Most vendors require buyers to purchase a minimum quantity when ordering inventory. This is known as the minimum order quantity (MOQ), which is the fewest number of units that a vendor requires you to purchase.
Minimum Order Quantity is the lowest number of units of inventory that a vendor is willing to supply to a customer on a single order. For instance, a company may decide that they won’t sell less than 1,000 units of a particular product.
This becomes their minimum order quantity, as any order below 1,000 units may result in a loss for the vendor. The minimum order quantity is calculated by vendors to ensure profitability per order and varies from one product to another.
Companies can define the MOQ based on a dollar value or based on per unit. The reason why companies generally use a MOQ is because they have to bear administrative expenses, raw material costs, and also have to pay for setup costs, all of which affect their bottom line.
Here are just some of the major reasons why vendors generally impose a minimum order quantity.
One of the main reasons why companies use a minimum order quantity is because it helps them maintain a sales margin. This is defined as the minimum profit that the company intends to generate by selling the product or service.
If the sales margin is incredibly tight, the company may increase the minimum order quantity to a higher amount in order to break even and eventually turn a profit.
Apart from the profits that the company intends to generate, there are other costs associated with the product too. For instance, the company wants to recoup its upfront expenditure, and in some cases, they need to plan for the sunk costs incurred in the development of the product or service.
Other costs that most vendors factor in are as follows:
There’s no specific amount that companies can use for their minimum order quantity. In fact, the MOQ varies depending upon the type of product and the nature of the industry that the vendor operates in. Here’s a brief set of steps that companies can follow to determine their MOQ amount.
The first step to accurately calculate the MOQ is to forecast the demand for a product. This means factoring in the type of product, user demand, competition for that product, and then determining just how much the company can sell.
Inventory forecasting is a common technique that businesses use to get a better understanding of demand for an upcoming season. The lead times for getting the inventory ready to ship from the moment an order is placed is also factored in, as most companies prefer keeping a safety stock to mitigate any fluctuations.
The next step is to determine the break-even point, which means recovering additional costs incurred in the sale of the product. The company also factors in the customer acquisition cost (CAC) when evaluating the minimum order quantity.
In certain cases, businesses also have to factor in any volume discounts when calculating the break-even point.
When calculating the MOQ, it’s also important for companies to determine the holding cost. This is the cost that companies pay to store inventory in their warehouse. In some cases, it doesn’t make financial sense to store the inventory for longer periods of time.
Finally, once companies factor in all of the costs, they can then apply the profit margin to determine their minimum order quantity.
As you can imagine, MOQ has a major impact on inventory for a vendor. A higher MOQ would mean that vendors have to produce goods in larger quantities, which may inflate their holding costs.
Here’s how inventory is affected if vendors opt for either a higher MOQ or a lower MOQ.
If the vendors choose to keep the MOQ low, suppliers won’t require as much inventory on hand to meet demand. As a result, their holding costs will reduce, and inventory turnover will likely increase. However, the average order size will decrease.
A lower MOQ means that the sales team will be under considerable pressure, as they’ll have to focus on maximizing orders and bring in more customers to generate more business.
With a higher minimum order quantity, the company will have to keep a higher inventory on hand to meet demand. For companies that use just-in-time inventory models, this may increase lead times.
In most cases, a higher inventory on hand means companies have to use up a significant portion of their working capital in inventory, which can pose some risks. However, it does reduce ordering costs over time.
There are two types of MOQs that you should know about: simple and complex. Here’s an explanation of each.
The simple MOQ just has one limit, defined either in dollar terms or in terms of units. Essentially, this means to place an order, companies have to spend a minimum amount.
Complex MOQs impose multiple requirements for each order, which includes more than just the quantity or the dollar value. For instance, a clothing manufacturer may require buyers to purchase a minimum number of units and may also impose other restrictions, such as the type of fabric to order or the thread count per each unit.
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