SPECIAL REPORT

What Is Inventory Management?

Reducing Retail Shrink through Customer

Service and Stock Control Methods
W
hat does shrinkage mean to you? For most
companies, the answer to this question would
seem to be obviousa significant problem
and usually something that is getting worse, not
better, despite unprecedented developments in
technological solutions and growing loss prevention
budgets.
When ECR Europe established its Shrinkage
Working Group in 1999, its first task was to agree
what it meant by the term shrinkage: what did it
include and what did it exclude? What seemed like a
deceptively simple task proved problematic.
Definitions varied enormously among the European
retailers and manufacturers present at the meeting.
Does it include known and unknown loss? Should
cash be considered part of shrinkage? What about
losses suffered in the supply chain? And should it be
valued at retail or cost prices? Eventually, the group
agreed upon a compromise and concluded that
shrinkage involved losses suffered by organizations
as a consequence of the following criteria:
Process FailuresLosses due to operating
procedures within an organization
Internal TheftThe unauthorized taking of goods
or cash by staff employed by the company.
External TheftThe unauthorized taking of goods
or cash by customers or other non-company
employees.
Inter-company FraudLosses due to suppliers or
their agents deliberately delivering fewer goods
than retailers are eventually charged for by them,
or retailers deliberately returning fewer goods to
manufacturers or suppliers than agreed or
specified.
It was also agreed that shrinkage included known
and unknown losses and that costs should be quoted
at retail prices.
While this was not a perfect definition of what
shrinkage was all about, it enabled the working group
to move forward in terms of carrying out research
and developing new thinking on how to tackle the
problem. It has proved to be a definition that is both
easy to explain and understand.
However, it can be argued that it oversimplifies a
complex and multifaceted problem. It requires the
user to delve deeper into each bucket before any
real notion of what constitutes the causes of these
types of shrinkage becomes apparent.
It also tends to overemphasize the problem of
malicious shrinkagethose types of shrinkage
purposefully carried out by individuals or
organizations intent upon profiting from loopholes in
flawed processes and procedures.
Given this, the ECR Europe Shrinkage Working
Group proposed an open debate on what the term
shrinkage should include and exclude. In order to
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begin this process, the group put forward their vision
of what it might be.
The ECR Europe Definition
and Typology of Shrinkage
The starting point is a clear definition of
shrinkage. An ECR Europe white paper, Measuring
Retail Shrinkage: Towards a Shrinkage KPI,
arguably offers the most concise and workable
understanding . This report suggests that shrinkage is
intended sales income that was not and cannot be
realized. In other words, a company did not receive
the income from the goods it has purchased that it
originally expected.
Known vs. Unknown Loss
An important point is whether both known and
unknown losses should be included in the typology.
Some argue that if losses are known, then they are
not part of the shrinkage equation. For example, food
that goes beyond its sell-by date is written off and
duly recorded. Likewise, stock that has been reduced
to clear typically involves calculating and recording
the reduction in profit.
For both of these examples, some companies
would argue that because a record has been made,
they should no longer be considered a part of the
shrinkage pie: We know where it has gone, why,
and what it has cost us. For others, simply because a
company can record the loss does not mean that it is
no longer a problem requiring attention.
What if members of staff are purposefully
discounting stock early for their family and friends?
What if staff hides stock to ensure it goes beyond its
sell-by date, thereby making it available to
themselves at lower or no cost? Might excessive
waste in a store be symptomatic of a management
team that has lost grip or indicate a supply chain that
is malfunctioning?
ECR Europes view is that both known and
unknown losses should be included in the typology
because both can be reduced and both can be
intimately related. Offering store managers an option
to prioritize unknown shrinkage less than known loss
is potentially a costly strategy.
Retail vs. Cost
Whether the costs of shrinkage should be
expressed at retail or cost price is another key part of
the debate. Those in favor of the former argue that
expressing losses at retail prices ensures that the
problem of shrinkage is taken more seriously within
the company and reflects the true cost of doing
business. Some companies with this view have
even renamed their loss prevention departments
profit protection.
 For example, simply considering items at cost
can exclude all the additional or consequential costs
of doing business associated with a particular
product, such as transportation, marketing, and the
salaries of the loss prevention team. Others argue that
the retail price is too crude a figure and does not take
into account the profit margin on a particular product
and can over-inflate the true cost of the problem.
Given these arguments, the view of ECR Europe
is that shrinkage should for the most part be
calculated at retail prices, but that there may be times,
particularly when discussing the problem internally,
that it should also be thought of at cost price. In
addition, the issue of profit margin should also not be
lost, and there may be times when this needs to be
part of the shrinkage equation.
A New Typology of Shrinkage
Proposed is a new typology for thinking about
shrinkage within retail businesses. Its starting point is
recognizing that shrinkage is part of a broader
concept called total loss, which is made up of two
elements: shrinkage and cash loss.
While focusing at this time on these two
elements, there may in fact be other elements to
consider. For instance, there is a growing debate
about the issue of the cost of safety within retailing,
while others point to the problems of counterfeiting
and the black and gray markets.
Focusing first on the typology as it relates to
shrinkage, four new headings under which a series of
causes can be grouped have been developed:
Physical loss
Value variance
Process variance
Unknown loss
Physical loss compartmentalizes those causes
that mean that the stock cannot be sold at all by the
business. Value variance looks at those causes of
shrinkage that consider changes to the price of goods,
meaning that the full price for those products is never
realized. Process variance looks at those causes that
can be categorized as being created by the flow of
goods and information throughout the supply chain.
And finally, unknown loss captures shrinkage for
which there is no evidence to suggest its cause.
Key to these four areas of shrinkage is that they
are all capable of being recorded by the business; the
last one by a simple process of deduction, meaning if
the other three are known, the remaining losses must
be unknown.
