Minimum Order Quantity (MOQ) – Formula, Benefits & Tips

High Minimum Order Quantities

Where the supplier has a high MOQ in place, the most obvious impact is that our average inventory levels will be much higher.

As highlighted in the graph below, at the point of replenishment the business will hold over 20 weeks’ of inventory. And as we explored in our recent article on inventory cost, holding inventory is very expensive.

With such a high level of inventory, we can expect the overall holding costs to be very high. After all, such a large volume of stock will take up a much greater amount of space in the warehouse.

We also need to consider all of the associated costs that come with this holding stock. And at what risk?

High MOQs will tie up a much higher level of working capital. In addition, the risk of obsolescence is far greater. And if the product never sells, this investment could be lost forever.

It is not all doom and gloom though. The upshot of high MOQs is that the product will not need to be reviewed or ordered as frequently. As a result, administration and ordering costs can be minimised.

Furthermore, the risk of stockouts is very low. After all, the supply chain team will have several weeks (or even months!) to respond to any potential availability issue.

So, to summarise:

Impact of High Minimum Order Quantity

Positive:

• Minimised admin, order processing and inventory costs
• Reduced risk of stockouts

Negative:

• High investment of working capital
• High holding costs
• Increased risk of product obsolescence

Impact of Low Minimum Order Quantity

Positive:

• Reduced holding costs due to lower level of inventory
• Lower investment of working capital
• Reduced risk of obsolescence

Negative:

• Frequent review and ordering of products
• Higher admin, order processing and inventory costs
• More exposure to demand and supply issues
• Greater risk of stockouts – *consider holding a strategic level of safety or buffer stock

* Top tip – Safety/buffer stock levels should not be determined on a whim. There are lots of factors you need to think about. And if their levels are misaligned with your business goals, they could cost you a great deal of money. Click here to read our Safety Stock Q&A.

Low Minimum Order Quantities

Low MOQs have a very different impact. For instance, if suppliers are willing to offer a much lower Minimum Order Quantity, this means you can hold a much lower level of inventory.

The real benefit here is that a lower investment of working capital is required to meet the MOQ and the risk of obsolescence is reduced significantly.

The danger of ordering a low MOQ is that the product will have to be reviewed and ordered far more frequently. This, of course, comes at a cost in terms of admin, order processing and inventory costs.

Unlike with high MOQs where volatility is absorbed by the fact that there is always likely to be a high level of inventory, low MOQs will mean that inventory levels are likely to be leaner.

Consequently, low MOQs leave the operation more exposed to spikes in demand and supply issues. Therefore, the risk of stockouts is much higher. To safeguard availability from such factors, it may be necessary to hold a strategic level of safety or buffer stock.

Top tip – Safety/buffer stock levels should never be determined on a whim. If their levels are misaligned with your business goals, they could cost you a great deal of money. There are lots of factors for you to think about. Click here to read our Safety Stock Q&A.

To summarise:

Impact of Low Minimum Order Quantity

Positive:

• Reduced holding costs due to lower level of inventory
• Lower investment of working capital
• Reduced risk of obsolescence

Negative:

• Frequent review and ordering of products
• Higher admin, order processing and inventory costs
• More exposure to demand and supply issues
• Greater risk of stockouts – consider holding a strategic level of safety or buffer stock to mitigate this risk

What happens if you get MOQs wrong?

We have covered the impact of low and high Minimum Order Quantities. But what about if you get the MOQ completely wrong?

“How could you possibly get them wrong?” you may ask.

A common mistake is around how the MOQ is defined. Does the MOQ unit value refer to a single product, a box, a pallet or even a container load?

Or is there a misalignment in the unit of measure? You may well be planning in pieces. But if your supplier works in weight, you are talking a different language. (As someone who has personally misunderstood the order criteria and gone on to order far more stock than required, I can assure you that this is a very embarrassing mistake to make!)

However, user error is not the only issue. Sometimes the mistake is more about the quality and structure of your data.

