Retail shrinkage refers to the actions a business takes to reduce theft and fraud. These preventable losses, caused by human error or deliberate efforts, are known as “shrinkage.”
Shoplifting and employee theft make up the bulk of a $61 billion annual problem for the retail industry. The increase in incidents and new ways to steal are encouraging retailers to invest in new technology to reduce inventory shrinkage.
So what preventive measures can you put in place to reduce loss and protect your profits? This guide will walk you through different types of inventory shrinkage, plus strategies and examples to help mitigate risk in your retail business.
Table of Contents
What is shrinkage?
Shrinkage is an accounting term used to describe when a store has fewer items in stock than in its recorded book inventory. Factors contributing to shrinkage include employee theft, shoplifting, administrative errors, vendor fraud, product damage, and more. Shrinkage has a direct correlation with profit: the higher your shrinkage, the lower your profits.
The 2020 National Retail Security Survey found shrinkage at an all-time high, accounting for 1.62% of a retailer’s bottom line, costing the industry $61.7 billion. Almost twice as many businesses reported shrink rates of 3% or higher compared to previous years.
Let’s apply shrinkage to your day-to-day operation: say you receive products to sell from a vendor worth $10,000. You’ll record the dollar value of the inventory on your balance sheet as a current asset. Each time you sell an item, the inventory account is lowered by the cost of the product and you record revenue for the sale.
Say you lose some inventory, for whatever reason. There will be a discrepancy between your physical inventory and book inventory. The difference between the two is shrinkage.
If your book inventory is $10,000 but your physical inventory is only $9,000, then some of that inventory is lost and the shrinkage is $1,000. The big issue?
If you lose inventory through shrinkage, you cannot recover the cost of the merchandise because there is nothing to sell or return, which directly impacts your bottom line.
Some businesses will try to cover the cost of shrinkage by increasing prices for the customer. They now have to carry the weight of theft and inefficiency. If your customers are price sensitive, shrinkage can also damage your customer relationships and sales.
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Types of inventory shrinkage
Now that you understand the basics of loss prevention and its impact on retailers, let’s look at common types of inventory shrinkage:
- Shoplifting or theft
- Return fraud
- Employee theft
- Administrative error
- Vendor fraud
- Unattributed loss
Shoplifting or theft
Jack L. Hayes International’s 33rd Annual Retail Theft Survey found shoplifting case value increased 13% in 2020. Shoplifting represents the largest single share of retail shrinkage, accounting for over 35% of annual losses.
When you think about shoplifting, you might picture someone walking out the door with a product tucked under their shirt—and that is part of the shoplifting problem.
But it isn’t the whole picture. Shoplifters may steal items ranging in price from $1 to $1,000. They may work alone or in a group of thieves. They may strike once or come back every week.
Shoplifting can take many forms and it can be a problem for any and every retailer. That’s why it’s vital that you take steps to mitigate the potential for shoplifting in your store.
Here are a few ways you can do just that:
- Conspicuous surveillance and signage. Don’t underestimate the power of monitoring your store and making it very clear to customers that you are doing so. Surveillance cameras enable you to catch shoplifters before they ever leave the store, and signage reminding customers about cameras and your willingness to prosecute shoplifters can go a long way in deterring that behavior.
- Deliberate store organization. Depending on your store’s layout, you might be making it even easier for shoplifters to do their thing. Dark or unmonitored corners and overflowing or disorganized merchandise make it easy for shoplifting to go undetected. After all, how can you tell something’s missing when you don’t know where it was to begin with? If your store carries expensive or frequently shoplifted items, consider locking them away in a case.
- Great customer service. Encourage your staff to greet customers when they enter the store, offer help as they look around, and always staff areas like fitting rooms. Reminding shoppers that there are people around to catch shoplifters is another great way to deter shoplifting behavior.
One of the more overlooked causes of retail loss is return fraud. It’s overlooked because return fraud can be tough to spot in the first place—its effects only evident as they add up throughout the year. Return fraud can also take several different forms, including:
- Returning stolen merchandise
- Returning merchandise purchased with counterfeit money
- Returning used merchandise
- Using counterfeit receipts to return merchandise
- Returning exchanged merchandise
Return fraud is harder to curb than shoplifting because of all the ways it can play out. Still, you can combat each form of return fraud with an intelligent return and exchange policy that employees consistently enforce:
- Require receipts for cash returns. Most retailers require a receipt to get a cash refund for returned items, and you should, too. No receipt means customers can only receive store credit or exchange the item. Make sure employees enforce this policy 100% of the time.