Physical Loss
This category refers to the actual loss of goods
within the business via the following factors.
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Damage. Goods that have been damaged during
the process of delivery, storage, and merchandising,
which means they cannot be sold for any value.
Wastage/Spoilage. Products that have reached
their expiration date or gone beyond agreed
temperature parameters and are no longer safe to sell
to consumers or staff.
Internal Theft. Known incidents of theft by
staff that have been recorded by the company.
External Theft. Known incidents of theft by
members of the public, including contract staff that
have been recorded by the company.
Value Variance
This category of shrinkage covers those causes
of loss that refer to changes in the value of the
product that mean that the original envisioned return
is not realized.
Reductions. The original price of a product is
reduced in order that the product is more likely to be
sold, such as goods about to reach their sell-by date,
have been partially damaged, or have been
discontinued.
Pricing. Losses caused by errors in the way in
which goods are priced and sold in the business.
Examples would include goods coded incorrectly on
the store inventory system, staff incorrectly pricing
product in the back room areas or on the shelf, a
mismatch between agreed and actual selling price, or
a member of staff entering the wrong price at the
register.
Missed Claims. A failure to claim for refunds or
rebates on items returned to a supplier.
Process Variance
This category contains four items that relate to
processes that impact upon the movement of goods
and information through the business and the way in
which they are monitored and accounted for.
In Auditing. Errors, such as stock being
incorrectly counted, in the audit process during
annual stock checks and periodic cycle counts.
At the Checkout. Errors occurring at the point
of sale that lead to a discrepancy in the store book
stock. Examples would include a checkout operator
entering the wrong code for a product; entering a
single code for multiple varieties of a product; not
scanning free products as part of a promotion, such as
buy-one, get-one free offers; a register operator
forgetting to scan goods, such as items at the bottom
of a cart or those removed from keepers/safer cases;
or a cashier using a dump code to sell items that are
not easily scanned or identified.
Product Movement. Errors generated by the
movement of goods within the business.
 Data Errors. Errors in the recording of stock on
company systems. Examples would include retail
buyers or suppliers incorrectly inputting item set up
details that lead to stores receiving fewer items than
identified on the system; items that are not correctly
associated with the book stock database, such as
promotional items not linked with items in the main
assortment; and products registered on the store
inventory that have not been delivered.
Unknown Loss
By their nature, the causes of unknown loss are
not apparent to an organization, but they can be
characterized as either losses of physical product or
the loss of value that the organization might have
received for the sale of the goods.
There is little value in trying to guess what may
be the causes of unknown loss. The important aspect
of this type of shrinkage is to develop ways in which
the amount of unknown losses can be minimized
and/or converted into known losses.
The percentage of shrinkage that is unknown
compared with known should be a key performance
indicator for any organization. The results from the
ECR Europe survey showed that 51 percent of
shrinkage was unknown, compared with 49 percent
that was known.
Cash Loss
The second category under the heading of total
loss is cash loss, which contains four areas relating
to the receipt, movement, storage, and processing of
cash within the business.
Internal Theft. Cash that is stolen by
employees.
External Theft. Cash that is stolen by members
of the public. This can take the form of overt
physical intimidation at the front end or cash office,
such as register snatches or armed robbery, or more
subtly through the exploitation of the companys
returns policy.
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Error. Non-malicious mistakes made in the
counting, auditing, and transfer of cash within the
business.
Unknown Loss. The loss of cash that cannot be
accounted for through internal and external theft or
errors in auditing or transfer of cash.
Impacts of this New Typology
There is undoubtedly a simple elegance to the
original definition of shrinkage that had earlier
been used by ECR Europe; it was easy for those new
to shrinkage to grasp the broad contours of the
problem. However, it required a secondary level of
analysis to begin to arrive at the key causes of
shrinkage for which solutions could begin to be
developed. While the ECR Europe Shrinkage
Working Group is not suggesting that this new model
is necessarily suitable for all retail organizations, it
will hopefully encourage organizations to reflect
upon three things.
First, recognize that shrinkage is much more than
just the theft of stock by external thieves. It is an
interwoven problem that transcends company and
departmental boundaries and requires a multifaceted
and coordinated solution.
Second, such a typology will enable detailed data
sets to be created that would allow more accurate
benchmarking across the industry.
Third, the proposed typology should enable
retailers to more readily identify the real causes of
shrinkage within their organizations and subsequently
develop solutions to respond to them. To date, much
solution selection has been premised upon guesswork
and presumption, self-interest, and longevity.
The greater degree of specificity in the recording
of shrinkage that the proposed typology requires
could also be translated into increased confidence at
the store level. Showing an appreciation of the
complex challenges faced by store staff could, in
turn, increase compliance with requests from the LP
department to tackle the problem more assiduously or
introduce new stock-loss programs.
These categories could be easily adapted to meet
the challenges faced in different organizational
settings, such as stores, distribution centers, or
manufacturer production plants.
Finally, by creating a more inclusive and holistic
typology of shrinkage, which prioritizes the
importance of measuring the problem in detail and
highlights the many non-malicious causes of loss,
important issues are raised about which skills and
competencies of those tasked to reduce and manage
shrinkage within the retail environment are needed.
How Much Are You Losing to Paper Shrink?
Each year, loss prevention directors are
evaluated based at least in part on inventory
shrinkage results. At a minimum, poor shrinkage
numbers negatively affect bonuses and department
morale. At times, unacceptable results may even lead
to dismissal.
Forward-thinking LP professionals continually
search for that new technology, idea, or process that
will lower inventory shrinkage and help transform
their departments from cost centers into profit
centers.
