When reordering products, many businesses place orders based on what they need at that exact moment rather than using a reorder quantity formula. Instead, before they order and pay for product, they should calculate the most optimal re-order quantities. This is where the Economic Order Quantity formula (ECQ) comes into play.
The EOQ formula helps calculate the optimal order quantity to save money on your fulfilment 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.
Table of contents:
- What is economic order quantity (EOQ)
- Why you should be calculating EOQ
- 3 factors you’ll need to calculate EOQ
- The economic order quantity formula
- Other factors that can optimize inventory
- Take the guesswork out of EOQ with ShipBob
- Economic order quantity FAQs
What is economic order quantity (EOQ)
Economic order quantity is a calculation companies use to figure out the optimal order quantity with the goal to minimise their fulfilment costs; including warehousing space, stock-outs, and overstock costs. The EOQ model helps to determine your ideal order quantity.
Why you should be calculating EOQ
EOQ calculations for your business offer 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.
Minimise inventory costs
Having excess inventory can quickly increase storage costs. Inventory costs can also go up depending on how you order, what gets damaged, and if products never sell. If you’re constantly re-ordering products that have low sell-through rates, 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 your sell-through rate over a given period of time, you can avoid stock-outs without having too much inventory on hand for too long. 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 a 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 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. Minimising 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 formula below:
Inventory Carrying/Holding Cost =
(Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory
2. Annual demand (D)
How much demand do you get for a product each year? By looking into historical order data, you can determine the likely number of units you sell each year.
3. Order cost (S)
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 20,000 per year = D
- Setup cost of £500 = S
- You’d get this formula: EOQ = square root of (2 x 500 x 10,000) ÷ 75 = 5,164 units per order.
Other factors that can optimise inventory
Things like seasonality or sales activity had a big impact on your inventory accuracy. In addition to EOQ, there are a few other ways to optimise inventory.
Instead of manually checking inventory levels to re-order products, you can set automatic re-order 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 spikes or supplier issues prevent you from having enough stock available. Safety stock is simply setting extra inventory levels beyond the expected demand. 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 is available to be shipped, make faster inventory decisions, and communicate any delays or 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 heavy lifting off your plate. If you outsource fulfilment and logistics to ShipBob, you get access to 35+ fulfilment locations globally, real-time order and inventory data, helpful 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 fulfilment network across the UK, Europe, USA, Canada, and Australia. You’ll be able to get closer to your shoppers, saving on shipping costs, reducing delivery times, and improving your overall fulfilment & shipping strategy.
Re-order inventory on time
ShipBob’s real-time fulfilment dashboard offers built-in inventory management software, which helps you gain control over your inventory. You can check inventory counts as they happen, set automatic re-order 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 with all your sales channels to bring all of the most important information together in one place to give you on-demand distribution metrics. Answering important questions like:
- Which shipping methods do my customers choose most often?
- What is my average shipping cost per parcel?
- What were my historical stock levels at any point in time?
- What is the total number of storage locations 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 stoc-kouts, and keep your supply chain running smoothly.
If you’re looking for a more robust fulfilment solution, ShipBob is a tech-enabled 3PL that provides warehousing and many inbound and outbound logistics services for thousands of ecommerce merchants. With a global network of fulfilment centre locations (plus more coming soon!), backed by best-in-class technology.
“My end goal when I started Drop FX was to create something that was fully automated, so I could focus on driving sales. I didn’t want to have to worry about inventory and distribution as much. When I was gearing up to launch the business, I was looking for someone who would automate fulfillment for us. I chose ShipBob, and it turned out to be a very easy and scalable solution.”
Josh Hollings, Founder & CEO of Drop FX
Learn more about ShipBob’s fulfilment 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 x setup costs x 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 20,000 per year (D). You would use the following formula: square root of (2 x 500 x 20,000) ÷ .75, which equals the order quantity of 5,164 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 x setup costs x demand rate) / holding costs.
What companies use economic order quantity?
The economic order quantity formula is used for any business that manages and stores inventory, such as a brick-and-mortar retailer or an online brand.