Inventory Management: Minimum Order Size and Volume Discounts

Dec 30, 2018

As a webshop owner, you assume the optimal order size for efficient stock management, which is the number for which the total costs of a new stock (order costs plus stock costs) are the lowest. However, with quantity discounts or minimum order sizes, suppliers try to tempt you into ordering more products in one go. Is this a smart thing to do? The answer to this question can be found in this blog.

Volume discount
A graduated scale is a so-called ‘step’ in quantity discounts. Put flatly: the more you order, the more discount you get. 

Assuming the optimal order size of the iPhone DS case is 170 at a time. With this number, the order costs and stock costs are perfectly balanced. When ordering, you may find that you end up with a higher quantity at a lower purchase price per product if you order 30 more products. To determine whether this favourable the following basic rule applies: check whether the extra stock costs you incur by applying the graduated discount, outweigh the purchase advantage you gain. 

Example: quantity discount
In the example above, the lower graduated scale gives you a € 10,- purchase advantage. You save 200 times € 0.05 on the purchase of iPhone 6S cases. On the other hand, you will have to spend more to store the 30 additional pieces. These stock costs can be calculated using the formula below:

Stock costs*:

0,5 x number of products x purchase price x percentage stock costs = 0,5 x 30 x € 1,60 x 25% = € 6.

* More information about this formula can be found in our previous blog.

So the extra costs to store 30 extra pieces are € 6,-. The quantity discount gives you a € 10- purchase advantage. Net the discount will be € 4,-. The table below shows that the graduated scale is appealing for 200 products from an optimal order size of 150 pieces.

Minimum Order Quantity
The subject of quantity discount also includes the minimum order quantity (MOQ). Some suppliers require you to place larger orders with a MOQ. You could, therefore, see the MOQ as the lower (mandatory) quantity of an order. If it is below your optimal order size, this is not an obstacle. If the MOQ is above your optimal order size, then it is up to you to decide whether you will go along with it.

Example: MOQ

Suppose supplier A can deliver your iPhone screensavers at a best price of € 0.60 each. The supplier requires you through an MOQ to order a minimum of 300 pieces at once. However, your optimal order size is 270 pieces. Is this appealing? For the answer to that question, you must identify how much extra stock costs you will incur. In doing so, it is especially important to estimate what the risk is that you will be left with stock.

Another way is to look at a possible alternative.

Supplier B, for example, does allow you to order 270 pieces, but charges € 0.65 per case. To determine whether it is favourable to place your order with supplier B, you check whether the total extra costs per product outweigh the reduced stock costs.

Total additional purchase costs: 0.05 x 270 = € 13.50
Reduced stock costs: 0.5 x 30 x € 0.60 x 25% = € 2.25

The above calculation shows that in this situation, it is more beneficial to follow the MOQ of supplier A. Although the stock costs at supplier B decrease by € 2.25, it costs a total of € 13.50 extra to place the order here. So in net terms, supplier B is € 11.35 more expensive.

In conclusion, the examples show that you can explicitly determine whether it is preferable to deviate from the optimal order size. In the case of quantity discounts, you should check whether the extra stock costs incurred outweigh the purchase advantage you gain with it. Alternatively, in the case of MOQs: check whether you can bear the (mandatory) risk of the extra stock, and if not, investigate whether there might be more expensive suppliers without an MOQ, but where you do save on stock costs.

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