Toward that end, many retail businesses have
implemented elaborate inventory control programs to
reduce real shrinkagethe out-the-door inventory
losses caused by employee theft, shoplifting, and
vendor fraud. Sophisticated camera systems, sensor
devices, exception reporting, and the like have
certainly cut shrinkage considerably. But, even the
most sophisticated loss prevention program can come
up short if, in addition to uprooting the causes of so-
called real shrink, the company does not identify and
eliminate the causes of paper shrink.
Paper shrink is the term applied to all
discrepancies between physical inventory and book
inventory that are not out-the-door losses caused by
theft, shoplifting, or fraud. Paper shrink results from
incorrect counting or pricing, misdirected shipments,
careless paperwork on the loading dock, and a range
of other accounting and recordkeeping errors. A 2000
Retail Survey Report from the University of Florida
found that this form of shrinkage leads to as much as
$17.50 of every $100 of shrinkage in a retail
business.
One reason for the laissez-faire attitude of some
retailers is that some paper shrink, such as that from
missed markdowns, has a netting effect on profits.
That is, these types of shrink are typically offset in
other accounts such as cost of sales or the shortage
appears as reverse shrink in the next period. But other
paper shrink may cause real bottom-line losses.
The primary reason to be concerned, however, is
that unidentified paper shrink hits hard when it
misdirects the efforts of LP programs designed to
attack the real shrink. That is, if the company cannot
identify its paper shrink, then it does not have an
accurate handle on its real shrink.
By knowing more precisely the causes of paper
shrink, companies can better determine the causes
and sources of real shrink, more accurately measure
its value, and more effectively use resources in
controlling shrink of all types.
Dollars Associated with Paper Shrink
According to Tom Yake, an inventory shrinkage
expert who has helped the Internal Revenue Service
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and Security Exchange Commission examine
shrinkage issues related to financial misreporting,
there are more than 100 causes of inventory
shrinkage. Though the theft-related causes cost
retailers billions of dollars every year, the impact of
the other causes can be substantial as well.
Administrative and Paperwork Errors Leading to
Shrink
The sources of paper shrinksometimes referred
to as book shrinkwill vary depending on whether
the company uses the retail method or the cost
method to account for its financial inventory. Some
causes of paper shrink are associated with the retail
method, some with the cost method, and others will
affect retailers using either method:
Price Changes (Retail Method). Company A, a
grocer that over the years moved toward a more
complex product mix, had policies and procedures in
place that were appropriately designed for the
grocery business. For example, the company did not
record markups or markdowns on existing inventory
when price changes occurred. This practice is not
unusual within the grocery industry, where the
inventory turnover is so high the net dollar value of
permanent price changes on existing inventory is
insignificant compared to the total flow through of
merchandise for each inventory period. However, for
general merchandise, the impact on shrinkage of not
recording markups and markdowns was significant.
General merchandise is the goods for which the
companys inventory turnover was under three turns
per year compared to over eleven for the rest of the
categories.
Cost of Goods (Cost Method). Company Bs
inventory transfers from the distribution center to the
stores were charged to the store inventory account at
an item level, using the actual cost at the time the
goods were purchased. That cost would naturally
vary during the year based on new vendor shipments.
The cost was further adjusted internally for
advertised goods purchased by the store. Sales were
converted to cost at an item level during the year
using the cost at the time the item was sold. Because
of timing differences between purchase and sale, an
item may have been purchased at different costs. If
the purchase cost is higher than the sales cost, the
result may contribute to inventory shrinkage
(depending on the value attributed to that item during
the physical inventory). On the other hand, if the sale
cost is higher than the purchase cost, the result is a
reported inventory overage.
In Transit (Cost and Retail Methods). Another
breeding ground for reported shrink at the store level
is merchandise in transit. Distortions in reported store
shrink can occur from improper timing in recording
or from a failure to record transfers to and from
distribution centers. In fact, not being able to
reconcile in-transit discrepancies is another situation
that may render a company unable to detect or
quantify the true impact of shrink caused by theft.
Theres More to LP than Preventing Theft
Since its inception in 1993, the Lowes
Companies loss prevention and safety department has
tailored its programs to identify and respond to losses
that can be directly attributed to employees. The LP
department believes that 80 percent of all losses can
be directly attributed to employees. Forty percent of
those losses come in the way of actual dishonest
activity by employees. To curtail this type of loss, the
department takes a proactive approach by
advertising its defenses, tools such as CCTV and
exception reporting.
The other 40 percent of losses attributed to
employees can be labeled as paper shrink.
Employees contribute to paper shrink daily due to
poor training, apathy, turnover, and other factors
beyond their control.
In the past, the company did not have a single
point of contact to coordinate and follow through on
issues as they were reported. In 2001, in an effort to
streamline reporting and coordinate solutions to
paper shrink issues, the LP department created the
manager of merchandise shrink control (MMSC)
position to work with merchants, trades payable,
store operations, inventory accounting, quality
assurance, and vendors for the purpose of further
reducing our level of paper shrink. This new position
proved to be beneficial in controlling shrink for
Lowes.
Item Set Up Maintenance
Item creation, or new item set up, is crucial for
minimizing operational shrink. As an example, if an
item will be available for sale in both single and
master carton units, the item set up information must
include the correct bar code quantities for your point-
of-sale system.
In one instance, store-level LP personnel were
the first to identify and react to an improper bar code
on a product: A master carton quantity of patio chairs
had been set up with a bar code on the master carton
of a single piece. When a box of patio chairs was
received at the store, it was received into inventory
correctlyfour pieces per box. The issue was with
the UPC quantities for each item as they were set up
in the system. The only bar code established in the
system for use at the point of sale was a UPC-A bar
code that was set up to scan one chair. This would
allow for a customer to take home four patio chairs
having only paid for one. This is not a situation of
6|Inventory Management Special Report
theft, because there was never any intent on the
customers part to defraud Lowes of three patio
chairs. It was a loss created solely due to poor
operational controls.
