Minimum Order Quantity can help preserve customers while lowering inventory, improving cash flow, and profitability.
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Manufacturing is predominantly a volume business. While there are some production models that use Engineer to Order (ETO) or Make to Order (MTO), most are either Make to Stock (MTS) or Assemble to Order (ATO) and require volume to justify production.
But volume business comes with tradeoffs. Because of the complexity of manufacturing finished goods in volume, the cost of goods is pressured downward. At the same time, there is a threshold, or floor, where it is no longer cost-effective to produce these goods without eating away the last bit of margin. Setup and changeover times can erode efficiency in short lot environments. Add to this the fact that your vendors may require minimum order quantities from your company for materials and the result could place a company in negative margins for small volumes past a certain point.
Here is an article about Make-to-Stock Manufacturing Process Flow and Best Practices
What is the Minimum Order Quantity?
Minimum order quantity (MOQ) is often the remedy to keep orders above this “floor”. Minimum order quantity is the least amount of product a company asks of its customers to process and produce the order. It helps manage cash flow and mitigates the impact of small orders in a volume manufacturing operation.
How Does Minimum Order Quantity Work?
Minimum Order Quantity is defined by the manufacturer. It may be the “break-even” point plus a very small percentage of profit to produce finished goods. It may also be determined by the requirements placed on a manufacturer by their suppliers who also require and MOQ.
For other companies, it may be based on sales order value to justify the sales and customer service expenses. And for larger manufacturers, it is often a convenience number because they don’t need to go past a certain point because they already have volume buyers.
While there is no specific formula, companies generally look at the lowest production volume of production for a finished good and still maintain current efficiency levels. It may also be impacted by product-specific issues where a small lot would not go “on spec” with a small production run thus creating a lot of scrap. And it must also include the value and holding costs of raw materials as well.
Once this is determined, they can then decide the degree of margin they will cede to capture the order without going too far and losing money. Unlike the inventory-driven and finance-driven Economic Order Quantity (EOQ), MOQ is sales and customer service-centric.
Benefits of Minimum Order Quantity
There are many benefits to using Minimum Order Quantity to drive your manufacturing sales. These benefits include:
- Healthier Cash Flow – By implementing an MOQ, companies can improve, or at least hold the line, on their cash flow. As mentioned, a manufacturer’s vendors will often have their own minimums and MOQ must be balanced between those minimums and what the producer’s customers will accept. By setting an MOQ, a manufacturer can ensure that they do not have valuable cash tied up in a large amount of raw materials while slowly dispensing finished goods in small quantities.
- Lower Inventory – Because most manufacturers make more than one type of product or product category, a well crafted MOQ can help lower inventory. By having a lower MOQ, companies can maintain lower finished goods and raw materials overall. This reduces the inventory level, freeing up cash, and holding costs.
- Reduced Freight Cost – While finished goods shipping is often recoverable, raw materials ordered frequently may result in higher freight costs. It may trigger special handling, alternate forms of transportation, or expediting. If the MOQ is set at an optimum level, the freight cost can be lowered while still capturing the best shipping rate from suppliers.
- Higher Profit – MOQ is tied to demand. This means that even though a company may set a relatively low MOQ, they know that the production will be in higher volumes within the production cycle. This requires a balance between demand and inventory holding costs so that the lowest viable price can be offered on smaller lots. By finding this balance and then producing larger quantities within the cycle due to known demand and forecasting a company can still realize a higher profit while satisfying customers who want lower purchase minimums.
Best Practices for Determining and Using MOQ
A key issue to remember when setting a Minimum Order Quantity is that type of finished goods sold matters. Some goods are more complex to manufacture while others are easier and relatively cheap to produce. But regardless of the type of goods sold, there are a lot of complex moving parts to modern manufacturing. Here are a few best practices for setting an MOQ:
- Setting MOQ for High Production Costs – Some finished goods require very expensive materials such as unique chemistries or precious metals. Others require well-trained and well-educated skillsets. If the cost of labor is intensive or expert, if the cost of materials is extremely high, or if both are true, MOQ should be set higher.
- Setting MOQ for Lower Production Costs – Because of the proliferation and advancement of high-speed production equipment, many finished goods have become commodified, meaning they are easier to sell by the pound or unit count rather than individually. If finished goods are easier and simpler to produce or if they require unskilled labor reducing labor costs, setting a lower MOQ Is feasible.
- Aggressive Vendor Negotiation – Even though suppliers and vendors may have MOQs of their own, the reality of the global economy and long-tailed supply chains means that these vendors are under the same pressure as the manufacturer. If MOQs are too high, a vendor relationship may lend itself to better terms that will result in their lowering their own minimum. It may also mean that it can be advantageous to accept slightly higher pricing from new vendors with significantly lower MOQs because the manufacturer can still lower their inventory cost and holding costs with lower overall inventory levels.
- Automate – Today, automation is built into ERP and MRP platforms as part of their core functionality. While balancing MOQ requirements can be done by hand, these platforms make it easier and more accurate to set MOQs because they have features and enhanced analytics that help decision-makers determine the optimum MOQ to use. Usually, this MOQ functionality can be applied at the purchase point for vendor management as well as in setting the proper MOQ for finished goods based on near real-time data. By automating, the system does the work faster, more accurately, and with better results, freeing managers to take on more difficult tasks and to make better business decisions.
While every manufacturer wants to sell as many units as possible, Minimum Order Quantity can help preserve customers while lowering inventory, improving cash flow, and profitability.