As a business owner, you’re tempted to say “yes” to every customer who wants to buy from you. Why would you turn down money? But the reality is that, for some companies, not all sales are good for your business.
Especially in the retail world, businesses have to make careful decisions about how much product they sell to customers. That’s because selling too little could result in taking losses on orders due to the inventory costs of holding those products.
On the other hand, you don’t want to turn away too many customers. Yes, their purchases are usually small, but they may still be profitable at a certain point.
So how do you find that sweet spot? That’s where minimum order quantity (MOQ) comes in. An MOQ will tell you exactly what the cutoff is in terms of the total quantity you sell with each order. With this number in mind, you’ll be able to confidently accept or turn down orders, knowing that you’re making the most profitable decision each time.
Overview: What is minimum order quantity (MOQ)?
Minimum order quantity, or minimum order amount, is the smallest amount of inventory that you can purchase from a supplier. Typically, non-retail customers will want to order smaller quantities from the supplier, and the supplier must carefully calculate their MOQ to make sure that they’re not selling at a loss.
At the same time, the supplier must maximize the number of customers they can sell to who don’t want to bulk-order large quantities of goods.
The MOQ illustrates the cost efficiency inventory management challenges a supplier faces. The MOQ must cover the processing and execution costs of the transaction, such as labor, shipping, administrative, and other overhead costs.
The stakes are high for the supplier when it comes to setting their MOQ. If they set it too high, they risk losing out on customers who would otherwise be profitable. And if it’s a low MOQ, they risk taking a loss on orders.
As a result, it’s critical that a supplier correctly calculate the right MOQ. An ABC analysis may also help make this determination — the supplier places a higher priority on products that have higher profitability, and the MOQ can be lower for these items.
How to calculate a minimum order quantity
Calculating an MOQ is a key part of inventory control, but it’s tricky because it differs with every business and every situation. There’s no single correct MOQ or fixed formulaic approach to the problem.
The requirements vary by business, and each firm must calculate the opportunity cost between paying a higher per-unit cost and enforcing a higher MOQ. Sometimes, a supplier may consider it advantageous to take some orders at a loss because it helps fuel orders of higher-profit items.
Consequently, you must come up with your own special, customized MOQ formula for your business. You must create it by collecting extensive data and then breaking down the numbers to determine at what point the MOQ is making your firm the most money. How do you do that? Follow the tips below to create your unique formula.
5 tips to implement a minimum order quantity
The following five tips will help you gather the information and make the calculations necessary to create a customized MOQ for your business.
1. Calculate demand
To determine your MOQ, you must understand the demand for products in your business. Implement demand forecasting based on product type, seasonality, and competition, and consider factors such as inventory ship times, lead times, freight transit times, and warehouse receiving.
Come up with a figure that accurately conveys how much inventory you must have on hand to respond to changes in demand, and assess sales forecasts constantly to adjust this figure.
Hypothetical example: ACME Widgets Inc. has determined that on average they sell 10,000 widgets per quarter, but their business is highly seasonal. They sell 5,000 in the winter, 7,500 in the spring, 15,000 in the summer, and 12,500 in the fall. The average widget takes two weeks to ship and spends eight weeks in the warehouse.
2. Determine holding costs
Next, determine what your holding or carrying costs are, which is the price you pay for storing goods. Some products cost more to carry than others. For example, goods that require refrigeration mean energy costs, while something else can sit on a warehouse shelf for months at room temperature.
Regardless of how much it costs to store the inventory, it’s always more profitable to not hold inventory for too long. Factor in the size of the product, any special needs (such as energy usage), how much time it spends in storage, and associated labor and overhead costs.
Hypothetical example: After a detailed analysis, ACME Widgets Inc. has determined that it spends $125,000 on holding costs to carry $500,000 in inventory, resulting in holding costs of 25%.
3. Determine break-even point
Now that you understand demand and holding costs, you must determine your break-even point. What is the minimum number of products you must sell to recover what you spent to acquire them?
If you sold five products to a customer, how much revenue would that bring in compared to how much it would cost to keep those products in inventory — carrying costs, overhead, and any other expenses? What if the order were 100? Eventually, you will find a break-even point where the revenue of the sale exceeds how much you spent on the products.
Hypothetical example: Based on how much product they must have in inventory at one time, how much it costs to keep widgets for eight weeks in the warehouse, shipping costs, etc., ACME Widgets Inc. has determined that a customer must order at least 350 widgets for it to be a profitable sale.
4. Draft a formula and a strategy
Now that you’ve gathered all the data and determined what a solid MOQ looks like, you can draw up a formula and a strategy for implementing it. This formula will describe the MOQ for each product type in your inventory, and the strategy will lay out how your team will incentivize customers who fall below the MOQ to get them to increase their order quantities.
With a formula and a strategy in place, you will avoid unprofitable orders that fall below the MOQ while minimizing the loss of customers in the process.
Proactively avoid the risk of unprofitable sales by working to increase the average order volume (AOV), perhaps through incentives such as bulk-buying discounts. This makes it less likely that customers will make a purchase that dips below profitability. Have a minimum purchase amount in place to control risk, but push customers to increase their buys by considering what you can do to incentivize them.
Hypothetical example: ACME Widgets Inc. found that it must sell 350 widgets to be profitable, but sometimes customers were trying to order 300. Instead of simply turning them away, ACME pointed out to these customers that they would be back in three months to purchase another 300. So, by placing an order for 600 now, they could have the first shipment sent immediately and the second at a date of their choosing — with free shipping to incentivize the larger order.
Software is necessary to determine an MOQ
It's unwise to try calculating an accurate MOQ with pen and paper, physical inventory counting, or a simple Excel spreadsheet. Today's inventory management software platforms are capable of gathering all of the essential data, such as inventory shrinkage, shipping costs, and turnover ratio.
The best next step you can take is to review the top software options available and try a few of them out so you can begin the process of coming up with an MOQ that will increase your company's profitability. These platforms have additional features that will make inventory management easier, such as supplier management, shipping tools, and product oversight.