When this issue was reported by store-level
personnel, the focus was put on minimizing shrink
for the remainder of the year, since the product had
already been manufactured, labels printed, and the
product was already in the supply chain. The next
step was to ensure that merchants and vendors were
on board with correct master carton information and
labeling requirements going forward. The
merchandising team, vendor partners, and store
operations worked together to ensure that new items
going forward were properly set up in the primary
item file as well as the proper UPC-A bar codes were
applied to the master cartons of patio chairs.
After taking these steps, patio furniture shrink
was reduced by 55 percent. Proper attention during
item set up would have prevented erosion of 55
percent of the profits in 2001.
Quality Assurance and Vendor Packaging
Vendor packaging issues are another focus area
for reducing operational shrink. These issues should
be addressed during the item set up-phase. However,
there will be times when a new item will arrive in a
store with packaging issues that will lead to
operational shrink.
A packaging issue could be something as
unobtrusive as the phrase item number appearing
on the package near a model number of the product,
or something as obvious as multiple bar codes
legitimately placed on the box. Some vendors will
use language on their packaging such as item
number, SKU number, or simply item on their
box near a number printed near the bar code. In a
small percentage of cases, these numbers will be
assigned to a completely different product in your
system.
Item 12345, valued at $250, may have item
number printed on the box to denote the model
number of 67890 for that product. If a cashier has
difficulty scanning the bar code of that product,
and doesnt want to hold up the line, the cashier
may notice the item number language beside number
67890 and could enter that into the point-of-sale
system. They could inadvertently sale the customer
an item valued at $10, instead of the true value
of $250.
Purchase Order and Receiving Discrepancies
Beyond the issues already addressed with UPC
issues and packaging problems, there is the potential
of duplicating the receipt of a purchase order. In most
cases, a duplicated purchase order should be
identified and deleted by the logistics department.
However, there may be times when a purchase order
could be entered into the stores system twice.
Buybacks, Resets, and Displays
A primary focus for Lowes LP personnel is
monitoring buybacks (return to vendor) and resets.
Each week, store personnel reads through the
merchandise changes, additions, and deletions
documents created by the merchants and notifies the
LP personnel of buybacks and resets that could have
shrink implications. These notifications include
details for products that are scheduled to be bought
back by a vendor. On average, before emphasis was
placed on tracking buybacks, stores were only
realizing 3035 percent of the merchandisers
negotiated buyback totals. After implementing an
increased focus on buybacks, the stores began to
realize a substantial increase of the negotiated totals.
If there is a reset of product associated with a
buyback, it is crucial to pay attention to items that
are placed on display. For many retailers, accounting
for displays is not an issue because all product on
display is considered sellable. However, in the
Lowes environment, some displays could result in
operational shrink if they are not accounted
for properly.
Becoming Profit Enhancers
Over the years, LP departments have had to
adapt to the ever-changing retail environment to
remain effective. External and internal theft
prevention programs remain a focus. However, for
LP departments that want to become profit
enhancers, you will need to develop programs to
partner with your merchants, store operations,
inventory accounting, and vendors to identify and
analyze the paper shrink component of loss.
Lessons from Low-Shrink Retailers
For retail loss prevention practitioners across the
globe, trying to find the best solution to tackle the
perennial problem of shrinkage has been a long and
frustrating journey. Partly they have been victims of
retail organizational cultures that have seen them as
an inevitable, yet regrettable, part of doing business.
This has caused them to be perceived as peripheral to
the core activities of the organization and primarily
responsible for arresting thieves and installing
alarms. But they have also been partly seduced by
technology providers who persistently offer quick-fix
technological panaceas to the problem of stock loss.
In addition, until recently, they have largely
operated in a data desert, often making decisions
based upon gut instinct and guess work rather than
solid data and informed analysis. In the absence of
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reliable data, the industry has tended to focus on the
most overt form of shrinkageexternal theftto the
detriment of other key problems, such as internal
theft and process failures. In turn, this has led the loss
prevention world to traditionally look to the military
and police for recruitment, leading to generations of
managers who may be more adept at adopting a
reactive rather than proactive approach to the
problem, and who feel more comfortable trying to
catch thieves than analyzing whether retail processes
are fit for purpose and designed to maximize sales
and minimize losses.
Despite this, some companies have bucked the
trend and become successful at keeping their losses
well below what the industry identifies as the norm.
In many respects, they have adopted a way of
working that could be described as New Loss
Prevention: an approach that is systematic, grounded
in evidence, and focused on developing the right
solutions for specific problems.
Following a study completed by ECR Europe,
which, as part of a broader survey looking at the scale
and extent of the problem of shrinkage, identified a
number of common organizational themes associated
with lower levels of shrinkage. This included the
existence of a written corporate policy, a willingness
to be innovative and experimental, a commitment to
link bonus payments to shrinkage performance, and a
willingness to actively collaborate with other
organizational functions. This led members of the
ECR Europe Shrinkage Group to think about whether
there were a series of common characteristics among
retailers who consistently have low shrinkage levels.
Method and Aims
The aim was to identify the key characteristics of
retail companies in the U.S. that are perceived to
have a track record for being innovative in the way
they deal with shrinkage. It is based upon interviews
with the head of loss prevention, a selection of their
staff, analysis of company documentation, and visits
to stores.
The five companies that took part are
Target, Limited Brands, Best Buy, CVS/Pharmacy,
and The Gap. The method used to select the
companies was the reputational approach,
whereby a group of experts, key practitioners, and
academics made recommendations based upon
personal and experiential evidence. The twenty-five
experts were requested to choose their top five
low-shrink U.S. retailers, and from this a rank
order of companies based upon those listed above
was established.
