Managing inventory can sometimes feel like walking a tightrope — lean too far one way, and you risk stockouts; lean too far the other, and you’re drowning in excess inventory. Striking the perfect balance is no easy feat, especially in the world of ecommerce. 

That’s where the Economic Order Quantity (EOQ) formula comes into play — a tried-and-tested tool to help retailers maintain just the right amount of stock while cutting costs.

EOQ becomes even more powerful with the right software in place, as technology offers the potential to streamline the application of EOQ principles, ensuring smarter inventory decisions. 

But what exactly is EOQ, and why should it matter to you? That’s what we’ll cover in this article. Let’s dive in.

What is the economic order quantity (EOQ) formula?

The EOQ formula is like the compass guiding businesses through the intricate maze of inventory management. It calculates the optimal order quantity that minimizes the combined costs of ordering and holding inventory. By pinpointing this “sweet spot,” businesses can ensure they’re not overstocking or constantly reordering.

EOQ is all about efficiency — helping businesses reduce unnecessary costs and improve operational flow.

Which is the correct formula for the economic order quantity?

At the heart of EOQ lies a simple yet powerful equation that works like a calculator for inventory management efficiency:

Here’s what each component represents:

• D = Annual demand in units. Think of it as the total number of widgets or products your business expects to sell over a year.
• S = Ordering cost per order. This includes the expenses associated with placing an order, such as administrative tasks or shipping fees.
• H = Holding cost per unit per year. These are the costs of storing inventory, including warehousing, depreciation, and insurance.

This formula ensures you order the optimal quantity to balance ordering and holding costs. Imagine it as the Goldilocks of inventory management — not too much, not too little, but just right.

What does the economic order quantity formula assume?

The EOQ formula operates within a framework of assumptions that, while simplifying calculations, may not reflect real-world complexity. Here’s what it assumes:

• Constant demand rate: EOQ presumes that the demand for a product remains steady throughout the year, like a metronome ticking at a consistent pace.
• Fixed ordering and holding costs: It assumes that costs per order and per unit stored don’t fluctuate — ideal for budgeting, but less realistic in a dynamic ecommerce environment.
• Instantaneous replenishment: The formula envisions a scenario where inventory is replenished immediately upon ordering, leaving no room for stockouts or lead times.
• No stockouts allowed: EOQ assumes businesses always maintain inventory levels to meet demand, ruling out the possibility of missed sales due to empty shelves.

Who designed the economic order quantity formula?

The EOQ formula was born over a century ago, crafted by Ford W. Harris in 1913. Harris, an engineer with a knack for problem-solving, developed the formula to address the complexities of inventory management in manufacturing. His work laid the foundation for modern inventory optimization, making the EOQ model a cornerstone of supply chain management.

Harris’ formula might seem simple today, but it was revolutionary for its time—a mathematical breakthrough that allowed businesses to minimize costs and operate more efficiently. Think of him as the Einstein of inventory, turning theoretical calculations into practical solutions.

How to calculate EOQ: A step-by-step guide

Think of calculating the EOQ as uncovering a treasure map for your inventory strategy — it’s not just math; it’s a key to saving time and money. Let’s break it down into manageable steps:

Step 1: Gather your data clues

Before diving in, collect the three crucial pieces of information:

• Annual demand (D): How many products you expect to sell each year.
• Ordering cost (S): The price tag for placing a single order (think admin fees, shipping, or setup costs).
• Holding cost (H): The cost of babysitting each unit of inventory for a year—storage, insurance, and more.

To illustrate this with a simple example, we’ll Imagine your business needs:

• 10,000 units a year (D)
• $50 per order to restock (S)
• $2 annually to store one unit (H)

Step 2: Crunch the numbers

The EOQ formula is like a cheat code:

Plug in the values: 

Crunch the equation:

707 units. That’s your Goldilocks order size — not too big, not too small, but just right.

Step 3: Let EOQ work its magic

So, what does this mean in practice? If you consistently order 707 units, you’re walking the perfect line between ordering costs and holding expenses. It’s like having a personal assistant fine-tuning your inventory flow.

