Economic Order Quantity (EOQ) — Manufacturing Glossary

Economic Order Quantity (EOQ) is a formula-based lot sizing method that calculates the optimal order quantity to minimize the total cost of ordering and holding inventory. EOQ balances two competing costs: the cost of placing orders (or setting up production) against the cost of carrying inventory in the warehouse.

At User Solutions we see manufacturers apply EOQ primarily to high-volume purchased components where demand is relatively stable. It remains one of the most widely taught and applied inventory management formulas in manufacturing.

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How EOQ Works

EOQ is built on a simple trade-off:

• Order frequently in small quantities → low carrying costs but high ordering/setup costs
• Order infrequently in large quantities → low ordering costs but high carrying costs

The EOQ formula finds the sweet spot where total cost is minimized.

The EOQ Formula

EOQ = √(2DS / H)

Where:

• D = Annual demand (units per year)
• S = Ordering cost or setup cost per order ($)
• H = Annual holding cost per unit ($ per unit per year)

The formula assumes constant demand, fixed ordering costs, and no quantity discounts. While these assumptions are simplified, EOQ provides a solid starting point that many manufacturers refine with real-world adjustments.

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EOQ Example

A manufacturer purchases steel bearings for assembly operations:

• Annual demand (D): 12,000 bearings
• Ordering cost (S): $45 per purchase order (requisition processing, receiving, inspection)
• Holding cost (H): $3 per bearing per year (warehouse space, insurance, capital cost)

EOQ = √(2 × 12,000 × 45 / 3) = √360,000 = 600 bearings

The optimal order quantity is 600 bearings per order, which means placing 20 orders per year (12,000 / 600).

Cost comparison:

EOQ saves $1,200/year compared to ordering in small batches and $1,470/year compared to large batches — for just one part number. Multiply across hundreds of purchased items and the savings become substantial.

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Why EOQ Matters for Scheduling

Reduces total inventory cost. EOQ provides a mathematically optimal order quantity that prevents both over-ordering (wasting cash) and under-ordering (wasting administrative time on frequent orders).

Feeds into MRP lot sizing. When MRP calculates net requirements, it needs a lot-sizing rule to determine how to group requirements into orders. EOQ is one of the most common methods, especially for purchased components with steady usage.

Supports capacity planning. For manufactured items, EOQ determines production batch sizes. Larger batches mean fewer setups but more inventory; smaller batches mean more setups but less WIP. Scheduling tools like Resource Manager DB factor batch sizes into capacity calculations.

Provides a baseline for improvement. Even if EOQ assumptions do not perfectly match reality, the formula provides a defensible starting point. Planners can adjust from EOQ based on supplier minimums, shelf life, or storage constraints.

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Related Terms

• Lot Sizing — The broader category of methods for determining order quantities, of which EOQ is one approach.
• Lot-for-Lot — An alternative lot-sizing method that orders exactly what is needed each period, with zero excess inventory.
• Safety Stock — Buffer inventory held to protect against demand variability, often used alongside EOQ to handle uncertainty.

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FAQ

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This term is part of the Manufacturing Glossary. For a deep dive into material planning, see our MRP Guide.