This research identified nine key areas that were
found to be present in most, if not all, of the case-
study companies. These areas can be associated with
above-average performance on controlling shrinkage.
It is further possible to group them into three key
factorsstrategic, cultural, and operational. The first
factor is focused on loss prevention within a broader
organizational context; the second on the way in
which loss prevention departments can develop ways
of understanding and dealing with shrinkage; and the
third looking at the role of store staff in delivering
effective loss prevention.
Strategic Level Factors
Establishing Senior Management
Commitment. The bedrock for the success found in
these companies was their ability to create, sustain,
and embed an organizational awareness of, and
commitment to, dealing with the problem of
inventory loss. This started at the top of the company
with senior management being fully committed to the
concept of loss prevention as an important priority
for all parts of the organization.
How this commitment was achieved varied
among case studies, although the impact of a tipping
point or moment of crisis concerning shrinkage was
important for some of them in gaining the attention of
their board of directors.
Ensuring Organizational Ownership. The
second strategic factor was the way in which the
case-study companies had developed mechanisms to
ensure that all parts of their organizations were
persuaded to take ownership of the problem. To
paraphrase one of the respondents in this research: I
cant think of any part of the business that shouldnt
be thinking about shrinkage.
What was interesting about the case-study
companies was that they often viewed themselves
more as advisors on shrinkage to other parts of the
business (particularly the stores), which would then
take responsibility for operationalizing that advice.
This seems a far more realistic and sustainable
approach given the limited resources available within
most loss prevention departments.
Embedding Loss Prevention. The third
strategic factor was ensuring that this organizational
commitment was embedded within the business
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practices, policies, procedures, and strategic thinking.
Each of the case-study companies had examples of
how they had formalized a commitment to tackling
shrinkage from all parts of the business. For some
this took the form of creating standard operating
procedures (SOPs) for departments to follow; for
others it was about getting shrinkage as a standing
item on agendas across the board.
Cultural Level Factors
The second group of identifiable themes related
to the way in which the loss prevention department
influenced the functioning of the business.
Providing Strong Leadership. What was
striking about all five of the heads of loss prevention
in this study was a sense of their ability to offer
direction and leadership to their teams and across the
organization. They saw a role for the traditional
former police or military personnel, but this was a
small part of a more cosmopolitan team that
incorporated staff with experience in operating
stores, working in the supply chain, auditing, and
other areas.
For a majority of the companies, this approach to
teambuilding was necessary in order to address the
complexities of shrinkage within modern retail
companies, and recognition of the range of
vulnerabilities that exist across supply chains. Loss
prevention was not just about catching thieves, it was
also about ensuring that stock arrived on time, at the
right place, and at the right price.
Prioritizing people could also be seen in the way
in which the LP team influenced the selection and
training of company staff, but particularly in the
stores. A range of strategies were adopted, including
pre-employment screening, use of external databases
to identify previously dishonest retail staff, and
innovative training strategies.
A common strategy used by most of the case-
study companies was to incentivize staff to take the
problem of stock loss seriously. For one company,
this meant all store staff shared a portion of any
savings they made on shrinkage in their store. For the
majority of companies taking part in this study,
incentivization was on the agenda for loss prevention
staff and store management.
Using Barometer Management. Another key
factor was the generation and analysis of data. The
need to be led by numbers and not by intuition was a
clear message. How this was achieved varied among
the companies, but all had invested in ensuring that
they could not only monitor the rate and extent of
shrinkage at a highly granular level (almost always
SKU level), but also that they could analyze data to
seek out trends and deviant behavior, usually through
some form of data-mining technology or software.
This enabled the LP teams to move away from
decision making based upon guesswork and intuition
and move towards a more evidence-based approach.
Innovating and Experimenting. The
prioritization of a culture of innovation and
experimentation was also apparent. These are
organizations that are not afraid to try new
approaches and technologies if they think they will
help to tackle the problem of stock loss. Indeed, most
of them wanted to be seen as trail blazers in this field.
All were using a range of technologies, including
CCTV, EAS, remote monitoring, data-mining
packages, and others, although most recognized that
they were not the fabled loss prevention panacea, but
merely tools to be used in the battle against
shrinkage. All were clear that any new intervention
needed to be carefully piloted and measured before
any decision on company-wide rollout was made.
Talking Shrink. All five companies had
developed a range of methods by which the company
as a whole was kept informed of the way in which
shrinkage was affecting the businessand how
different parts of the organization could be part of the
solution.
The loss prevention teams used regular
communication to influence different parts of the
business, particularly through the provision of
statistical data. This helped a range of functions,
including stores, merchandising, and logistics, to
adjust their approach and was key to the institutional
embedding of shrinkage.
Prioritizing Procedural Control. Issues of
process and procedural compliance can often be seen
as a non-LP issue, or something to be dealt with by
logistics or store operations. However, the impact of
process failure on a business can be profound, and
the loss prevention teams taking part in this study all
recognized the need to keep it high on their agenda.
This was partly achieved by ensuring that the
loss prevention department was made up of a
multifaceted team, some of whom had detailed
experience of how stores and the supply chain
operated. But it was also done by keeping a close
watch on the inventory data and looking for signs of
deviance or lack of compliance.
Operational Level Factors
Empowering Store Staff. The final theme that
emerged from this work was the importance of
empowering store staff to take responsibility for
dealing with shrinkage. Store personnel have often
been seen as both the start and end point for
controlling shrink; after all, they are the ones who
deal almost exclusively with the goods and cash
transactions with customers.
9|Inventory Management Special Report
The scale of most retail concerns is
breathtakingtens of thousands of SKUs being
distributed on a daily basis by a similar amount of
people to thousands of retail outlets. Keeping control
of this is impossible unless clear processes and
procedures are in place and responsibility for
ensuring adherence to them is delegated to supply-
chain and store staff. But unless the strategic and
cultural level factors highlighted are not first put in
place, then they will not have the necessary operating
environment as well as access to appropriate
solutions to deliver low shrink.
