Container Ship With Minimum Order Quantity Moq

Minimum Order Quantity (MOQ) Explained – Formula & Tips

How can you make Minimum Order Quantity work for you?

Imagine a world without Minimum Order Quantities (MOQs). 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?

Cartoon With Questions About Minimum Order Quantity

 

What is minimum order quantity (MOQ)?

Let’s start with the basics…

Supplier 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 sometimes set the Minimum Order Quantity in terms of order value. For example, Supplier ABC Ltd will only accept an order in excess of £1000.

Chances are that you too impose some predefined Minimum Order Quantities on your customers.

There is a whole range of reasons why businesses set MOQs. And we will dive into these later.

However, it is important to understand just how much of an impact minimum order quantities (MOQs) have on your day-to-day operations.

Why do suppliers set a minimum order quantity (MOQ)?

Like every business, suppliers face a range of costs & constraints. And at the end of the day, suppliers need to ensure that they make at least some amount of profit out of each order.

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:

Scenario 1 – Large MOQ Scenario 2 – Small MOQ Scenario 3 – No MOQ
 Batch size from supplier (units) 10,000  10,000  10,000 
 MOQ offered to the customer 1000  10   1
Number of boxes sold per pallet  10  1000  10,000 
Selling price (per unit)  £0.10  £0.10  £0.10 
 Sales Turnover  £1000.00  £1000.00  £1000.00
 Cost Per Unit  £0.08  £0.08  £0.08
Total Cost From the Supplier  £800  £800  £800 
Cost to breakdown the pallet & repackage (per box)  £0.20  £0.20  £0.20
Total Processing Costs  £2.00  £200.00  £2000.00 
Cost of goods sold  £802.00  £28,000.00  £0.20
Gross Profit  £198.00  £0.00  -£1800.00

 

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.
And this is exactly why suppliers set minimum order quantities: To protect their margins.

What impact do minimum order quantities have on your inventory?

So, we have explored why suppliers set a minimum order quantity (MOQ). But do these constraints impact you?

Well, MOQs have a massive influence on your business. For example, the Minimum Order Quantity (MOQ) affects some of the following:

  • The average level of inventory we hold 
  • The amount of working capital we tie up in stock
  • The frequency in which review orders
  • The optimal moment to place a replenishment order with the supplier

Let’s take this a step further…

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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!

And with such a high level of inventory, we can expect the overall holding costs will 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 what risk?

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

It is not all doom & 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 also very low. After all, the supply chain team have will several weeks (or even months!) to respond to any potential availability issue!

Chart With Impact Of High Minimum Order Quantity

So, to summarise the impact of high MOQs:

  • High investment of working capital to meet the MOQ requirements
  • High holding costs
  • Products need to be ordered less frequently 
  • Increased risk of product obsolescence
  • Reduced risk of stock outs

Low Minimum Order Quantity

Low MOQs have a very different impact on inventory. 

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 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 MOQ 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. Therefore, the risk of stock-outs 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 stock levels can’t be determined on a whim. There are a lot of factors you need to think about. And if your they’re levels are misaligned with your business goals, they could cost you a lot of money. Click here to read our Safety Stock Q&A.

Chart With Impact Of High Minimum Order Quantities

Before we continue, let’s wrap up the impact of low MOQs:

  • Lower investment of working capital required to satisfy the MOQ constraint
  • Lower inventor holding costs
  • Products need to be reviewed more frequently
  • Ordering & admin costs may be higher
  • The risk of obsolesce is reduced 
  • The risk of stock-outs is increased.

What happens if you get MOQs wrong?

We have covered the impact of low & high minimum order quantities (MOQs). But what about if you get the MOQ wrong completely?

“How could you possibly get them wrong,” you 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 suppliers work in kilos, you are talking a different language.

(As someone that has personally misunderstood the order quantity and then 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 & structure of your data.

For example, lots of businesses overlook this critical parameter. And 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 if 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 & costly ordering
  • Avoidable build of excess stock
  • Wasted investment of working capital
  • Unnecessary exposure to risk (both in terms of excess stock & 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!

Is your MOQ master data up to date?

This takes us nicely on to our next point: Master data!

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 the 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 our handy guide!

Cartoon Analysing Mionimum Order Quantity Charts

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 & what happens if your MOQ is incorrect.

But 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 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 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 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 of the box. And that means rethinking our approach to purchase orders, order frequencies and review times! But maybe even the suppliers we work with.

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

Cartoons Adjusting Minimum Order Quantity Sliders

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

But even if the product freshness is not an issue, such as for nuts & 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 what do you do now?

There might well be a good reason why you are happy to accept such a high Minimum order quantity (MOQ).

Perhaps the products are highly customised to your specific requirements & therefore your order must match your suppliers’ production constraints. If this is the only supplier who can fulfil your requirement, your choices here may be limited.

Maybe the item is of such low value, that holding a year’s worth of inventory is not actually that much of a financial hardship.

Equally, this analysis may flag some products where the MOQ is too high & you need to take action.

And for these items, we have a few options:

  • Option 1 – Negotiate with the supplier & agree on smaller order quantities 
  • 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 & 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 do we mean by 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 & often.

However, it’s worth considering that every order we place has an associated cost. Furthermore, it takes up valuable time to create, process & send each order to the supplier.

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

Well, we can start by identifying products where we often 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 stock-outs 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 & admin costs.

And the other concern is that we may be missing out on volume discounts!

Cartoons Holding Clock With Gear Minimum Order Quantity

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 & often.

How can we fix these issues?

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

Increase 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 review period

The other option is that we set a rhythmical review period & 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 quaintly.

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 dive 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 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 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. 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 tires 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 (MOQ) on bread. Instead of buying a single loaf, you now have to buy at least 50 loaves of bread.

Even if the retailers 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:

  • How many orders are received per day? 
  • And what’s the average volume of units requested (or rather expected) by each customer?

Internal constraints

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

For example, does your operations team have the capacity to pick, pack, & 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 MOQ that is simply not profitable for your business.

Cartoon With Spanner And Cogs Minimum Order Quantity

Some final thoughts on minimum order quantity (MOQ)…

Hopefully, this article has helped you to understand why MOQs exist, how they are calculated & how they impact your business.

As a key factor in your day-to-day inventory decisions, you must understand how MOQs work. More importantly, you much understand how this critical parameter can work for you!

In our upcoming articles, we will take this concept to the next level. We will explore delivery lead times and how they influence our inventory requirements as well as how you can apply the EOQ formula in your business.

In the meantime, we would love to hear how you manage MOQs in your business!

Download our guide to unravelling the secret of optimal order quantities!

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