Benefits of using the EOQ formula

Imagine running a marathon where every step is perfectly measured to conserve energy and reach the finish line faster — that’s what the EOQ formula does for your inventory management. Optimize your processes, helping your business achieve maximum efficiency with minimal waste. Here are the standout benefits:

1. Cost savings you can count on

By balancing ordering and holding costs, EOQ slashes unnecessary expenses. You’ll avoid the pitfalls of overstocking, which ties up capital and racks up storage fees, and understocking, which risks lost sales and unhappy customers. It’s like having a financial safety net built into your operations.

2. Streamlined order processes

EOQ determines the ideal frequency of orders, helping you avoid the frantic, last-minute scramble to restock. 

3. Smarter inventory levels

Say goodbye to “just winging it” when it comes to stock decisions. EOQ gives you the confidence to manage inventory like a pro, ensuring you have exactly what you need, when you need it. 

4. Better cash flow management

Inventory is one of the biggest expenses for any retailer. EOQ ensures you’re not tying up funds in excess stock, freeing up cash for other growth-driving initiatives like marketing or new product development.

5. A foundation for scalability

As your business grows, EOQ grows with you. Its principles apply whether you’re managing a single warehouse or a sprawling multi-location operation. 

Consider Shpresa Ltd, a flower retailer that faced challenges with excess stock and lost sales due to ineffective inventory management. By implementing the EOQ model, the company optimized its order quantities and reorder points, reducing holding costs and increasing efficiency. This change resulted in a 15% reduction in total inventory costs, showcasing the transformative power of EOQ in streamlining retail operations.

Limitations of the EOQ model

While the EOQ formula is a powerful tool, it’s not a magic wand. Like any method, it has its boundaries and can stumble when faced with real-world complexities. Here are some of the key limitations to keep in mind:

1. Assumes demand stays steady

The EOQ formula thrives in an ideal world where demand never wavers. In reality, sales often fluctuate due to seasonality, promotions, or external factors. Relying solely on EOQ without accounting for these shifts can lead to missed opportunities or overstocked shelves.

2. Ignores supplier constraints

Suppliers don’t always operate on your ideal schedule. Minimum order quantities or delivery timelines can throw a wrench into your perfectly calculated EOQ. 

3. Doesn’t account for bulk discounts

Sometimes, ordering in bulk makes more financial sense than sticking rigidly to EOQ. The formula doesn’t consider the potential savings from supplier discounts, which can significantly impact your bottom line.

4. Requires precise cost tracking

EOQ relies on accurate input data, particularly for ordering and holding costs. If these figures are off, your EOQ results will be, too. 

5. Overlooks real-world complications

Factors like lead times, perishability, and sudden disruptions (hello, global supply chain crises!) aren’t built into the EOQ model. 

Integrating EOQ with modern inventory management systems

The EOQ formula is like the skeleton key to unlock efficient inventory management, and its potential grows exponentially when supported by modern inventory solutions. 

1. Automation: Goodbye spreadsheets, hello efficiency

With inventory software like Linnworks, EOQ moves from being a manual exercise to a fully automated process. These systems use real-time data to recalculate EOQ as demand, costs, or other variables shift, ensuring your inventory stays optimized without lifting a finger.

2. Real-time insights: Data you can act on

EOQ’s effectiveness hinges on accurate data, and this is where platforms like Linnworks shine. By tracking stock levels, demand patterns, and cost variables with laser precision, they ensure that your EOQ calculations reflect the real-time state of your business.

3. Multi-channel harmony

Selling across multiple channels can turn inventory management into a juggling act. Linnworks simplifies this by syncing inventory across platforms, applying EOQ principles seamlessly, and preventing overselling or stockouts — no matter where your customers shop.

4. Flexibility for bulk orders and supplier quirks

EOQ is great for minimizing costs, but real-world constraints like bulk discounts or supplier lead times require a bit more nuance. Modern systems let you tweak EOQ recommendations to accommodate these factors, giving you a flexible yet optimized strategy.

Unlocking the power of EOQ with smart technology

Inventory management isn’t just about crunching numbers — it’s the beating heart of a successful ecommerce operation. The EOQ formula gives businesses the roadmap to balance costs and stock levels perfectly. But the real magic happens when this formula integrates with intelligent technology, transforming it into a practical powerhouse.

Platforms like Linnworks take EOQ from concept to action. With real-time insights and seamless automations, Linnworks ensures your inventory strategy evolves with demand, eliminating guesswork and reducing human error. 

Ready to take your inventory management to the next level? Book a free demo today and find out how Linnworks can help.