The companies taking part in this study
recognized how critical it was to make sure that store
staff in particular were given the data, training, and
support to be able to deliver the strategic plan on
shrinkage control developed by the loss prevention
team. Partly this was achieved through
incentivization (staff bonuses being predicated on
shrinkage performance), but also through a process of
ensuring staff were made accountable for loss and
enforced with potential sanctions, such as managers
losing their job or being demoted.
Through the development of a credible
organizational framework, the case-study companies
had created an environment in which operational
managersparticularly store managerswere
expected to take responsibility for the day-to-day
monitoring and control of shrinkage.
Conclusion
This research set out to identify what it is about
certain retailers that enable them to be consistently
regarded as best in class when it comes to
controlling shrinkage. It identified three interlinked
groups of factors that characterize their approach:
1. The necessity of having a strong organizational
commitment to recognizing and responding to the
problem,
2. A range of cultural factors that create the
environment for delivering low shrinkage, and
3. The operationalization of a shrinkage plan across
the company.
The first enables the second, which then creates
the third.
Physical Inventory Counting Practices
What is the single most important measure of
the success or failure of your companys loss
prevention efforts?
If you were to ask most senior retail executives
this question, the answer you would likely hear is,
Our shrinkage results. This would not be surprising
as shrinkage results affect company profitability,
shareholder return, incentive and bonus plans, and
resource allocation decisions in most retail
organizations.
Therefore, it is a reasonable question to pursue
how companies measure this important metric, how
often they measure it, and whether this number can
be predicted and tracked throughout the year. This
section summarizes the results of a survey that
focused on the frequency of inventory counting and
how the count was conducted.
The purpose of this survey was to benchmark
retailers current physical inventory processes as they
relate to the frequency of inventory counting and
whether counts are conducted using proprietary
personnel or through use of an outside agency. This
survey was conducted in July 2007 and involved
fifteen U.S.-based organizations comprised of eight
hard-lines specialty retailers and seven soft-lines
specialty retailers. The companies ranged in store
count from 350 locations to over 4,000 locations and
represent over $132 billion in annual sales in the
aggregate. No mass merchandisers, department
stores, or grocery chains were in the sample group.
The survey was conducted by interviewing
senior-level loss prevention executives in each
organization. This allowed for discussion and
elaboration that provided detail and insight into
several of the questions.
Following are the questions asked of each
organization, the responses they gave, any rationale
they gave for their approach, and some commentary
on the results from an outside perspective. Results
tables are broken down by hard-lines versus soft-lines
retailers to explore whether different operating
formats beget different inventory counting processes.
1. How often do you conduct physical inventory in
each location during your fiscal year?
This question seeks to answer how often, as a
general rule, physical inventory counting is done in
each location throughout the year. It is notable that
hard-lines retailers overwhelmingly depend on one
count per year whereas soft-lines retailers are
conducting physical inventory twice a year.
However, this disparity may be somewhat balanced
by the different approaches each segment takes
towards interim inventory counts.
2. Are any groups of subset stores counted more
frequently?
This question attempted to determine if there
were processes in place to count certain stores more
often. Overwhelmingly, both hard-lines and soft-lines
retailers used second counts as a means for following
up to initial inventory results. The rationale most
often cited by the participants was to conduct follow
10 | I n v e n t o r y M a n a g e m e n t S p e c i a l R e p o r t
up inventory counts in their target or high-shrink
locations.
If a stores inventory is off by a pre-determined
percentage, it is recounted, was a comment
reflective of most respondents. As for the actual
selection of stores to be recounted, one of the largest
retailers surveyed explained that the subset store
selection was a cooperative effort between inventory
control, store operations, and loss prevention.
3. Do you conduct wave or snapshot inventory
counts?
Originally, participants were asked whether they
were using cycle inventories or snapshot inventories.
Snapshot inventory refers to the common practice of
taking physical inventory counts in all stores at
approximately the same time. This is often done near
the end of the fiscal year, such as January or June.
The term cycle inventories reflects the practice
of taking the physical inventory count of the store all
at one time, but splitting the total stores up so that a
certain percentage of the stores were conducted in
each cycle. Some retailers use this method and take
several cycles of counts throughout the year.
However, the survey changed this terminology to
refer to this methodology as wave inventories.
This change was made to allow for the practice
of true cycle countsthe practice of counting
inventory throughout the year in a store by counting
certain sections on periodic basis. Theoretically, this
could eliminate the need for an inventory where the
entire store is counted at one time. This is not an
uncommon practice in distribution and warehouse
environments.
Nearly 90 percent of the respondents conduct
their inventory using a snapshot method as their
primary approach. The few retailers that use a wave
method determine their waves by spreading the
number of stores counted each month on a
proportional basis, which essentially means counting
one-twelfth of their stores each month. One retailer
actually conducts wave inventories throughout the
year and then does a snapshot inventory at year-end.
Benefits of Snapshot Inventories
Ability to synchronize shrink results for entire
chain for purposes of performance appraisals,
bonus payouts, target-store selection, and other
operational programs
Clear apples-to-apples comparisons from year to
year without timing issues
Allows entire company to treat physical inventory
counts as an event where there is greater
attention to store preparation, training sessions, and
management attention
Ease of inventory cut-offs for receiving, shipping,
markdowns, and promotional events, which allows
for cleaner inventory reconciliation
Benefits of Wave Inventories
Ongoing measurement of shrinkage performance
to allow for adjustments to financial accruals
throughout the year, meaning no surprise at
year-end
Regular reporting of results keeps managements
attention on the issue of shrinkage
Ability to adjust inventory schedule
Greater management coverage and supervision
of inventories
Lower average inventory service costs, since rates
are higher during peak counting periods
4. Do you have an interim count process in place?
Across all respondents, over half of them did not
conduct interim inventories. However, there is great
variance when looking at the results by segment.
