How much to order: EOQ

If you order rarely, in big batches, you pay little in ordering costs but hold lots of stock. If you order often, in small batches, you hold little stock but pay for lots of orders. Somewhere in between is the order size where the two costs added together are lowest. That's the economic order quantity, EOQ.

The formula is EOQ = √(2 × D × S ÷ H). D is the yearly demand in units, S is the cost of placing one order, and H is the cost of holding one unit for a year.

Say a shop sells 2,400 lamps a year, each order costs $50 to place and receive, and holding one lamp for a year costs $6. EOQ = √(2 × 2,400 × 50 ÷ 6) = √40,000 = 200 lamps. It should order 200 at a time, which is 2,400 ÷ 200 = 12 orders a year.

At the EOQ the yearly ordering cost and the yearly holding cost come out equal. Here: 12 orders × $50 = $600 in ordering, and an average of 200 ÷ 2 = 100 lamps held × $6 = $600 in holding. That's a handy way to check your answer.

EOQ assumes steady demand, a fixed price and an order that arrives all at once, which real life rarely gives you. But the total cost curve is very flat near the best point, so ordering 180 or 250 instead of 200 costs only a little more. EOQ is a good starting point, adjusted for price breaks, pack sizes and truck loads.