What is Minimum order quantity (MOQ)?
16 Aug 2021
Minimum order quantity (MOQ)
What is the minimum order quantity (MOQ)?
The minimum order quantity (MOQ) is the lowest number of inventory units the supplier sets for the buyer to purchase at once. To say it alternatively, when choosing to buy that specific product the customer has to purchase at least as many numbers of it as the seller has set for the minimum.
Why do suppliers set a minimum order quantity?
Generally, the main incentive for setting a minimum order quantity is to sell bigger amounts of inventory. Also, it should generate a reasonable amount of profit. Let’s take a look at these components separately.
Selling a greater quantity of an inventory
Suppliers always want to sell their inventory as fast as possible. However, in cases when the inventory is available for a great amount and should be consumed immediately, the wholesalers start putting effort into selling them even faster. An example of this can be a pack of fresh fruit. It will be spoiled if not sold in a day or two. The seller might set a minimum order quantity of 3 packs for this to sell it faster. In this case, he will generate profit instead of throwing them into the trash when they are not edible anymore.
Increase profits quickly
Another key benefit of setting a MOQ is the increased profitability. Since the suppliers get to sell more units of inventory they get to earn more profits in a shorter period of time simultaneously.
Types of minimum order quantity
Two main types of MOQ are separated in the market. High MOQ does not have a specific value. It depends on the particular industry it is applied to. The reason beyond setting high MOQs is usually the suppliers’ willingness to restrict access to their product. This usually happens
when the supplier is willing to distribute their product to a certain layer of customers. This is a strategy mostly implemented by already successful producers who have their grown customer niche to which they are selling their product.
Apart from this, the business has to be in a stable financial state to afford to set a high MOQ. This is because with a high minimum order quantity the business has to have a higher amount of inventory produced. This infers bigger labor, greater holding costs, etc. To say it simply, to be able to produce as much inventory as set by the MOQ, the business has to face bigger costs.
The graph below illustrates the high amount of inventory needed to be produced in order for the company to set a high MOQ.
Low MOQ is usually set by suppliers who are new to the industry. They are usually willing to develop a customer community for themselves. The low MOQ is mostly set from 1 to 50 units of inventory. However, it is important to take into consideration that the prices for the MOQs set by a beginner industry are usually negotiable.
Furthermore, less amount of inventory is needed to be produced. Also, fewer costs are to be generated for paying the workforce and taking care of the recurring expenses.
How to calculate the minimum order quantity?
After familiarizing yourself with the types of MOQ, you may now be willing to calculate the minimum order quantity that would be the best to implement for your business.
There is not a specific formula or technique to calculate the MOQ for your business. Instead, there are a couple of factors determining the best MOQ for your business.
Let’s evaluate them together.
Determine your demand
The first step of setting up the most effective MOQ for your business is to determine the demand for your product. Once you have understood the metrics of your demand growth, you will be able to proceed with accurate inventory forecasting. The higher the demand is for your product, the greater number of inventory units you can produce. As a result, with a high inventory number, you may claim a high MOQ for your product.
Know your break-even point
The break-even point of a business is the stage where the generated revenue equals the costs of production. Thus, the earned profit is zero as a result.
For claiming a minimum order quantity, you should be able to calculate your margins. You need to understand how many units of inventory you need to sell to reach a break-even point.
Calculate your holding costs
Holding costs represent the costs for storing your inventory before selling it. Depending on the type of your product, you should be able to determine the approximate holding costs for your inventory and avoid overproducing the inventory in particular cases. For example, if your product is too big of a size, you may want to produce a fewer number of it for the beginning to avoid huge holding costs you will have to pay for storing them.
Holding costs include the warehouse rent, the maintenance fees, the additional costs for facilitating your warehouse, etc.
Set your minimum order quantity (MOQ)
Once you have figured out all the factors above, you are ready to set your MOQ. Say you have relatively high demand, and your customers have consistently demonstrated the pattern to buy at least 10 units of your product. You have calculated that you need to sell at least 7 units to be at a break-even point. You can now set a minimum order quantity of 8, for example, to ensure that your customers will be buying your product since they have been willing and able to buy it for 10 units consistently. Moreover, you will be able to make a profit since you will be selling a greater number of units than you need to stay at a break-even point.
- Remember that setting up a MOQ should serve you for two main purposes: selling more inventory at once and generating a big profit simultaneously.
- Know your customer community well to be able to set the right amount of MOQ for your business. Be careful not to set too high a minimum order quantity if you are a new business or if you do not have a specific segment of customers that have consistently demonstrated the willingness to purchase your product.
- The strategy you will be implementing to determine the best MOQ for your business should involve calculations related to your demand, your break-even point, and your holding costs.