Economic Order Quantity (EOQ) Formula and Definition for Ecommerce Shops
February 26, 2020
When reordering products, many businesses place orders based on what they need at the exact moment rather than using a reorder quantity formula. Instead, they should optimize the way they order and pay for product by using the Economic Order Quantity formula (EOQ).
The EOQ formula helps calculate the optimal order quantity to save money on logistics and ecommerce warehousing costs. By calculating EOQ, you’re able to make better decisions on how much product to order in a given period of time.
What is EOQ (economic order quantity)?
Also referred to as ‘optimum lot size,’ the economic order quantity, or EOQ, is a calculation designed to find the optimal order quantity for businesses to minimize logistics costs, warehousing space, stockouts, and overstock costs.
Why you should be calculating EOQ
Calculating the EOQ for your business offers several benefits that impact your bottom line. It’s a great way to grasp how much product needs to be purchased to maintain an efficient ecommerce supply chain while keeping costs down.
Here are the top benefits of calculating EOQ.
Minimize inventory costs
Storing extra inventory can quickly increase storage costs. Inventory costs can also go up depending on how you order, what gets damaged, and what products never sell. If you’re constantly re-ordering products that have low velocity, EOQ can help determine how much to order in a certain time period.
EOQ can help you better understand how much you need to re-order and how often. By calculating how much you need based on how much you sell in a given period of time, you can avoid stockouts without having too much inventory on hand for too long. You may be surprised that ordering in smaller quantities may be more cost-effective for your business, or it could be the opposite — calculating EOQ can help determine this.
Improve overall efficiency
Overall, calculating EOQ can help you make better decision when it comes to storing and managing inventory. The truth is that many ecommerce business place orders based on a “gut feeling” of how much to order, instead of actually ordering how much product is actually needed. Calculating EOQ is a smart way to better quantify how much you need based on important cost variables.
3 factors you’ll need to calculate EOQ
The EOQ formula is made up of three variables: holding costs, demand, and order cost. We break down each variable below.
1. Holding costs (H)
Holding cost (also known as carrying costs) refers to the total cost of holding inventory. Minimizing inventory costs is an important retail supply chain management strategy. How much do you spend on holding and storing inventory, per unit, per year? In order to properly calculate EOQ, you’ll first need to determine your holding cost. To do so, you can refer to the simply formula below:
(Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory = Inventory Carrying/Holding Cost
2. Annual demand (D)
How much demand do you get for a product each year? By looking into historical order data, you can determine how much product you sell year over year..
3. Order cost (S)
Also referred to as ‘setup cost,’ how much does an order cost per purchase? This is done on a per-order basis and includes both the shipping and handling costs.
The economic order quantity formula
The formula for economic order quantity is:
EOQ = square root of: [2SD] / H
S = Setup costs (per order, generally including shipping and handling)
D = Demand rate (quantity sold per year)
H = Holding costs (per year, per unit)
An EOQ example
If you haven’t used EOQ before, here’s an example of how to calculate it:
Let’s say you have these variables:
- $0.75 in holding costs per unit = H
- Demand rate of 10,000 per year = D
- Setup cost of $500 = S
- You’d get this formula: EOQ = square root of (2)(500)(10,000)/.75) = 3,652 units per order.
Your optimal order quantity is 3,652 units for that specific product.
Other factors that can optimize inventory
Things like seasonality or big sales can also affect your inventory accuracy. In addition to EOQ, there are a few other ways to optimize inventory.
Instead of manually checking inventory levels to reorder products, you can set automatic reorder points that automatically place an order once your inventory levels hit a certain threshold. Investing in an inventory management software or partnering with a 3PL) makes this easy to do.
Safety stock measurements
There are times when demand can increase suddenly or there are issues with a supplier that can prevent you from having enough inventory. Safety stock is simply extra inventory beyond the expected demand. Safety stock is also often used during busy shopping seasons like the holidays or during a big promotion or flash sale.
Real-time inventory tracking
Easily monitor your and control stock levels and know where products are stored in your warehouse by tracking inventory in real-time. That way, you know how much product can be shipped now, make faster inventory ordering decisions, and communicate any delays of out-of-stock items quickly.
Take the guesswork out of EOQ with ShipBob
Determining your EOQ can be challenging, but 3PLs like ShipBob can take some of the related heavy lifting off your plate. If you outsource warehousing and logistics to ShipBob, you get access to coast-to-coast warehousing, transparent and real-time fulfillment data and insights, and a more efficient and cost-effective inventory management process.
Only pay for the storage that you need
ShipBob reduces inventory costs by allowing you to only pay for the space you need in our warehouses. By tapping into our extensive fulfillment center network, you’re able to take advantage of fulfillment services (like distributed inventory) that can help you save on shipping costs, reduce transit times, and improve your overall logistics and fulfillment strategy.
Reorder inventory on time
ShipBob’s best-in-class fulfillment technology offers built-in inventory management software, which helps you gain control over your inventory. You can check inventory counts in real-time, set automatic reorder points, and better forecast demand.
Gain insights to help your business improve
Make better ecommerce inventory decisions using ShipBob’s free analytics and reporting tool. ShipBob’s software syncs up with your ecommerce store to bring all of the most important information together in one place to give you on-demand distribution metrics. You can gets answers to important questions like:
- Which shipping methods do my customers choose most often?
- What is my average shipping cost per shipping method?
- What were my historical stock levels at any point in time in any location?
- What is the total number of bins/shelves/pallets I’m being charged for?
- And more!
By using EOQ for your ecommerce business, you can improve your overall inventory management process. By ordering the right amount of inventory instead of guessing what to order, you can reduce costs, prevent stockouts, and keep your supply chain operating smoothly.
If you’re looking for a more robust fulfillment solution, ShipBob is a tech-enabled 3PL that provides warehousing and many inbound and outbound logistics services for thousands of ecommerce merchants. We offer affordable 2-day shipping, and network of fulfillment center locations (plus more locations coming!), and best-in-class fulfillment technology.
“Off the bat, I liked that I would be able to control multiple warehouses through one page with ShipBob. With my old 3PL, I could never just open a page and get the info I wanted. I had to click several times, then export it, and try to make sense of it. ShipBob lets you manage your inventory while providing important data in a very digestible way.”
Wes Brown, Head of Operations at Black Claw LLC
Learn more about ShipBob’s fulfillment services by filling out the form below.
Economic order quantity FAQs
Here are some of the most common questions about the economic order quantity (EOQ) formula:
What is EQQ and its formula?
Also referred to as ‘optimum lot size,’ the economic order quantity, or EOQ, is a calculation designed to find the optimal order quantity for businesses to minimize logistics costs, warehousing space, stockouts, and overstock costs. The formula is: EOQ = square root of: [2(setup costs)(demand rate)] / holding costs.
What is an example of economic order quantity?
Let’s say you have these variables: 1) $0.75 in holding costs per unit (H), 2) Setup cost of $500 = S, 3) demand rate of 10,000 per year (D). You would use the following formula: square root of (2)(500)(10,000)/.75), which equals the order quantity of 3,652 units for that specific product.
How do you calculate the economic order quantity?
To calculate the economic order quantity, you will need the following variables: demand rate, setup costs, and holding costs. The formula is: EOQ = square root of: [2(setup costs)(demand rate)] / holding costs.