Inventory shrinkage is not limited to just retail stores – it occurs at every level of the supply chain and distribution channel. The impact of stock loss hurts business owners in both direct and indirect ways.
Simply put, when a shopper wants to buy a product advertised as available for sale, but it is not (due to loss of inventory) – the opportunity for profit is lost. The reduction of valuable stock available for immediate sale reduces a retailer’s ability to meet customer demand, draining retailer revenues and decreasing profits. At the same time, the often unforeseen expense to replace stolen goods, whether caused by would-be thieves, vendor fraud or employee theft – increases operational costs and further intensifies the pressure on net margins.
The National Association for Shoplifting Prevention estimates that the degree of inventory shrinkage attributed to retail crime in the USA is nearly $50 billion per year, with 550,000 shoplifting incidents occurring every day.
What Is Inventory Shrinkage?
From an accounting perspective, inventory shrinkage is the amount of inventory listed in the company’s bookkeeping records but no longer exists as actual stock available for sale.
High shrinkage levels can indicate loss of inventory by theft or damage, supplier fraud, incorrect physical counts, wrong units of measure or failure of internal warehouse, transport and retail store processes.
How to Calculate Shrinkage
Calculating inventory shrinkage requires retailers, including e-commerce specialists, to know the precise amount of stock in their business. Let’s say a fashion retailer purchases $2,000,000 of apparel COGS (Cost Of Goods Sold). The company makes sales, and its accounting records now show a remaining book value of $1,500,000. It conducts a physical inventory count and determines that the total amount available is actually only $1,400,000. Therefore, the amount of inventory shrinkage is $100,000, and the business is trading with a COGS shrink percentage rate of 5% = ($1,500,000 – $1,400,000) / $2,000,000).
Keep in mind the importance of store sales performance in maintaining, enhancing, or weakening your shrink results. Loss Prevention Media has an excellent article outlining some of the pitfalls and how best to calculate shrinkage that we would recommend reading.
According to Statista, in the fiscal year 2019, 18.2% of retailers in the United States declared that they experienced an inventory shrink of 3% and higher. 19.7% experienced inventory shrinkage of between 1% and 1.24% that year.
The National Retail Federation backs up these numbers. Their recent July 2020 security survey shows a shrink averaged of 1.62% of sales during 2019, up from 1.38% in 2018 (a 17.3% increase) after hovering around 1.4% over the past few years.
What Are The Primary Causes Of Inventory Shrinkage?
Retailers with precise knowledge of their business inventory shrinkage typically shift their focus from a ‘what’ strategy to a more seasoned operational plan that includes a deep dive into the problem. Budgets and teams have funds and resources allocated, and the overall goal is to answer the obvious questions, ‘where did my stock go?’ and ‘how do we fix it?’.
According to Statistic Brain Research Institute, the sources of Inventory Shrinkage in Retail are:
> Employee Theft 42.7 %
> Shoplifting 35.6 %
> Administrative Error 15.4 %
> Vendor Fraud 3.7 %
> Unknown 2.7 %
Business Impact Of Failing To Identify Inventory Shrinkage
Regardless of the products you sell or who your customers are, you’ve more than likely suffered from inventory shrinkage. It doesn’t have to be a lot, but you’ll have experienced it, and so you’ll know (even if it is only instinctively) that the damage it can do to your business can be severe.
Here are the four principal consequences of inventory shrinkage:
Reduced Cashflow and Profits
You may have heard the saying, “cash flow is king”, and that’s because cash flow affects your company’s ability to grow. All of the stock on your retail shelf (or e-commerce warehouse) is dormant cash flow waiting to be freed up by a sale. If your inventory shrinks, you have fewer assets available to acquire new stock, pay sales staff and grow your business.
The second, and the most apparent effect of inventory shrinkage issues, is the loss of revenue and bottom-line profit. Retailers often operate on modest profit margins where shrinkage can be the difference between turning a profit and experiencing a prolonged period of non-profitability.
Prices, Wages & Purchasing Capacity
If you experience a loss of revenue, reduced profits and negative cash flow, you may not be able to settle your accounts on time. Business owners often feel they are compelled to raise the prices of their products to make up the difference. They may also have to lower wages and hold back on wage increases, making it challenging to attract and retain high-quality employees. In turn, this can result in vendors reducing credit limits or renegotiating trading terms.