- Train employees to spot return fraud. Fraudulent returns aren’t as obvious as shoplifting. That’s why employee training to spot and stop return fraud is a must.
- Require an ID to track returns. Regardless of your return policy and staff training, some fraudulent returns slip through. It’s a good idea to require a valid ID during all return and exchange transactions so you can flag and address customers with frequent or iffy return behavior.
Fortunately, return fraud only makes up about 6% of returns, according to the National Retail Federation. If you want to get the most from your returns policy, read Recurring Refunds: How Retailers Can Deal with ‘Serial Returners.’
Employee theft isn’t something retailers want to have to worry about. It’s easy to say you trust your employees and leave it at that.
Failing to properly prepare for internal theft leaves you vulnerable, however. After all, employee theft makes up 90% of significant theft losses, with businesses losing $50 billion per year as a result.
Employee theft can take many forms, and not all of it looks like the straightforward theft you might envision. Employee theft includes:
- Straightforward merchandise theft
- Ringing up fake returns and issuing fraudulent gift cards
- “Sweethearting” (neglecting to scan all of a friend or family member’s items or improperly using their employee discount)
- Skimming off the cash drawer—usually done in small amounts at a time that can add up to big losses
So, how can you stop employee theft in your store? You always have the option of placing surveillance cameras throughout employee-only areas, posting signage that employees are being monitored, and checking employees’ bags before leaving. But as you can imagine, that kind of enforcement doesn’t create the best morale or work environment.
Here are a few more practical ways to curb employee theft and fraud:
- Audit your hiring practices. Retailers aren’t always known for stringent hiring requirements, but you should take care in deciding who your frontline partners in the loss-prevention fight will be. Look for conscientious employees who conduct themselves with integrity. They’re less likely to take advantage of their power as employees and will be better allies in helping you combat all the other types of retail loss, too.
- Train employees properly. Once you have the right team in place, it’s your job to give them the training they need to mitigate errors and losses, identify shoplifting and fraud, and bring down your retail shrinkage rate.
- Consider your store culture. When your retail store has a great workplace culture, employees stick around longer and are more invested in your store’s success. Work to create a positive, low-turnover culture (in addition to the tips above) and you’ll see incidents of employee theft and fraud drop off.
Shockingly, 75% of employees admit to stealing at least once from their employer. But there are ways to keep employee fraud at bay.
When your bottom line takes a hit, it never feels good. But not all retail losses stem from malicious or illegal behavior. Simple administrative and paperwork errors actually account for as much as 18.8% of annual shrinkage—sometimes called “paper shrink.”
That’s a big chunk of sales you can hold onto just by implementing the right systems to seamlessly and accurately track inventory and sales.
How does an administrative error translate to retail losses? Mistakes like mislabeling, incorrect markdowns, and accounting errors can lead to merchandise being sold for less than it should be or refunded for more than it should be. That means real dollars are lost.
Administrative errors are by nature accidental, but that doesn’t mean they can’t be prevented. Let’s look at how to avoid and catch “paper shrink” before it costs your store:
- Employee training. Whether they’re conducting inventory audits, running around with the price gun, or processing returns, properly trained employees are less likely to make mistakes that end up contributing to your retail losses.
- Cycle counts: Depending on the number of products and variants you carry, counting all your store’s inventory can be a lengthy process. Consider doing cycle counts (also known as partial inventory count)—where you count inventory on-hand for one product type rather than all the products you carry at once. Since they can be done quicker and more often than full physical inventory counts, cycle counts can help you spot shrinkage and address it before it becomes a larger issue.
Only about 5% of shrink is due to vendor fraud. This type of inventory shrinkage involves two sides: fraud involving check tampering and billing schemes, or vendors stealing from the store when delivering inventory.
Some ways to combat vendor fraud include:
- Conduct rigorous background checks on new vendors. Vendors are an extension of your retail business, especially if they are delivering orders to your store. How well do you really know your vendors and their employees? Be sure to run a check on their reputation or any existing fines or lawsuits. You could also look at their social media, check for corporate record verification, and see if employees have any criminal convictions.
