What costs does EOQ consider?

EOQ balances two cost categories: ordering costs (purchase order processing, shipping, receiving, and inspection) and holding costs (warehousing, insurance, depreciation, opportunity cost of capital tied up in inventory). The optimal order quantity is where total combined costs are minimised.

Does EOQ account for quantity discounts?

The basic EOQ model does not include quantity discounts. However, extended versions of the model incorporate tiered pricing. In practice, businesses compare the EOQ cost with the total cost at discount quantity breakpoints to determine whether larger orders at lower unit prices are more economical overall.

Is EOQ still relevant with modern inventory systems?

Yes. While modern systems use more sophisticated algorithms, EOQ remains a foundational concept. Many inventory management tools use EOQ as a starting point, then layer on adjustments for demand variability, supplier constraints, and other real-world factors.

Inventory & Supply ChainIntermediate4 min read

What Is Economic Order Quantity?

Discover how economic order quantity minimises total inventory costs by finding the optimal order size that balances ordering and holding expenses.

Key Takeaways

EOQ calculates the order quantity that minimises the combined cost of ordering and holding inventory.
The formula balances the fixed cost per order against the cost of holding each unit in stock.
EOQ works best for products with stable demand and consistent costs.

What EOQ Means

Economic order quantity is the optimal number of units a business should purchase in each order to minimise total inventory costs. These costs have two opposing components: ordering costs, which decrease with larger, less frequent orders, and holding costs, which increase as more inventory is stored. EOQ finds the sweet spot where the sum of both costs is lowest. The concept was developed by Ford W. Harris in 1913 and remains a foundational tool in inventory management.

The EOQ Formula

The classic EOQ formula is: EOQ = square root of (2 x Annual Demand x Cost per Order / Annual Holding Cost per Unit). For example, if annual demand is 10,000 units, each order costs $50 to place, and holding one unit costs $2 per year, the EOQ is approximately 707 units. This means the business should place about 14 orders per year of 707 units each to minimise total inventory costs.

Assumptions and Limitations

The basic EOQ model assumes constant demand, fixed ordering costs, fixed holding costs, and no quantity discounts. Real-world conditions rarely match these assumptions perfectly. Demand fluctuates seasonally, suppliers offer volume discounts, and holding costs change. Despite these limitations, EOQ provides a valuable starting point that can be adjusted for real conditions. Businesses in African markets may need to factor in import duties, currency fluctuations, and variable shipping costs.

Applying EOQ in Practice

Businesses use EOQ as a baseline, then adjust for practical constraints like minimum order quantities, container sizes for imported goods, or warehouse capacity limits. A wholesaler importing electronics into East Africa might calculate an EOQ of 500 units but adjust to 480 to fit standard shipping container configurations. EOQ analysis is most valuable for high-volume, regularly purchased items where small improvements in order sizing yield meaningful cost savings over time.

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