Hard-lines retailers are much more likely to have an
interim counting process in place. This may partially
explain why soft-lines retailers are more likely to
take multiple inventories in each location.
The other factor that may be operating here is the
fashion orientation of many soft-lines retailers.
While hard-lines retailers generally have many items
that are on a replenishment schedule from their
warehouse, many soft lines and apparel retailers are
flow-through operations where a seasonal fashion
line might be shipped to stores, and when it is gone,
there is no replenishmentthe merchants have
moved on to another fashion look.
Therefore, there is not much demand from a
merchandise replenishment or buyer perspective to
get updated inventory counts on that merchandise.
However, a hard-lines retailer may find this
information critical not only from a shrinkage
perspective, but, as importantly, for the ability to
have accurate perpetual inventory counts for
replenishment and promotional purposes. This may
11 | I n v e n t o r y M a n a g e m e n t S p e c i a l R e p o r t
be one of the operational drivers for the segment
variance we see in these responses.
5. Do your interim adjustments correlate to your
shrink?
Of those respondents who indicated they conduct
interim inventories, they were asked if their interim
inventory adjustments correlate to shrink.
Overwhelmingly, the group indicated that they do
correlate to shrinkage, although there was no effort
made to identify how they have defined that
relationship in their organization.
6. Do you use an outside agency to conduct your
inventory counts?
Respondents were next asked if they employ an
outside agency to conduct their inventories. Nearly
90 percent of the respondents outsource their physical
inventory process. The majority of retailers who
outsource the physical inventory process employ one
national agency. Four companies that outsource their
physical inventory also have an internal system in
place. For example, one company conducts inventory
internally in stores with poor inventory results. The
stores who had a good inventory in the previous
count, outsource the process. Another large retailer
has outsourced the inventory process for a number of
years; however, they are piloting an internal physical
inventory process.
Only two companies relied solely on conducting
their inventory internally. They rent scanning
equipment from vendors.
7. Have you changed your physical inventory process
in the last two years?
Nearly 60 percent of the surveyed companies
changed their inventory process in the past two years.
The respondents reported that the changes are
working, except for the two retailers who changed
their inventory cycle counts. Those two retailers
indicated the change in cycle counts is making the
inventory process more difficult.
Commentary and Conclusions of the Survey
The goals of the original survey were to identify
common practices as a benchmark for participants to
use in evaluating their own programs and processes.
The most significant finding in looking at the results
is what it says about the current state of metrics and
data in the retail loss prevention world. It is clear that
most companies still only have one or two
measurements for shrinkage per year.
The implications of this finding are important. In
any business, it is difficult to manage performance
and results without frequent, reliable measures of
outcomes. It would be nearly impossible to imagine a
retail organization that measured sales performance
only a few times a year or gross margin or cash flow
metrics or personnel turnover or any of the other
important drivers of business performance.
Therefore, it stands out that most retailers have
settled for infrequent measures of shrinkage, even in
this time of information systems, distributed
databases, and dashboards. The reasons for this are
likely reflective of many challenges in developing
more frequent measures, as opposed to resistance on
the part of senior loss prevention executives.
Identifying these challenges was not part of the scope
of this survey project, but would be a worthy topic to
investigate in future research and work.
Developing New Loss Prevention
For those who have been in the loss prevention
business for a number of years, you are familiar with
the shrinkage life cycle. It is a familiar story of
shrinkage success, followed by a gradual decline in
performance before shrinkage once again becomes a
major problem within the business to be conquered
and tamed. Across the world, retail companies have
regularly circumnavigated this tortuous yet
predictable routeone year being seen as the best in
class, while the next year talked about as a company
that used to do shrinkage well.
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As detailed in the diagram, there are a number of
valid reasons why this cycle might occur. On the
downward trajectory, you tend to find that there was
some tipping point moment that triggered the
business into action: shrinkage hit an all-time high, or
a business merger spurred a review of the way
shrinkage was managed.
You then see a number of characteristics
associated with a business on a downward shrinkage
trajectory. There is suddenly a renewed degree of
commitment from across the business to tackle the
problem: It now matters to us all. This frequently
comes from senior business leaders championing the
importance of the business targeting shrinkage: Its
as important as sales. This commitment can generate
plenty of energy, enthusiasm, and, perhaps most
critically, access to resources. All of a sudden, the
loss prevention team starts getting invited to meetings
they had never heard of, requests for new equipment
no longer get ignored, and the business seems to
think that reducing shrinkage is exciting and
important.
This improvement phase can also be facilitated
by the introduction of new LP leadership: the new
kid on the block with ideas, energy and drive who
will turn the business around.
When you get the business focused and
committed to deal with shrinkage, chances are that
the shrinkage number will quickly come down to an
acceptable level. But this is when the real challenge
begins. How do you sustain this low number over
time?
Once the shrinkage problem appears to be under
control, business leaders can feel like they have
done shrinkage and begin to re-allocate resources
and prioritize other issues within the business. Other
factors can also put shrinkage management under
pressure, such as a downturn in the economy leading
to cutbacks across the business, or the go-ahead loss
prevention leader leaves (while the going is good).
The culmination of these factors is that the cost
of shrinkage begins to rise in the business and the life
cycle is once again complete, waiting for the next
tipping point to start the cycle all over again.
Why does this cycle exist and what can be done
to halt the inevitable slide back to high levels of
shrinkage? Can we help organizations to break out of
this loop and enable them to keep rates of shrinkage
at low and acceptable levels?