Aside from the massive financial impact, inventory controls influence retailers in other, less obvious ways. For example, if a store is out of a particular item, the stock control software may show that the same product is available at a nearby location. Suppose a sales clerk promises the customer it will be shipped to their home from that nearby store in 24 hours, but it turns out that the information is wrong and the physical item has disappeared from inventory. The result may be delivery delays, an unhappy customer who would otherwise be a repeat customer, a lost sale, a costly returns procedure, or perhaps a negative online review that remains indefinitely available to the world.
Staff Focus On Security
While in the past, retailers could rely on the criminal justice system to assist with shoplifting, the current federal and state focus on increasing felony thresholds and criminal justice reform means retailers need to accept the lions share of the preventative and deterrence burden in their stores. Consequently, Loss prevention Incentive Programs are often added to store manager’s compensation agreements to encourage staff to be more vigilant regarding security measures. It is a strategy that typically routes resources away from essential tasks like training, customer service, promotions and other day-to-day operations and towards loss prevention, often at the expense of sales.
Employee Theft – What Are The Risks?
Employee theft is a topic most retailers would like to believe happens elsewhere, but in reality, it is probably closer to home than you care to admit. After all, employee theft makes up 42.7% of annual retail losses in the USA and is easily the most significant source contributor to inventory shrinkage. Failing to prepare for internal theft properly leaves retailers vulnerable.
Retailers may want to consider using a background check service to verify a potential employee’s criminal record, education, employment history, and other past activities. Common types of employee theft include:
Dishonest employees might steal products from you, whether to keep them for themselves or sell them to friends, at market stalls or on the internet. Examples include hiding valuable items in the trash when they take them out and then retrieving them from the dumpster later. Employees may also hide small items on their person or in their bags.
Gift Card Theft
Gift card theft is prevalent these days, mainly because it’s challenging to detect. There are various methods to pull off this scam, but typically, employees will issue fake refunds to gift cards they will keep. They may also give a customer purchasing a gift card a blank gift card while keeping the loaded one. This form of fraud is costly to both your bottom line and your reputation.
“Sweethearting” is when an employee theft occurs at the Point of Sale (POS), deliberately opting to falsely process a sale for a friend or family member that visits the store. It can also be when a cashier gives their store discount to their friends or family members. More recently trends include staff sneakily attach EAS security tags to clothing using the Pin Park feature allowing co-conspirators to remove the tag without a detacher and then walk out of the store without activating the EAS detection systems.
Retail employees have ample opportunities to steal customers’ identities. An employee may have hundreds of options a year to keep a customer’s SSN and credit card information. This method of internal theft may not be directed against the store but is within the same grouping of activities and could ruin your stores’ reputation.
Employees have been skimming off the top of the cash drawer for years. Employees who know that a retail operator doesn’t care about a discrepancy of a few dollars in the cash drawer, or perhaps it is evident that processes are sloppy, may take advantage by slowly skimming quite a large amount of cash over time.
Employee Training – Preventative Strategies And Incentives
The easiest way to prevent employee theft is to establish a positive work environment. Employees who feel valued, heard, and appreciated will take more pride in their work, build a sense of loyalty, and be less likely to steal from you. You can do this in several ways, including;
- Promote a workplace with a positive atmosphere
- Provide good benefits
- Offer perks
- Reward employees for good work
- Pay employees properly
Encourage Whistleblowers & Setup a Reporting System
While most managers want to think that their employees are loyal and do the right thing, don’t rely on that alone to result in hotline tips. Staff may fear retaliation if they’re found to be a “snitch” or do not want to get involved. To encourage employees to report theft and other wrongdoing:
- Inform employees of the consequences
- Establish a company culture of ethics
- Offer incentives
- Stress the company’s commitment to confidentiality
- Have a way to correspond with anonymous whistleblowers
- Report on findings
Write Strong Policies
Employees might make mistakes on the job, so clear, well-written and comprehensive policies go far towards reducing inventory shrinkage due to a lack of staff awareness. Make sure your workplace policies on theft prevention (and data theft) are strong and that you communicate them widely.