- Create an anonymous support line. Some employees or even external parties may be hesitant to report fraud. They may not want to attach their name to a report in fear of the consequences. You can create an anonymous support line or messaging system where people can report fraud without giving up their personal information.
- Authorize specific employees for inventory handling and invoicing. If you aren’t handling all the invoicing and purchase of goods, have separate employees manage each task. One for purchase of goods, one for invoicing.
Here’s the most bizarre and frustrating type of shirk: unknown causes. According to the National Retail Security Survey, over 6% of shrinkage cannot be accounted for under the above categories, leaving you and the millions of other retail stores out there in the dark.
Retail shrinkage prevention strategies
Despite the many known (and unknown) causes of inventory shrink, there are useful ways to prevent it. Any mix of the following methods can work:
- Audit hiring and training practices
- Institute clear policies
- Create strong deterrents
- Get buy-in
- Hire a loss prevention manager
- Develop strict accounting practices
- Improve inventory management
Audit hiring and training practices
While the latest technology and tools can improve your operations, old-fashioned employee training is making a comeback. Talking about loss prevention during new-hire orientation was up significantly in 2020, with 95% of companies using these tactics respectively.
By taking loss prevention into account during the hiring and training processes, you can impact the two largest of those factors—shoplifting and employee theft.
When it comes to employee theft, you might imagine store workers pocketing merchandise for themselves. But employee theft also includes things like refund abuse and overuse of discounting.
When you hire store workers, what qualities and skills are you looking for? You should be screening for conscientious candidates who conduct themselves with integrity.
Employees who excel in those areas are partners in the loss prevention fight. They’re less likely to abuse their power as employees and be more invested in a retailer’s success. They’re more dedicated to helping you reduce retail shrinkage.
Good employees want to prevent inventory losses, but it’s your job to give them the tools and training they need to make it happen. Employee training to identify and stop shoplifting can make a big difference in your shrinkage.
When it comes to loss prevention training, you have plenty of options. You can try an online course from an organization like the Loss Prevention Academy or Loss Prevention Foundation. Or you can bring in a third-party loss prevention and security expert to train employees in person.
Institute clear policies
A clear policy is essential to reduce inventory shrink. In fact, over 92% of businesses reported using a code of conduct as part of their loss prevention awareness program in 2020. While this doesn’t physically prevent criminal behavior from employees, it communicates your business’s commitment to ethical conduct and sets the expectations for employee behavior.
Create a policy that highlights acceptable use of company property and show it to employees during onboarding. Be clear about the disciplinary actions you’ll take if someone is caught stealing from the business.
It’s important that everyone is held to the same standards. For example, if you don’t want store associates to steal money or use supplies for personal pursuits, don’t let supervisors or managers do it either.
Create strong deterrents
Organized retail crime (ORC) continues to be a serious problem for retailers, with average losses topping $700,000 per $1 billion in sales. Relaxed law enforcement guidelines and decreased penalties have caused an increase in ORC activity, according to the NRF 2020 Organized Retail Crime survey.
Businesses often change their strategies for fighting retail crime, whether it’s employee or customer driven. Giving the appearance of strong security is equally as important as having it. This shows you take losses seriously and can deter people from carrying out bad behavior.
When was the last time you examined your loss prevention system and its effectiveness?
In 2020, the top five loss prevention systems in use were:
- Burglar alarms or electronic article surveillance (95%)
- Digital video recorders (88%)
- Live customer-visible CCTV (78%)
- Armored car deposit pickups (77%)
- POS data mining (72%)
Each of these tools saw significant growth from 2019, according to the NRF.
But those aren’t the only deterrents retailers are using. The same study from the NRF showed big year-over-year jumps in the following five loss prevention systems:
Point-of-sale analytics and live customer-visible CCTV are becoming widely used tools. On the other hand, retailers continue to rely on the classics like a burglar alarm to deter crime. The question to consider here: what new or emerging technology should you consider exploring?
Small businesses today can leverage tools like CCTV and digital video recorders with ease. For example, Shopify partnered with Google and Nest to help merchants use high-tech security cameras at an affordable price.
Rather than install a clunky, expensive security system in your store, you can get up and running with a Nest Cam for just $199. It takes minutes to set up, and with the Shopify app, you can monitor in-store activity from anywhere, saving you time and protecting your hard-earned money.