Lots of businesses overlook this critical parameter, so it’s not uncommon for businesses to set the supplier’s Minimum Order Quantity to “1” as a default value.

Likewise, many businesses forget to update the MOQ parameters whenever they change. Consequently, the MOQ may be far higher or lower than the real constraint.

This is where the problems begin.

If the MOQ you use to plan your inventory requirements is not a true reflection of the actual MOQ, you could face:

• Inefficient and costly ordering procedures
• Avoidable build-up of excess stock
• Wasted investment of working capital
• Unnecessary exposure to risk (both in terms of excess stock and product obsolescence)
• Higher risk of planning errors
• Lack of clarity throughout the ordering process

But the worst problem here is that if your data is incorrect, you may be unaware that you even have a problem!

This takes us nicely on to our next topic: Master data.

Is your MOQ Master Data up to date?

As we have seen, MOQs are one of the main constraints we need to think about when planning our inventory. Therefore, it’s vital that the Minimum Order

Quantities for each product are up to date and correct in your existing master data.

If it is not, this could lead to costly mistakes or avoidable delays when placing the purchase order.

Top tip – Master data is very important. However, it is often a contentious topic for businesses. To help you keep your master data up to date, check out our handy guide.

How can you use MOQs to optimise your purchase orders?

So far, we have explored the influence of Minimum Order Quantities, the importance of master data and what happens if your MOQs are not kept up to date in your ordering system.

But now let’s look at how we can use MOQs to make better purchasing decisions.

The first thing we need to keep in mind is that disproportionate order quantities cause expensive, high-average inventory levels and create unnecessary risks related to obsolescence.

Equally, order quantities that are too small cause unnecessary warehouse operations and avoidable transportation and administrative costs.

So how can we strike the balance between satisfying the MOQ and keeping costs and risks under control?

Up to this point, we have talked about the MOQ as though it is set in stone. However, this may not always be a cause for concern. For instance, where the

MOQ is low, in reality, the purchase order will most likely be way above the Minimum Order Quantity anyway.

Likewise, with high MOQs, there is always the option to either negotiate a more favourable MOQ or even find another supplier.

Ultimately, if we want to squeeze new opportunities for optimisation, we may need to think outside the box. And that may not only mean rethinking our approach to purchase orders, order frequencies and review times … but maybe even changing the suppliers we work with.

In the next section, we will explore some practical steps you can take to assess MOQs.

How to detect if the MOQ is too high

The first question we want to answer is: does the MOQ align with the level of demand we anticipate?

This is an important question because it influences how many days of inventory we hold at any given point.

We have previously discussed the dangers of high order quantities. But how do we determine how high is too high?
Sadly, the answer is that it depends.

If the products in question are short-shelf-life items such as fresh food products, we probably can’t accept an MOQ if it is greater than a couple of days’ worth.

After all, there is a high risk that the stock will go off before we can sell it on or use it ourselves.

But even if the product freshness is not an issue, as in the case of nuts and bolts, we still need to be conscious of how many days of inventory a single MOQ will cover.

As a starting point, you can analyse how many of the products within your assortment have an MOQ that is greater than 1 years’ worth of demand.

If your market is particularly dynamic, you may need to reduce the period from 1 year down to 6 months, or maybe even 3 months.

Either way, this quick analysis will instantly flag those products which could be a problem.

But how do you use this information?

There might well be a good reason why you are happy to accept a high Minimum Order Quantity.

• Perhaps the products are highly customised so as to meet your specific requirements, and therefore your order must match your suppliers’ production constraints. If this is the only supplier who can fulfil your specifications, your choice may be limited.
• Maybe the item is of such low value that holding a year’s worth of inventory is not actually too much of a financial hardship.

Equally, this analysis may flag some products where the MOQ is too high for you, so you’ll need to take action. For these items, we have a few options:

• Option 1 – Negotiate with the supplier and agree on a smaller Minimum Order Quantity.
• Option 2 – Find an alternative supplier.
• Option 3 – Investigate whether this product should be stocked within your active assortment at all.

