Dec 28, 2021
How minimum orders quantities (MOQs) impact inventory management
While a supplier imposes an MOQ to help increase their profits, it's vital to understand how supplier MOQs affect your inventory planning.
Over the past 18 months, supply chains have experienced more ongoing disruptions, such as extended lead times, escalations in logistics costs, and instability in demand and supply. In many instances, raw materials are scarce or completely unavailable.
According to the ISM, "companies and suppliers continue to deal with an unprecedented number of hurdles to meet increasing demand." Last week, the [US] government reported that the economy grew at its slowest pace in more than a year in the third quarter because of widespread shortages tied to the COVID-19 pandemic.
If manufacturers cannot source raw materials, they will likely impose high minimum orders quantities (MOQ’s) as they will face inflated prices.
In this post, we will explore:
- What is an MOQ, and why do suppliers impose them?
- The impact of MOQs when managing your inventory
- Tips to help navigate the complexities of MOQ's
1) What is a minimum order quantity, and why do suppliers impose them?
An MOQ is the smallest number of items one can order in one delivery from a supplier.
The supplier imposes a minimum order quantity to cover their production costs and help pre-determine their profit margin. Of course, the MOQ may differ from supplier to supplier for the same item, so inventory buyers should review more than one supplier to establish the best MOQs to optimize their inventory planning.
Usually, a manufacturer will set higher MOQs because they require more resources to create the product than an MOQ defined by a supplier providing to a wholesaler or retailer.
2) The impact of MOQs when managing your inventory
An inventory turn is how businesses profit from their inventory by measuring how many times they have sold and replaced stock over a given period. By calculating your inventory turn, you are in a better position to make informed decisions on pricing, manufacturing, marketing, and purchasing new stock.
It then stands to reason that if you are ordering an MOQ that results in you purchasing more than what you need, you will be holding extra stock, which will reduce your inventory turns.
The directive that most inventory planners abide by is to source inventory at the lowest possible price, and this is not always the smartest thing to do!
A practical example:
If you purchase a MOQ at a 20% margin and this inventory lasts you for one year, you have made a 20% margin over the year. If you bought stock for a one-month supply (not complying with an MOQ) and sell that inventory within one month, you make 20% per month, i.e., 240% per annum on your inventory investment. Even if you get an extra 10% discount on your MOQ, this means you will make 30% over the year as opposed to 240% by maintaining monthly inventory turns.
An MOQ needs to be at a substantial discount if it is worth considering. Instead, spend your working capital on inventory that frequently turns than falling into the trap of MOQ’s.
Of course, an MOQ is not always a bad thing. If, for example, the MOQ is less than your monthly demand, applying the MOQ to a monthly order will not force you into carrying higher stock levels. This is low risk for you, and you can happily commit to the supplier's MOQ.
Actionable excess stock
Accumulating excess inventory resulting from an MOQ is not necessarily a bad thing. In a situation where you are forced into a highly effective replenishment cycle because you had to buy more than you needed, you either won't need safety stock or much less safety stock. This type of excess stock is planned for and helps to mitigate against demand and supply risk.
Other factors affecting your inventory planning
Understand your demand
Before accepting a supplier or manufacturer's MOQ, you need to do some homework. To estimate how many units you will sell, you need to understand your demand by taking into account:
- your product range
If you do not accurately know your demand, placing an MOQ can dramatically affect your business's cash flow, profitability, and overall financial well-being.
Place more orders
You may find that the MOQ aligns well with your demand and subsequent forecast, and you may need to place even more orders. In this instance, ensure you consider:
- Supplier lead times and potential delays
- If you have enough safety stock
- Review your forecasts and adjust your orders accordingly.
Before investing too heavily in an MOQ, consider the holding costs of the items and the product's longevity. You don't want to end up with a load of obsolete or expired goods.
Placing orders with high MOQ's on fast-moving products is beneficial. However, when you have a high MOQ on an item that doesn't move quickly, that's where you need to get creative with your ordering and planning so you don't end up with excess stock that could potentially become obsolete. Even if items are inexpensive, if you must purchase a few thousand as a minimum, this can be a costly exercise.
3) Tips to help navigate the complexities of MOQs
- Keep your product range at a reasonable size. You don't have to stock every color, shape, or size of an item. Apart from the costs of MOQ's, it would be best to consider additional inventory costs . Remember: 20% of your items make up 80% of your turnover.
- Understand what makes up the 20% by classifying your inventory. Classifying your items gives you valuable information so you can avoid MOQ's on the wrong items - or at least come up with a plan to lower your risk.
- Don’t be tempted to take shortcuts and ask for cheaper materials in the manufacturing process. Be careful not to sacrifice quality.
- Find other inventory buyers that can split the order with you. Even if they are a competitor, they will most likely have the same challenges with MOQ's and may be happy to split an order.
- Arrange with the supplier that you split the payment. When you order the MOQ, you pay 50%, receive half the shipment, and take the balance of the stock a few months later.
- Communicate your three to four month forecast with your supplier to help them understand your demand. Sharing this information will help the supplier plan the raw material needed, and if you commit to your forecasts, the supplier may be inclined to lower the MOQ.
- Manufacturers often make to order and don't hold stock. If the item in question is made regularly, you may negotiate a lower MOQ. For products that aren't produced that often the MOQ will generally be higher. Discover which items they manufacture often.
- Consider calculating your MOQ to your customers as a safeguard. Of course, you must calculate what your breakeven point is. If your customers have been ordering 50 units of an item, consider making that your MOQ.
- Offer free shipping to your customers based on a minimum spend.
The ideal situation is to avoid MOQ’s by selecting suppliers that do not impose them. Of course, this is not always possible. To lower the risks associated with MOQs, work with an inventory management tool that measures your supplier’s performance, and allows you to work from a dashboard that highlights only the top key areas that need attention. With accurate information about your inventory, you will be in a better position to select the right suppliers with the best MOQs to optimize your inventory.
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Written by The Inventory Mentor
The Inventory Mentor provides thought leadership insights and industry trends for the supply chain industry.