Every business is making monthly decisions based on Profit and Loss statements. One of the easiest ways to grow the numbers in the Profit column is to take action on factors contributing to the Loss column. For retail suppliers, those factors causing loss can range from low sales to high returns.
One factor causing an unnecessary loss for suppliers and retailers is shrinkage. While shrinkage is usually unpredictable, it can be controlled when appropriate safeguards are put in place.
What Is Shrinkage?
Shrinkage (or simply shrink) is a loss of retail inventory. This means an item was not purchased but was still taken from a store. Shrinkage also happens when more inventory is reported as having arrived at a store than is physically in the shipment.
For retailers, shrinkage averages around 2% of total sales. This percentage seems small at first glance, but for big box retailers like Walmart, it accounts for millions of dollars in loss.
How Do I Calculate Shrinkage?
Retailers should be calculating shrinkage on a regular basis. This is done by counting existing inventory then comparing it to the value of the inventory reported on the balance sheet (or “what’s on the shelf vs. what’s in the books”).
During a sales period, the formula for calculating a shrinkage percentage is:
(Value of Loss ÷ Total Sales for the period) x 100 = % shrinkage
Here’s an example of how the formula works:
During an inventory, a retailer reports $230,000 in merchandise on the shelf (cost value).
On the balance sheet, this merchandise is showing to be at $250,000 (cost value).
Sales during this period are reported at $500,000.
First, calculate the loss ($250,000 – $230,000 = $20,000).
Then plug the loss and sales into the formula:
($20,000 ÷ $500,000) x 100 = 4% shrinkage
In this example, shrinkage was calculated using the cost value of the items. However, there are retailers that choose to calculate and report shrinkage based on the retail price and not the cost.
You can use the same formula, but calculate the lost amount and the sales at either both at cost or both at retail.
What Causes Shrinkage?
The first step in reducing or eliminating shrinkage is to find the root cause. Depending on the item or where it is happening in the supply chain, it can be a number of factors:
One of the common causes of shrinkage is basic shoplifting. Customers taking items from a store without paying impacts not only sales but replenishment and reporting.
Loss prevention technology is constantly combating shoplifting with innovations from locked cabinets and security tags to Radio Frequency Identification (RFID) and integrated software. As shoplifters get more sophisticated, the industry works to keep up with new technologies.
For retailers, the question is not “Are my employees stealing from me?” The question is, “How many are stealing from me, and how often?”
Compare Camp did a study of employee theft for 2020 – 2021. As they researched the impact and cost to businesses, what they discovered was:
- Employee theft impacts about 95% of businesses
- Average employee fraud will happen for two years before detected
- Three out of four employees admit having stolen from their employer at least once
- From 2002 to 2018, non-cash property theft climbed from 10.6% to 21%
To reduce employee theft, retailers must look beyond loss prevention measures put in place for customer shoplifting. In some cases, employees can take product before it reaches the sales floor.
Was the purchase order (PO) filled out and entered correctly? Did fewer items actually ship than were scanned at receiving?
These errors can show up as shrinkage. Of all the factors that lead to shrinkage, administrative errors are the easiest to correct. To improve this part of the process, from PO to replenishment, see 8th & Walton’s Walmart Supply Chain classes.
While supplier fraud is not a common contributor to shrinkage, it is still a factor for retailers to consider in their loss prevention planning. Areas where this is most likely to happen are in the delivery and return processes.
For example, much vendor fraud happens when outside vendors deliver product directly to the store and also come in to stock it on the shelves. All merchandise is checked in, monitored, and stocked by the supplier. Supplier fraud occurs when the person stocking does not provide as many items as the retailer was invoiced or steals other products.
Suppliers have arrangements with retailers on items they will accept in return for credit. If an item is damaged in the store and it can not be sold or returned to the supplier, it becomes shrinkage.
Fresh items that expire, broken merchandise, and items with a protective seal broken are a few common occurrences of shrinkage from damage.
How Should Retailers Focus On Shrinkage?
Shrinkage is loss. The big issue is, when a retailer loses inventory through shrinkage, there is no way to recover the cost of that inventory. There is physically nothing to return to the supplier, so it comes out of the retailer’s bottom line. Retailers normally tackle loss via shrinkage in one of two ways: take steps to eliminate future loss or try to make up for the loss.
The goal for retailers should be to reduce (and if possible, eliminate) shrinkage. Simply accepting shrinkage as a given and trying to make up for the loss in other areas can be a huge mistake.
Making up for the lost sales normally means raising prices or even cutting costs (employee salaries, headcount, benefits, etc.). This can lead to loss of customers and problems in keeping quality employees on staff. Retailers should place resources into loss prevention measures to avoid shrinkage and not accept it.
Best Practices to Prevent Shrinkage
While shrinkage comes in many forms, the majority of loss comes from shoplifting and employee theft. To reduce shrinkage, retailers can implement some best practices and long-term investments:
- Provide excellent customer service: Never underestimate the power of eye contact and letting the potential shoplifter know you’re close! Employees posted at the front of the store and approaching customers in each aisle to offer assistance can serve as shoplifting deterrents.
- Install signs, cameras, and frontend detectors: The more customers know about your anti-theft practices, the less likely they are to steal. Post signs letting customers know they are being monitored by security cameras. Cameras out in the open are even more effective. Anti-theft detectors at the front of the store also prevent shrinkage on tagged items.
- Keep things neat and organized: Messy or disorganized merchandise is easier to steal. The message it sends to the potential shoplifter is no one is covering this area of the store and no one cares. If it were actually being monitored, it would look more presentable. Prevent this shrinkage by keeping shelves and displays looking neat and organized.
- Invest in technology: As mentioned before, loss prevention technology is a must to get shrinkage under control. RFID tagging, alarm systems, digital video recorders, and live customer-visible CCTV are just a few tools for consideration.
Retailers and suppliers are in business to grow profits. A big part of growing the profit is reducing the loss, which is why shrinkage should be a key focus in planning.
The reduction or elimination of shrinkage grows profits, keeps costs down, and prevents having to recoup lost dollars from areas like payroll production resources.
Are you struggling with shrinkage or loss somewhere in your supply chain?
Our team supports suppliers like you with these issues each week! Contact the experts at 8th & Walton for a free 15-minute consultation.