- Include specific examples
- Explain why even the most minor theft incident can harm both the organization and the employee
- Outline the consequences for violating the policies
- Emphasize consistency
- Communicate your policies well and regularly
Strategies To Lower Inventory Shrinkage
Management should tackle the complex problem of retail inventory shrinkage with a multi-disciplinarian approach to loss prevention. The key to an effective loss prevention program is the integration of LP into the company’s operational structure.
Each store should also develop an individual detailed shrink plan, specifically to address the top five or ten inventory items, vendors or merchandise classes that experienced the highest loss in the most recent inventory cycle. These plans should also include detailed mitigation steps regularly communicated storewide and discussed at weekly staff meetings.
Use Technology To Stay One Step Ahead
Today, the loss prevention field has benefited from technological innovations like mobile, cloud-based audit technology deployed via smartphones and tablets and other new solutions such as biometrics, facial recognition tools, AI and machine learning.
Retailers deploying POS facial recognition technology reported a 34% decrease in shoplifting. Additionally, one in 10 retailers has or plan to implement in 2020 POS fingerprint-recognition technology (2020 National Retail Security Survey).
Married with item-level Radio Frequency Identification (RFID) and big data analytics, these emerging technologies aid retailers by enhancing audit productivity, increasing operational effectiveness and improving reporting capabilities.
But, even with these technological advances, old-school periodic physical inventory counts are still critical in the loss prevention puzzle. Nothing beats annual physical counts, and we would recommend that all stores and distribution centres run a physical inventory count at least twice per year at high-shrink locations (using the 80/20 rule).
Beyond audits and inventory tracking, technology serves a vital role in loss prevention as a real-time deterrent to prevent shrinkage in stores and a tool for apprehension both during the act of theft and afterwards.
Electronic Article Surveillance (EAS)
EAS offers critical decision support by capturing, interpreting, analyzing, and responding to real-time operational theft attempts at the store level to employees and shoppers. EAS tags have long been used in retail for 50 years to prevent shrink caused by external theft. Today, EAS continues to prove its potential to reduce 60-80% of external theft, principally when using high-security hard tags that shoplifters find difficult or impossible to remove, such as those designed by OMAC.
EAS has three elements:
- detectors & controllers
- deactivators & detachers
- labels & hard tags
The EAS sector is continuously witnessing technological advancements. Many manufacturers, including OMAC, are developing new technologies that are backward compatible and can upgrade older, existing EAS systems to produce vastly improved results with data showing a return on investment of six to twelve months.
According to Market Research Engine, the Electronic Article Surveillance (EAS) market is expected to grow more than USD $1,300 million by 2026, at a CAGR of 3.6%.
Closed Circuit Television (CCTV)
CCTV is another popular technology for deterring both internal and external theft. The cameras are generally placed in high-risk or hard-to-monitor areas of the merchandising floor and can be deliberately visible to customers or hidden.
Some retailers also install CCTV cameras that integrate with point-of-sale (POS) systems to help research exception-based reporting and catch employee theft. Other CCTV integration opportunities for extensive data analysis include people counting solution, shelf alert systems, cabinet locks, entry & exit access control and
According to the NRF, in 2019, over 78% of retailers deployed live customer-visible CCTV in stores, a 16.4 percentage point increase over 2018.
Not So High Tech Options
Don’t have the budget for EAS or CCTV? Consider mirrors instead, which can serve as inexpensive yet effective tools when it comes to monitoring your store for shoplifting and other suspicious activities.
Installing security signs in your store is another low-cost way to deter shoplifters and shady characters. Anti-theft signs should be installed close to the entrance and near your fitting rooms.
While the solutions and strategies above will help increase store security and reduce inventory shrink, keep in mind that the most critical item for success rests not in these tools alone but in how your business implements and uses them.
Before you jump into any one or a combination of technologies, be sure to assess your needs and create a plan that you can implement. Most importantly, check and double-check the historical data so that you can identify what actually works in stores, and weed out what is just the latest ‘shiny new tech’. Data remains your best friend and is still one of the most critical drivers to answer these questions;
- What is the expected reduction in shrink percentages?
- What is my Return On Investment (ROI)?
- What are my implementation / operational costs?
- Will my staff find it easy to run and maintain?