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Retail Inventory Shrink: A New Perspective
by Joseph Marchese — Partner, Clear Thinking Group
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As many Retailers will tell you, inventory is one of your most valuable assets. And for those companies with Asset Based loans, inventory is usually the largest component of the collateral securing that loan. Unfortunately, the true value of the inventory can be reduced significantly by inventory shrinkage or shrink.

Inventory shrink is the difference between recorded and actual inventory. Most companies attribute inventory shrink to employee theft, shoplifting, administrative error, vendor fraud, obsolescence, and cashier errors that benefit the customer. While companies do their best to track and manage this valuable investment, most fall prey to inventory shrink. It is a significant problem that is getting worse despite unique developments in technological solutions and growing loss prevention budgets.

A study released at NRF PROTECT, the industry’s largest retail loss prevention event, found that US retailers lose billions of dollars to shoplifting, employee and vendor theft, and administrative error. According to the National Retail Federation/University of Florida National Retail Security Survey, retailers say inventory shrink averaged 1.38% of retail sales or $44 billion in 2014. Retailers surveyed bucketed their 2014 shrink into the following categories:

  • Shoplifting — 38.0%
  • Employee/internal theft — 34.5%
  • Administrative and paperwork errors — 16.5%
  • Vendor fraud or error — 6.8%
  • All other — 4.2%

A New Typology
The ECR Europe Shrinkage Working Group proposed a new typology for evaluating inventory shrink within retail businesses. They believe that the first step is to recognize shrinkage as part of a broader concept called total loss, which is made up of two elements: shrink and cash loss. However, for the purpose of this article I will concentrate solely on shrink.

The ECR Europe Shrinkage Working Group defined four new headings under which the causes for shrink can be grouped:

  • Physical loss
  • Value variance
  • Process variance
  • Unknown loss

The main key to these four areas of shrink is that they are all capable of potentially being tracked and recorded by the company, with the last (unknown loss) determined by a simple process of deduction. Therefore, if the other three are known, the remaining losses must be unknown. Outlined below are the basic parts of each typology along with some examples to illustrate what is included.

Physical Loss
This category refers to the actual loss of goods within the company by the following factors:

  • Damage: These goods have been damaged in delivery, storage, and/or merchandising, which means their retail sale value is zero. Examples would include bags of flour left outside in inclement weather, cartons of flat screen TV’s that get crushed by a forklift truck, fruits or vegetables that have been badly bruised, or bottles of liquids that have been smashed.
  • Wastage/Spoilage: These goods have reached their expiration date or are past the recommended sell by dates and are no longer safe to sell. Examples would include fresh milk and dairy products, vegetables, fresh meat and fish, bread, and fresh cut flowers.
  • Internal Theft: These are the discovered incidents of theft by staff members of the company. Examples would be empty packaging found onsite in the company distribution center or “staff only” sections of the stores. Also included would be staff members giving friends or family members additional product without ringing it up at the register.
  • External Theft: These are the discovered incidents of theft by members of the public. Examples would include items that were recovered from shoplifters and cannot be resold. As with internal theft, these are empty packaging found in dressing rooms, rest rooms, or anywhere outside the “staff only” sections of the stores.

Value Variance
This category deals with reductions in the value of the product where the original sale price is not achieved.

Reductions: This is where the company discounts the original price of a product in order to entice the customer to buy. Examples include goods that are about to reach their sell-by date, have been partially damaged, or have been discontinued by the company.

Pricing: These are losses caused by errors by the company in the pricing of the product. Examples include entering a lower cost into the company inventory system, a staff member putting a lower price sticker on the product, an error in the advertised price in the company circular, or a staff member manually entering the wrong SKU or price at the register.

Missed Claims: This is the company failing to return items to a vendor for refunds or rebates. Examples include broken product received in the distribution center that was not returned to the vendor for credit, refund, or replacement.

Process Variance
This category contains four items relating to errors the company makes during processing and accounting for product in their inventory system.

Auditing: These represent counting errors made during annual inventory takes and periodic cycle counts. An example would be incorrectly counting a product that is displayed in multiple locations within a store.

POS/Checkout: These errors occur at the point of sale and creates a discrepancy in the inventory system. Examples include entering the wrong product code or entering a single code instead of a multiple product code; not scanning free products as part of a promotion; not scanning items at the bottom of a shopping cart, or a cashier using a “dump” code to record items that are not registering in the system.

Product Movement: These errors are created when moving product within business locations. This includes mistakes made when receiving of goods in the stores, the transfer of goods between stores, and customer returns, or refunds. Examples include shortages of product drop shipped directly to stores, transfers between stores where the transaction is not recorded properly by either one store or both, or customer returns that are not entered back onto the system properly.

Data Errors: These errors mostly occur on the corporate level while entering items into the inventory system. Examples include promotional items not set up properly in the system or linked to items in the main assortment, and products received into the store inventory that were not delivered.

Unknown Loss
Any unknown loss that the company cannot readily identify is characterized as either losses of physical product or loss of value on the sale of the goods.

There is little value in trying to guess what may be the causes of unknown loss. Companies set goals to keep this type of shrink to a minimum and/or convert it into one of the known categories above.

Impacts of the New Typology
The original definition of shrink has been used by companies since the late 1990s and early 2000s. It was easy for almost anyone learning about inventory shrink to grasp these broad classifications. But the new typology offers a secondary level of analysis that provides Loss Prevention professionals with the tools to identify the key causes of the shrink. Armed with this information, better solutions could be developed. While this newer model may not be suitable for all retail organizations, it may encourage organizations to reflect upon three things:

  1. Recognize that inventory shrink is much more than just the theft of stock by external thieves. It is a complex problem that goes beyond company and departmental boundaries and requires a much more organized approach to manage it successfully.
  2. The new typology will allow for the gathering of more detailed data sets that will assist in benchmarking across industries. By adding granularity to the measurement of shrink and using more concrete definition of each component, companies should be able to compare and contrast their data more reliably.
  3. The new typology should enable retailers to readily identify the real causes of shrink and subsequently develop the appropriate solutions to combat them.

It is also believed that the use of more specific categories to record inventory shrink could translate into increased company participation. Staff compliance along with the guidance of their Loss Prevention professionals could help companies tackle the problem more diligently.

In the past, much of loss prevention focused on external theft, which concentrated on security-oriented solutions. This newer typology emphasizes the many components making up inventory shrink, of which the majority will have little or nothing to do with catching thieves. Loss Prevention professionals must now fully understand their environment and develop solutions that are more about effective procedures than they are about tagging goods and arresting shoplifters.

Sources:  
1. https://nrf.com/resources/retail-library/national-retail-security-survey-2015.
2. http://losspreventionmedia.com/insider/inventory-shrinkage/redefining-shrinkage-four-new-buckets-of-loss/.

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