Minimum Order Quantity (MOQ) Explained
In a perfect world, suppliers would supply the products your business needs in the exact quantity that you need them. More importantly, they would be more than happy to do this at no extra cost.
However, in reality, placing orders with suppliers is far more complex. Given that most suppliers will impose a Minimum Order Quantity, all constraints must be considered before the order is placed.
But what are minimum order quantities? Why do suppliers need to impose such constraints? What impact do MOQs have on your inventory position? More importantly, how can you optimise purchase orders to satisfy order constraints without exposing your business to risk?
What is a minimum order quantity?
Minimum order quantities or MOQs are the minimum order size that the supplier is willing to accept. This is often expressed as the minimum number of units. However, suppliers may also set the minimum order quantity in terms of order value. For example, Supplier ABC Ltd will only accept an order in excess of £1000.
As a major constraint, it's important that the minimum order quantities for each product is up to date and correct in the master data. If it is not, this could lead to costly mistakes or avoidable delays when placing the purchase order.
Why do suppliers have minimum order quantities?
While MOQs may price some potential customers out, suppliers still need to ensure that they make a profit. After all, the supplier still has transportation, holding, handling and administration costs to cover. Often these overheads account for a small percentage of the overall value of the order. However, the smaller the order quantity, the more these costs eat into the profit margin.
Take for instance the following scenarios:
In scenario A, the supplier makes a healthy profit. However, in scenario B where the customer order quantities are much smaller, the supplier makes no profit at all. Worse still, if the supplier would allow customers to purchase in single units, such as in scenario C, they would actually make a loss on every transaction!
While this is just a simple example, from the supplier’s perspective, selling the products in such small quantities makes no financial sense at all. As a result, suppliers set minimum order quantities to protect their own margins.
What impact do Minimum Order Quantities have on your inventory?
MOQs have a major influence over how many days of stock a business holds as well as how frequently purchase orders are made with suppliers. In the example below, we explore how low MOQs impact the inventory position:
High Minimum order quantity
Where the supplier has a high MOQ in place, the most obvious impact is that inventory has to be held in much higher quantity. As highlighted in the graph below, at the point of replenishment, the business will hold over 20 weeks of inventory. The consequent of this is that the overall holding costs will be very high such as a large volume of stock will take up a much greater amount of space in the warehouse. More importantly, however, a much higher level of working capital will have to be invested in order to satisfy the MOQ. Consequently, the risk of obsolescence is far greater.
However, the upshot of high MOQs is that 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 also very low. After all, the supply chain team have several weeks to respond to any potential availability issue!
Low Minimum order quantity
Low MOQs have a very different impact on inventory. If suppliers are willing to accept a much lower minimum order quantity, businesses can hold a much lower level of inventory and replenish inventory when required. The real benefit here is that a lower investment of working capital is required and the risk obsolescence is reduced significantly.
The danger of ordering to lower MOQs 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 and order processing costs.
Unlike with high MOQ where volatility is absorbed by the fact that there is a high level of inventory in the first place, low MOQq will mean that the inventory levels are likely to be leaner. Consequently, low MOQs leave the operation more exposed to spikes in demand and supply issues. To safeguard availability from such factors, it may be necessary to hold a strategic level of safety or buffer stock.
Summary: High MOQ Vs Low MOQ
How can you optimise your purchase orders?
Disproportionate order quantities cause expensive high average inventory levels and unnecessary risks related to obsolescence. Equally, order quantities that are too small cause unnecessary warehouse operations and avoidable transportation, administrative costs. So how can supply chain teams find the balance between satisfying the MOQ and keeping costs and risk under control?
Up to this point, we have talked about the MOQ as though it is set in stone. However, where the MOQ is low, in reality, the purchase order will most likely be way above the minimum order quantity. Likewise, with high MOQs, there is always the option to either negotiate a more favourable MOQ or even find another supplier. Even so, all purchase orders, order frequencies and review times must be carefully considered!
Thankfully this is where the economic order quantity (EOQ) comes in to play!
In essence, the EOQ formula focuses on the main cost areas in order to determine the most cost-effective order quaintly. By ordering the right quantities, this will ultimately reduce the operational expenses while boosting the return on inventory investment, thereby resulting into integral optimisation of your total supply chain costs!