55. Economic Order Quantity (EOQ)
How to Order the Right Amount of Inventory — Minimizing Costs While Avoiding Stockouts
What Is EOQ?
Economic Order Quantity (EOQ) is a fundamental concept in inventory management and logistics. It helps businesses determine the ideal order quantity that minimizes the total costs associated with purchasing, ordering, and holding inventory.
The goal of EOQ is to answer this key question:
"How many units should I order each time to keep costs as low as possible without running out?"
It’s especially important for businesses that carry physical stock and want to optimize warehouse operations, reduce waste, and improve cash flow.
Why EOQ Matters
EOQ helps balance two conflicting types of costs:
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Ordering Costs – The cost of placing and processing each order (e.g., admin, shipping, setup).
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Holding Costs – The cost of storing unsold inventory (e.g., warehouse space, insurance, depreciation).
EOQ helps you find the perfect balance between these two forces.
EOQ Formula
The classic EOQ formula is:
EOQ = Square root of [(2 × D × S) ÷ H]
Where:
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D = Demand in units per year
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S = Ordering cost per order
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H = Holding cost per unit per year
Example Calculation
Let’s say:
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Annual demand (D) = 10,000 units
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Cost to place each order (S) = €50
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Holding cost per unit per year (H) = €2
Apply the formula:
EOQ = √[(2 × 10,000 × 50) ÷ 2]
EOQ = √(1,000,000 ÷ 2)
EOQ = √500,000
EOQ ≈ 707 units
→ This means the most cost-efficient order quantity is 707 units per order.
Terms You Should Know
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Ordering Cost (S): Cost incurred every time you place an order — includes shipping, handling, administrative work, and setup.
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Holding Cost (H): Cost of keeping one unit in inventory for a year — includes storage, capital cost, insurance, and risk of obsolescence.
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Demand (D): The total number of units your business needs over a year.
Benefits of Using EOQ
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Lower total inventory cost
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Reduced stockouts and overstocking
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Improved cash flow management
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Better warehouse space utilization
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Optimized replenishment cycles
When EOQ Works Best
EOQ is ideal when:
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Demand is relatively stable and predictable
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Unit costs and holding costs are known
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Lead times are consistent
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You deal with standard SKUs or finished goods
Limitations of EOQ
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Doesn’t account for quantity discounts (like bulk order pricing)
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Not suitable for highly seasonal or perishable items
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Assumes constant demand and lead time, which may not apply in real life
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Assumes no stockouts or backorders, which may not always be true
For complex or dynamic environments, EOQ can be adapted using real-time data, safety stock buffers, or integrated into modern ERP/WMS systems.
EOQ in Practice: Logistics Example
A distribution center receives orders from retail stores weekly. Their old system used fixed ordering without cost analysis. By applying EOQ:
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They reduced order frequency
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Lowered storage costs by 15%
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Cut handling labor time by 20%
They also added automated reorder triggers in their WMS based on EOQ and lead time forecasts, resulting in better service levels and reduced waste.
Summary
Economic Order Quantity is a powerful yet simple tool for optimizing inventory strategy. It ensures that you're:
By applying EOQ correctly, businesses can make smarter purchasing decisions, reduce operational costs, and keep inventory flowing smoothly.