Is the current MOQ resulting in inefficient ordering?

High Minimum Order Quantities and the impact on our average stock holdings are not the only issues we need to watch out for. We also need to consider whether we are ordering inventory as efficiently as possible.

What is ordering efficiency?

In essence, we are talking about how often we place an order.

Where the MOQs are small, you might be tempted to order little and often.

However, we know that every order we place has an associated cost; it takes up valuable time to create, process and send it to the supplier.

So how can we detect products that may be at risk of inefficient ordering practices?

We can start by identifying products where we place multiple orders within the same lead time.

Why is this a problem?

Well, it suggests that we are under ordering.

As a consequence, the risk of stockouts may be higher.

By running the inventory levels at such a lean level, it would only take a small spike in demand or late delivery to result in availability issues.

Furthermore, we may be incurring unnecessary ordering and admin costs.

Another concern is that we may be missing out on volume discounts.

Are there any exceptions to this rule?

Of course, there are some scenarios where it makes sense to order multiple times within the same lead time. If we take our fresh food example, we may want to place more frequent orders to guarantee the best possible product freshness.

Alternatively, perhaps we are limited by our warehouse capacity. And therefore, we have no choice but to order little and often.

How can we fix these issues?

If there are no constraints in place, we have a couple of options:

Increase the order size

Minimum Order Quantities are just that – they are the ‘minimum’ level of inventory we can order. Therefore, we could always increase our order volume.

Optimise the review period

The other option is that we set a rhythmical review period and build this into our inventory requirement. Therefore, instead of simply ordering up to the MOQ, we now order a little more strategically.

However, balancing order levels with optimised order costs is a bit of a dark art.

Thankfully this is where the Economic Order Quantity (EOQ) comes into play.

In essence, the EOQ formula focuses on the main cost areas to determine the most cost-effective order quantity.

Ordering the right quantities will ultimately reduce the operational expenses while boosting the return on inventory investment, thereby resulting in integral optimisation of your total supply chain costs.

We will delve into this topic in one of our upcoming articles.

What do you need to think about when setting your own MOQs?

So far, we have focused mainly on supplier Minimum Order Quantities.

But what is the right MOQ to offer your own customers?

This is an important question as it could have a big impact on how your operation is structured.

For instance, a business that sells products with Minimum Order Quantities in the thousands will look very different to a business that sells products with no MOQ.

Essentially, there are 3 big factors we need to think about:

Supply-side constraints

Every point of the supply chain is impacted by the constraints of the level above. Take a manufacturer of bicycles, for example. Before they can produce anything, they first need the right raw materials.

But, the supplier of the metal, or even the producer of the rubber required for the tyres has to produce in a volume large enough to make the order cost-effective.

This, in turn, will impact the MOQ they can offer.

Demand-side constraints

MOQs can’t be set based on just the economic parameters alone. They also need to be competitive from the customer’s perspective.

Imagine if your local supermarket imposed a Minimum Order Quantity on bread. Instead of being able to buy a single loaf, you now have to buy at least 50.

Even if the retailer offered you a fantastic volume discount, you are unlikely to be happy to buy such a large quantity at once. After all, you only have so much space in your kitchen cupboard. Consequently, you would have little choice but to take your business elsewhere.

The point here is that, to be competitive, the Minimum Order Quantity has to work for your target customer.

And to work this out we need to think about:

• The amount of orders received per day.

And:

• The average volume of units requested (or rather expected) by each customer.

Internal constraints

Sure, some market forces influence the Minimum Order Quantity. But there are also factors within your business that shape the MOQ.

For example, does your Operations Team have the capacity to pick, pack and ship thousands of individual units to customers?

Equally, do you have the warehouse space to ship orders by the container load?

There is little point in setting up a Minimum Order Quantity that is simply not profitable for your business.