Shrinkage, sometimes referred to as “shrink,” is the loss of inventory between when it arrives at your facility and when it’s sold or used. This issue can be easily overlooked because it tends to occur in small increments over time. However, shrinkage does add up — to the tune of $95.4 billion in losses in 2021 for the retail industry alone, according to the National Retail Federation’s “2022 National Retail Security Survey.” Smaller businesses will feel the resulting losses in profitability to a higher degree than their larger counterparts.
The largest impact of shrinkage is a loss of profits. This is especially negative in retail environments, where businesses operate on low margins and high volumes, meaning that retailers have to sell a large amount of product to make a profit. The more shrink you experience, the greater the chance that your business may experience a prolonged period of non-profitability. This, in turn, has a negative impact on other aspects of your business.
Definition of Shrinkage and its Impact on Business
Shrinkage stems from many different issues, but the end result is always lower profit for the business. When procurement shrinkage occurs, it not only affects the financials but also impacts the reputation and trustworthiness of a business. Acceptable levels of inventory shrinkage vary by industry and by individual businesses. Some industries, like food and hospitality, may be able to tolerate a higher shrinkage rate than, say, retail, though a mom-and-pop coffee shop would be less able to rebound than a restaurant chain.
Importance of Identifying and Preventing Shrinkage
If your tills are coming up short on a regular basis or your merchandise is damaged or stolen, you’ll experience shrinkage. All of these situations affect your bottom line. To sum up, shrinkage is a serious issue that businesses must address if they hope to remain profitable over time. By identifying potential causes of shrinkage within their supply chain early on, companies can take steps towards preventing further losses from occurring down the line.
Understanding the Causes of Shrinkage
There are many different causes of shrinkage, but they can be broadly classified into two categories: internal and external.
Internal Causes of Shrinkage
Employee Theft
One of the most significant causes of shrinkage is employee theft. According to the National Retail Federation’s “2022 National Retail Security Survey,” employee theft accounts for 35.7% of inventory shrinkage. Employee theft can take many forms, including taking merchandise, giving discounts to friends and family members, and manipulating records to cover up theft.
Administrative Errors
Administrative errors can also contribute significantly to shrinkage. These errors may include failing to record sales accurately, incorrectly recording inventory levels, or misplacing merchandise. While these errors may not be intentional, they can still lead to significant losses for a business.
External Causes of Shrinkage
Shoplifting
Shoplifting is another common cause of shrinkage. According to the same study by the National Retail Federation, shoplifting accounts for 36.5% of inventory shrinkage. Shoplifting can take many forms, including concealing merchandise, swapping price tags, and returning stolen items for a refund.
Vendor Fraud
Vendor fraud is another external cause of shrinkage. This occurs when a supplier or vendor overcharges for products or services, delivers less than what was ordered, or delivers subpar quality items. Vendor fraud can be difficult to detect and prevent, but it can have a significant impact on a business’s bottom line.
Effects of Shrinkage on Business
The effects of shrinkage can be devastating to a company’s bottom line. When procurement shrinkage occurs, it not only affects the financials but also impacts the reputation and trustworthiness of a business.
Direct Impact on Profits
Shrinkage directly reduces a business’s profits. It can also lead to price increases to cover losses, added expenses in terms of prevention and customers taking their business elsewhere due to higher prices and/or product unavailability.
Indirect Costs
One major effect of shrinkage is its impact on inventory accuracy. Shrinkage leads to incorrect records, which results in inaccurate stock levels and potential over or under-ordering. This can lead to lost sales opportunities for businesses as they struggle to meet customer demand. Another significant effect is an increase in costs. As businesses try tomake up for losses caused by shrinkage, they are forced to raise prices on their products or services. This can result in customers seeking out lower-priced alternatives causing further loss of revenue.
Covering Losses through Price Increases
In order to offset the financial impact of shrinkage, businesses may need to increase their prices. This can be a difficult decision, as raising prices can deter potential customers and drive existing ones to seek more affordable options. However, without addressing the issue of shrinkage, businesses may find themselves unable to maintain adequate profit margins, which could lead to long-term financial instability.
Additional Expenses for Prevention Measures
Implementing measures to prevent shrinkage can also come at a cost. For example, businesses may need to invest in enhanced security systems, employee training programs, or even loss prevention specialists to address the issue. While these investments can help reduce shrinkage, they also add to the overall expenses of the business, potentially impacting profitability.
Loss of Customers due to Higher Prices or Unavailability of Products
When customers encounter higher prices or are unable to find the products they want due to inventory issues, they may choose to take their business elsewhere. In this way, shrinkage can indirectly lead to a loss of customers, further exacerbating the financial impact on the business.
Acceptable Levels of Inventory Shrinkage
Variations by Industry
Acceptable levels of inventory shrinkage can vary depending on the industry in question. For example, businesses operating in the food and hospitality sectors may be more willing to tolerate higher levels of shrinkage due to the perishable nature of their products. On the other hand, industries such as retail may have lower acceptable levels of shrinkage due to the tight profit margins and competitive nature of the market.
Considerations for Individual Businesses
When determining what constitutes an acceptable level of shrinkage for a specific business, factors such as the size of the company, the types of products being sold, and the overall financial health of the organization must be taken into account. In general, smaller businesses may be more vulnerable to the negative effects of shrinkage and may need to take more aggressive measures to prevent and address the issue.
Mitigating the Risk of Shrinkage
There are several strategies that businesses can employto mitigate the risk of shrinkage and minimize its impact on their bottom line.
Strategies for Reducing Internal Causes
Employee Training and Accountability
One of the most effective ways to reduce employee theft is through comprehensive training programs that educate workers about the consequences of theft and the importance of maintaining accurate inventory records. Implementing a system of accountability, such as regular audits and checks, can also help deter employees from engaging in dishonest behavior.
Improved Record-Keeping and Auditing
Accurate record-keeping is essential for preventing administrative errors that can lead to shrinkage. Businesses should invest in robust inventory management systems that track stock levels in real-time and flag any discrepancies for further investigation. Regular audits can also help to identify and correct administrative errors before they result in significant losses.
Strategies for Reducing External Causes
Enhanced Security Measures
Preventing shoplifting and vendor fraud requires a combination of physical security measures and vigilant monitoring. Installing surveillance cameras, employing security guards, and using electronic article surveillance (EAS) tags on merchandise can all help to deter potential thieves. In addition, conducting thorough background checks on vendors and monitoring their performance can help to identify and prevent instances of vendor fraud.
Partnering with Vendors to Detect and Prevent Fraud
Working closely with your vendors can also help to reduce shrinkage resulting from fraud. Establishing clear communication channels and sharing information about potential risks can enable both parties to better detect and prevent fraudulent activities. In addition, implementing contractual agreements that outline the expectations and responsibilities of both parties can help to minimize the risk of vendor fraud.
Shrinkage and its Impact on Retailers
Shrinkage is an issue that can have far-reaching consequences for businesses, affecting not only their profitability but also their reputation and overall operational efficiency. By understanding the various causes of shrinkage and implementing effective strategies to address them, companies can mitigate the risks associated with inventory loss and maintain a healthy bottom line. In today's competitive business environment, it is essential for organizations to proactively address shrinkage and take the necessary steps to ensure their long-term success.
