Economic Order Quantities
(Otherwise Known As
Purchasing Volume and Value)
Do You Need It?
Business is about making money and spending the money you have wisely.
But those expenses need to be carefully considered. For every item or
service that you order, there is an economic order quantity. If you ask
for too little, the price for each item goes up, but if you ask for too
much and do not use enough or use it slowly or ineffectively, you waste
money. So how do you determine what the economic order quantity for
If you truly need something, postponing that need until you can lump it
together with other things to get a discount is often chasing a false
saving. Leaving one toilet clogged until you have some more plumbing
work to do is not a good idea. The inconvenience and later expense will
easily wipe out any savings you might hope for. People often ask me
When should I buy
? I always tell them, When you need it. You
may need it because (ranked from easy to see to harder to see):
(1) The old one is broken.
(2) It does not do the job it used to do as well.
(3) It is not doing the job as fast or as well as you want it to today.
(4) It is not up to doing the occasional tasks you have in a timely
(5) You use a different method rather than the one you are supposed to
(it can be very hard to see bad habits).
(6) It will soon fall short or has reached its natural replacement time
when it will cost more to use it than its replacement will (most people
do not deal with the future well, so this is hard for them to evaluate).
There are some easy ways to tell if you have waited too long. Imagine
giving the product or denying the service to your wife, child, or a very
valued employee. If you think that they would be disappointed, you have
waited too long to do it for yourself or your business.
How Do You Satisfy Your REAL Need?
Once you have decided you need something, the question becomes How
much do I need? The answer is often, More than you think. If you
ever have a question as to whether a certain feature or function is
necessary, think of the future. Now, imagine having to deal with that
issue at a future time and going through the same decision making and
other processes you have to go through now. Will it be worth it? Here
are some examples:
(1) Recently, I needed to apply for a personal line of credit. I had to
fill out exactly the same paperwork no matter how big the line was to
be. Since it was a line of credit, I did not have to pay anything if I
did not borrow any money. The solution was simple; I imagined the
largest expenditure I might have. I also asked the lending agent what
was reasonable and would not trigger more paperwork, hassle, or a
rejection. I then asked for a much larger limit than I needed at the
moment. It was granted and now I know I have a lending safety net
already in place should I need it. Getting more of something may
require little in the way of actual effort or resources.
(2) I "bought" that credit line by committing time, energy, and other
resources I have now and the commitment to pay interest later. Having
something in place when you need it is easy, inexpensive, and causes
little disruption compared to having to deal with an "emergency." While
you may not consider not having a toner on hand to be a big deal, what
if you cannot print the $3 million invoice you need to print to get
paid? Not having what you need can be very expensive (basically the
reverse of (1)).
(3) Whenever I am asked, Do I need this less capable product,
component, or warranty, or this one? I always reply, Buy the more
capable one. You do not know what the future will hold. Buying more
than you actually need is inexpensive when stacked against a wholesale
replacement and/or expensive services later. It is not "gold plating"
if you think you might later use it.
(4) Buying less than you need or know you will need is almost never a
good choice. Settling for a less expensive tool or service that does
not do all the things you need it to do will cost you a bundle. I said
need here, not want. Having to go through the purchasing office again
in very short order or having to trash what you have done and rework
something is wasting more money than you could ever save. That said,
the future is unknown. If you have 70% confidence that an off the shelf
product or service will do what you need, it is probably enough to go
ahead with the buy. Often people feel pressured to resolve a situation
and "buy something." I will often advise my clients that if they want
to get from here to there, a bridge too small will not do it. Instead,
they need to figure out something else to do or save their money until
they can buy a bigger bridge.
(5) Budgeting is similar to buying. I find the most expensive numbers I
can possibly find when preparing a budget. Circumstances change.
Sometimes you may need to buy two, or a more expensive component, or the
market price goes up, or the unit you want is replaced with a more
expensive one, or your brother-in-law runs off with a waitress and is
not available to paint your house. If you budget at the higher end and
allow for contingencies, then your chances of success and actually
lowering your costs are better. Never budget off what something
currently costs. Assume it will cost more to be safe. It is easy to
spend less than your budget but may be impossible to spend more.
Budgeting is not just about money. It is about time and other resources
as well. Getting the phones installed two months after you have
occupied a new space is not fun. Time, people, availability, equipment,
and other projects need to be allowed for as well or your costs will go
up. I often have to tell clients, Im good. Im not magic. I
cannot make stuff appear in negative time nor can I produce product that
is not available. Oh, and please remember that budgets should not
take too much time as they are often bullshit. The federal government
is a very budget driven organization and I have done business with them
for many years. However, todays needs and expenses may have very
little to do with a budget thought up even a short time ago.
(6) Savings may not be obvious. Buying energy efficient equipment can
pay you back over time. Employee training can pay huge dividends.