Operational Failure and Opportunity
A starting point was to reconsider the true causes
of shrinkage within retail businesses. As previously
mentioned, much of the history of retail loss
prevention has been dominated by the specter of
shoplifting (external theft). Others have reflected
upon the role staff can play in generating shrinkage
(internal theft).
Trying to understand shrinkage from the
traditional perspective of identifying which type of
thief was responsible is not the best place to start. It
may be possible that most incidents of internal and
external theft, and inter-company fraud (vendor
fraud), and virtually all process failures
(administrative errors) are actually caused by
operational failures within the business.
Outlined in the diagram is a schematic showing
the relationship between operational failures and
shrinkage, with the former being the root cause of the
latter.
The Role of Opportunity. A key part of this
thinking is understanding the role of opportunity and
how it is created by operational failures and
subsequently exploited by thieves. Much
criminological research has been undertaken on
understanding the importance of opportunity and how
it facilitates crime. By removing the opportunity, you
make it more difficult to commit the crime, making
the crime less rewarding or more risky for the
offender, who is then likely to desist from the
behavior.
A simple but effective example is the move by
the automobile industry to integrate music systems
into the dashboards of vehicles. It is now difficult and
time consuming to remove them (hence more risky),
and there is little demand for the end product (hence
little reward).
Defining Operational Failures. Operational
failures can be seen as any fault in the design,
implementation, operation, monitoring and control,
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and review of processes and procedures used within
the retail environment.
Operational failures can occur at any point in the
supply chain from manufacture through to the
eventual sale of goods to the customer (and beyond in
respect of product returns).
For example, a particular (date sensitive) product
is consistently out of stock at the shelf, despite the
store regularly reordering the product through manual
adjustments to the automatic ordering system.
Persistent external theft is viewed as the root cause of
the problem.
A more detailed analysis reveals that the store
has plenty of the items in the back of the storein
fact, too manybecause of the constant reordering of
further stock and much of the product has to then be
written off. The problem is that the staff is not able to
easily identify the stock in the backroom areas, due to
the outer packaging of the product, which makes it
difficult to differentiate from similar items. It is
revealed that the design of the outer packaging,
which consists of only a bar code, has been primarily
designed for ease of handling in the manufacturer and
retailer distribution network.
Initial attempts to reduce shrinkage on this item
could have been focused upon trying to deal with a
perceived external theft issue, such as applying EAS
tags. However, root cause analysis reveals that an
operational failurein this case, poorly designed
packagingis actually the problem.
The solution is not necessarily more security, but
more thought on how the packaging can be designed
to enable store staff to quickly recognize the product
among the many others in the backroom area.
Breaking the Shrinkage Cycle
We believe that the key to breaking the
shrinkage life cycle and sustaining low levels of loss
over a long period of time is through what we
describe as New Loss Prevention.
This approach is conceived as a pyramid because
all the elements that make up the pyramid need to be
in place in order for it to be sustainable. Take out any
particular factor(s) or block(s), and the whole edifice
will come crashing down. Not only does it represent
a sense of the interrelationship among components
necessary to deliver effective shrinkage management,
but it also symbolizes how those who ultimately have
to deal with the problem on a day-to-day basis (store
teams), reside at the top of the pyramid. Unless the
underlying building blocks are in place, store teams
will be unable, and likely unwilling, to take on the
role of shrinkage management.
Setting the Foundations. The bedrock for
successfully implementing the loss prevention
pyramid is the ability to create, sustain, and embed an
organizational awareness of, and commitment to,
dealing with the problem of stock loss. This starts at
the top of the company with senior management
being fully committed to the concept of loss
prevention as an important priority for all parts of the
organization and considering it as part of the overall
corporate objectives.
Providing an Organizational Framework.
The second group of factors that make up the loss
prevention pyramid relates to the way in which the
loss prevention department can influence the
functioning of the business through:
Ensuring strong loss prevention leadership
The creation of high-quality data and data
management systems
Prioritizing the development of operational
excellence through identifying and minimizing
operational failures
Ensuring that the right people work within the
business as a whole and more specifically within
the loss prevention department
The forging of intra- and inter-collaborative
initiatives
14 | I n v e n t o r y M a n a g e m e n t S p e c i a l R e p o r t
The prioritization of innovation and
experimentation
Keeping shrinkage on everybodys agenda
All of these factors are important in themselves
and require a plan to ensure they are developed and
maintained, but they are also dependent upon each
other. For instance, it is difficult to conceive of an
effective communication strategy without having
access to high-quality data.
Operationalizing Shrinkage. The final theme is
that of store management responsibility
empowering store staff to take responsibility for
dealing with the problem of shrinkage. Occupying
the top of the loss prevention pyramid, this can
only be achieved if the other factors outlined here are
in place.
New Loss Prevention
As detailed earlier, underpinning our thinking is the
importance of recognizing how operational failures
are the root cause of most forms of shrinkage, and
this should be viewed as a thread that runs through
the loss prevention pyramid. It is representative of a
mind shift away from traditional ways of dealing
with shrinkage, which have a heavy reliance upon
catching thieves (primarily shoplifters), seeking out
technological panaceas focused more upon the
symptoms of the problem rather than the underlying
root causes, and viewing the store as the only place in
which shrinkage occurs.
As one of the respondents to our research
succinctly said, You cannot arrest your way out of
shrinkage. The business needs to develop a more
proactive and coordinated approach to deal with
shrinkage problems. In our view, the shrinkage life
cycle can be halted and low levels of loss sustained
over long periods of time, but it requires a mindset
change away from how shrinkage is currently
perceived and managed.
Contributors to this special report include Mark J.
Sullivan; Jacque Brittain, LPC; Terry Hennessee;
Adrian Beck; Walter E. Palmer, CFI, CPP, CFE;
Colin Peacock; and Chris Richardson, CPP.