Economic Order Quantity
What problem does EOQ mathematically solve?
It minimizes the sum of annual ordering cost and annual holding cost for a single item under stable demand and constant lead time.
What assumptions must hold for EOQ to be valid?
Demand is steady or known with certainty, lead time is constant, and costs are stable enough that the classical model can approximate real replenishment behavior.
How is EOQ different from reorder point?
EOQ sets the order quantity; reorder point sets the trigger level for placing the order.
Economic Order Quantity (EOQ) is the ideal replenishment lot size that minimizes total inventory costs by balancing ordering cost and holding cost. In the standard deterministic model, EOQ equals the square root of (2DS)/H, where D is annual demand, S is cost per order, and H is annual holding cost per unit. It is used when demand is stable and lead time is constant.
On a manufacturing shop floor, EOQ tells procurement how many units of a raw material, component, or packaging item to order each time, preventing stores from being overloaded with excess stock while avoiding frequent small purchases that drive up receiving, paperwork, and supplier transaction costs. In warehousing, EOQ balances pallet-space utilization, handling effort, and capital tied up in inventory against the administrative and logistics cost of each replenishment order. In raw material tracking, EOQ is paired with a reorder point: EOQ determines how much to buy, while the reorder point determines when to buy, so production can feed line-side demand without unnecessary overstock. Operationally, the model works best when consumption is predictable, carrying cost is measurable, and setup cost is repeatable. In a high-volume plant, embedding EOQ into ERP/MRP procurement parameters or min-max rules reduces total annual cost by finding the cost-minimizing tradeoff between ordering too often and holding too much inventory.
Demand volatility breaks the model: When actual usage swings with seasonality, rush orders, or scrap spikes, an EOQ based on average annual demand underbuys during surges and overbuys during slow periods, causing line stoppage or excess aging stock.
Incorrect holding-cost calculation distorts the order size: Omitting storage space, insurance, obsolescence, shrink, or capital cost makes the calculated EOQ too large, leading to excessive inventory and tied-up cash.
Ignoring real replenishment constraints causes execution failure: Supplier MOQ, pack size, truckload economics, or dock capacity may not match the theoretical EOQ, forcing non-optimal order multiples that create receiving bottlenecks or line-side shortages.