Paying a consultant to point out what needs to be fixed can pay you back
well, too. Maintaining your equipment and being nice and supportive to
your people will pay big dividends. Buying a five year maintenance deal
might not fit well into a yearly budget, but if you intend the product
to last for that period of time and you get a good deal buying it up
front and do not have to go through the purchase process another four
times, you can save gobs of cash. Keeping someone or something (like
malware) from soaking up your entire Internet bandwidth or keeping
people from spending too much time on unproductive Internet sites could
improve the productivity of your entire organization. People *think*
that hardware, software and services are expensive. You just buy these
things to help people do what needs to get done. If they cannot get it
done easily, well, or at all, you hemorrhage money. The best way to
find out about potential savings is to ask a professional sales
representative about them. He will often ask what your people are
doing. That is where the rubber meets the road.
(7) Buying a lot may not be a good deal. You might not be able to use
it all at once. You then shoulder market, technological, and businesses
risks you do not need to. While it may be less expensive to buy a
bunch, it is not always. Sometimes, the price for quantity 1 is $X and
so is every one after that. Build a relationship with your
salesperson. If that person is a professional, they are looking to do
business with you over and over. They know they can do that best by
taking care of you and NOT assuming the customer is always right.
They may tell you to buy 25 software licenses instead of the 23 you know
you need and asked for because you will not only get a price break, but
you will have two extra licenses to use if you need them. If you need
only one license more than the 23 you bought later, you may have to buy
five or more licenses and that would hurt. As another example, you may
need to buy 1000 printers to distribute through your company, but the
difference in price between 100 and 1000 per unit may be nil while your
up front costs, storage costs, risk of technological obsolescence and
vulnerability to product issues and business risks increase.
(8) Think about the future. What do you expect to get out of your
purchase? One common mistake I have seen is that governments will make
a sexy buy of 1000 cameras or laptops one year. But they do not buy the
maintenance. Worse, they do not think about them wearing out or needing
to be replaced or the carry bags and other accessories they need. Buying
333 over three years and looking at a three year lifetime for the
products decreases business and technological risks immensely. It also
lowers the barrier in terms of supporting and maintaining the fleet of
items and the "gotcha" costs of the accessories will become more
(9) Do not ignore the present or be afraid to think small. It can be
hard to buy an extra charger or a carry bag for a laptop, but the
benefits can be amazing. While some organizations make it difficult to
hire consultants or run pilot or demonstration projects, you can lower
your risks greatly and increase your success markedly. Waiting to do
something you need to do costs you monetarily and in terms of morale.
(10) Partner with people you trust. If you only want cheap prices, you
can get that, even from good companies. Do not expect the company or
its people to do much else for you. A rule of thumb to always follow is
that No business is better than bad business. The federal
government used to have a buying system that demonstrated savings of
2-5% on procurements. The problem was that the error rate was something
like 30%. The system only valued the lowest price. There was no real
incentive to deliver on time, deliver what the customer wanted, ask any
questions about the procurement (they would not be answered), or even
bid the correct amount, among other issues. That error rate ended up
costing them far more than they ever saved and the buying system got
scrapped. Treating your business partners as disposable vendors
encourages them to treat you the same way. Look at the long term
relationship and the value you can get out of working with a particular
business partner. After all, you are buying something not because it
costs only so much, but for the value it gives you having boughtit.
(11) Sometimes the economic order quantity is zero or less than what you
have now. I will often get someone saying, "I need this." If they have
given me the chance to know them well enough, I may be able to say, "You
don't need it. You have this and it can do the same thing." It is
natural to want to "do something." But sometimes the best thing to do
is NOT to do it at all. I have often been able to say to my consulting
clients, "What is the best thing about hitting your head against the
wall? When you stop." Sometimes you need someone to point it out to
you. Sometimes you may need to do more in one area to save in another.
You might purchase a software inventory program and find that you have
1250 licenses of software in use, but you are really only using 500.
Next time, you should only buy 500 units worth and spend the money you
(12) Sometimes there is NO economic order quantity or it is not what you
think. Everyone makes mistakes. The question is, how will you recover
from it? In logistics, if everything goes as planned, consider yourself
lucky. But, if it does not or something is difficult, then having good
business relationships with your vendors is key. If you treat them as a
disposable commodity or do not value customer service, be prepared for a
nasty and expensive road ahead. At Iron Horse, we can document a 0.2%
or less product return rate for any reason over 20 years. Some of the
Internet mass marketers have return rates more than 100 times that. Be
as diligent as you can on the front end, but work with people who really
value you and your business. An easy example of an economic order
quantity being not what it seems is buying insurance or a warranty that
is very difficult to deal with or does not pay. The entire purpose of
those agreements is to mitigate your potential loss. If they add to it
at a more critical time, the "savings" of a couple of bucks in premiums
or fees is not justified. As another example, your brother might be
happy to pull your tooth for a quarter, but the dentist at $100 may be a
(13) It can be advantageous to buy everything you need in one place.
These are all or none orders. Then again, it might not. Some suppliers
are better at some things than others. And, you may want to encourage
vendors to keep doing business with you. Put yourself in their shoes.
