 

What do different EOQ figures mean?

It’s rare to have a perfect economic order quantity. What does a too little or too high figure mean? If your economic order quantity is high, your product demand or costs are high. But if the quantity is low, your holding costs are too expensive.

 

Who should use the EOQ calculation?

Any company that sells physical products can use the economic order quantity calculation to manage inventory. Since this formula was developed in the 90s, it was commonly used by brick-and-mortar stores. Today, it’s a popular formula for ecommerce businesses.

 

Apply Economic Order Quantity to Your Business

If you notice you purchase too much or too little inventory, you’ll need a more accurate formula to calculate your product purchases. 

Economic order quantity is one formula for meeting customer product demands while cutting costs. It’s been used since the 1990s and is a popular inventory management formula today. 

If math isn’t your strong point, you can use the stock management tools provided by Amazon to improve your inventory management.

Ecommerce uses more tactics than inventory management. If you struggle to manage your online store, you may need help unlocking your full potential. AMZ Advisers can help with many e-commerce functions, such as SEO and sales management. Contact us today!

 

Author

Stephanie Jensen has been writing ecommerce content for seven years, and her copy has helped numerous stores rank on Amazon. Follow her on LinkedIn for more insight into freelance writing and creating high-quality content.

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