If you never order from them or only turn to them as a vendor of last
resort or treat them as a disposable commodity, then would you be all
that excited about doing business? And, if you are a pain to deal with,
any vendor may well "fire" you or raise their rates so you end up firing
yourself. A professional salesperson would rather have no business than
bad business which costs him time, money, and resources that would be
better spent elsewhere. If you only buy one or two from one company and
then thousands from someone else once they have proved their value, do
not be surprised if they do not want to take your call. Look to develop
long term, mutually beneficial business relationships.
(14) Good business is often dull. If something is exciting, there is a
good chance it is because something went wrong. And, it is often the
dull things that mean the most. You need to set appropriate goals and
expectations, provide adequate training and maintenance, provide
technical help and managerial support, ensure that there are resources
available, provide policies and standards, and provide all the ancillary
items (bags, install services, cloud services, power adapters, etc) to
allow for the success of a "sexy" purchase like a new laptop. Your car
is not important, per se. That it can get you to and from where you
want safely is. The fact that you know how to drive and maintain it
is. The fact that you know what to expect when you are on the road is.
The same is true of your business purchases. While it may be "sexy" to
order 10, 100, or 1000 laptops at once, are all the other "little
things" in place to make that a truly valuable purchase?
(15) Time and resources are both your friend and your enemy when it
comes to a getting a good deal. If you have to have it now, then your
choices become more limited. If your system forces you to buy a one
year support agreement and will not let you buy a three year one for the
price of two, then you may be stuck. Or are you? Given enough time,
you could fight the system to change the rule or negate it in your
specific case. Without enough time, you still have options. One tactic
I have often used in the past, though it almost always caused short term
issues, was to ignore the rule and do what needed to be done. The rule
for an underling is that you can ask for permission or forgiveness. It
can be risky, but it can also be the best or only thing to do to get the
job done to ask for forgiveness.
The shorter the time frame, the more likely asking for forgiveness will
be necessary. If the time frame is too short, you may not be able to
accomplish what you want to no matter how much money or resources you
throw at the problem. You cannot make backordered product magically
appear, for example. Given more time and more flexibility, however, the
prices and terms can come way down. If you put in an emergency call for
a plumber to come out and fix your toilet, it will be much more
expensive than if you shut the water off and have a scheduled call to
fix the same issue.
(16) Shopping-itis and administritis are real problems. It is easy to
lose sight of what you are doing, especially if you approach shopping as
a game show where you are looking for the lowest price. Price says
nothing about value or relationship. Price is only one factor. An
overemphasis on price or cost is corrosive. Don't believe me? Please
go see the lowest priced doctor you can find for your child's heart
surgery. Still don't believe me? I will give you a lower price than
you can find anywhere on the Internet....but, I will not deliver until I
damn well feel like it, like 9 months later when I can buy in bulk. Need
help with your product? Fine, e mail me at this address which has an
unhelpful autoresponder. I can name lots of factors that matter more
Spending a lot of time shopping can cost you. We all do it, so do not
say you do not. I am sure you are not one of those who drives 30
minutes to buy cheaper gas for your car. Those people find that in the
gas costs alone they have probably lost money, not to mention the time
and hassle of actually making that run. OK, I will admit it. I often
look at what is available on the market and what other people charge for
it. It may or may not reflect what I charge for it or whether I sell it
at all. You do the same. Gas may be $2.50 in East Texas, but if you
want to fill your car in Virginia, it means little.
Sure it is fun to "play the price game." It can also be a scary thing
to finally pull the trigger and commit yourself to an alternative, so
you might want to spend lots of extra time looking. But, from a
business and personal standpoint, you are wasting time, effort, and
money. You may need a salesman's help to "convince" you that what you
really need to do you can do with them. [Professional salespeople help
you see what you need to do is OK, they do not really "convince" you of
anything.] Avoiding a decision is not OK. Especially in business
shopping, the goal is to do it quickly and easily. If you know people
you can trust, you can cut your time spent shopping to almost nothing.
Administritis is *showing* how much effort you made. It may just be a
way to cover yourself in case something goes wrong. It may even be
satisfying some procurement rules. Governments are famous for this.
They will happily spend $1,000,000 to document how they saved $5. To
them "accountability" is all important. That is budget and bean counter
thinking. It is not a good way to actually save money, create value, or
achieve business objectives. Try to avoid procedures that will drive
the total cost up dramatically. Governments do not like to think in
terms of cost, so for those in large organizations, look for the best
method to realize a good Return on Grief (tm). If you possibly can,
look at procedures in your organization that make getting what you need
far too hard and attack them. Administritis is a debilitating long term
illness that can sap morale and cost a ton of money. As a personal
example, before I got married I had administritis. I tracked all my
expenses very closely. That did not sit well with my wife. Pre-marriage
it was "$0.05 for gum." Now it is "$1000 for miscellaneous expenses."
My wife and I are both happier and I spend less time with my personal
accounting program. I resisted it, but it was a win all around. Do NOT
tell her she was right!
I would like to hear any thoughts or questions you have on this topic.
You are welcome to use all of this thinking to improve your buying or
you can simply call Iron Horse for your business computing needs. We
will be happy to apply what we have learned to make your experience a
Stirk, Iron Horse email@example.com