Unify your inventory management with Shopify
Only Shopify POS helps you manage warehouse and retail store inventory from the same back office. Shopify automatically syncs stock quantities as you receive, sell, return, or exchange products online or in store—no manual reconciling necessary.
Effective loss prevention starts at the top and flows down and out throughout the organization. Fighting shrinkage means securing buy-in from everyone in the business—from the owner down to rank-and-file store workers.
But how do retailers accomplish this?
The most important tactic for getting your team invested in loss prevention is simple:
- Be transparent about the problem.
- Communicate shrinkage numbers across the organization.
- Help your team conceptualize how much you have to gain by addressing shrinkage.
- Share loss prevention goals and connect them with the progress you make.
For most senior-level managers, the benefit of loss prevention comes down to the numbers. What about store workers who may not be as invested in the organization’s performance? You need buy-in from them, too.
To get it:
- Empower store employees to take responsibility for the store’s success.
- Set clear benchmarks and reward employees who reach and surpass their goals.
- Share team success with every member of the organization.
Hire a shrinkage prevention manager
Hiring and training to reduce retail shrinkage gives you a headstart in the fight against losses. For many stores, it's easy to push crafting and enacting a loss prevention strategy off of one person’s plate … and onto no one’s.
That’s why hiring someone whose primary role is to spearhead loss prevention efforts is an option worth considering, particularly as your business grows.
Loss prevention jobs are common for retail stores at all levels. These roles involve:
- Leading, conducting, and delivering results regarding investigations of theft, fraud, workplace violence, and other critical incidents
- Keeping owners informed on key issues and loss prevention strategy performance
- Analyzing data, conducting audits, and identifying trends to create action plans that mitigate risk
- Promoting and executing security best practices
- Performing spot checks on foot throughout the store
Another option: You also can bring in a specialized retail security officer to serve that purpose rather than relying on your own employees to confront potential shoplifters themselves.
Strict accounting practices
Not all shrinkage happens in-store. Sometimes you’ll only see losses on your balance sheet. You may want to rethink your accounting practices if you want to improve loss prevention.
In accounting, retailers must establish the cost basis of all inventory. Cost accounting is a less involved inventory valuation method based on costs. You only track inventory based on what you paid for it when received. But it’s not the best approach for realizing inventory shrinkage.
Retail accounting, on the other hand, values inventory based on retail price. It lets you track prices over time, including mark ups, mark downs, and sale prices on individual products. While retail accounting is a more attentive style of accounting, it can help identify shrinkage.
Another reason to adopt new accounting practices: If your inventory reports and sales records don’t align, you’ll have to spend a lot of time reconciling your receipts. If these documents are full of errors, the IRS may also get involved and could audit your business.
Improve inventory management
Inventory management should be a priority for your business if you want to improve loss prevention. With proper inventory control, you can account for items and prevent shrinkage.
Some ways to improve inventory management include:
- Implement item tracking. Tracking items is easy and can help you see where a product disappeared, whether in the warehouse or on the floor. You can attach RFID tags to products, which use radio frequencies to track items, and automatically track inventory and stock levels.
- Count inventory often. While a full inventory count may be too time intensive to do regularly, consider doing partial inventory counts instead. With Shopify, you can compare the stock levels you physically have in store with the recorded inventory levels in your point of sale system, reconcile and update recorded inventory levels when you find discrepancies.
- Do surprise audits. If you sense an employee is stealing from you, run a surprise audit. A random inventory count can uncover anomalies in your stock without giving employees time to prepare.
- Invest in inventory management technology. Using inventory management software rather than notebooks or spreadsheets can make stock management less prone to human error—it also equips you with tools, data and reports that help manage inventory more efficiently and maximize your return on investment.
With Shopify POS, for instance, you can order and categorize an unlimited number of products and variants, track, count and reconcile inventory across multiple store locations, and access detailed stock on hand reports to see cost price and retail value of your current inventory on hand from one back office.
As your retail business grows and inventory becomes more challenging to manage, inventory shrinkage will likely rise. Consider investing in the right tools to help you understand potential vulnerabilities and mitigate risk so you can turn a higher profit for your business.
Create a shrinkage prevention plan for your store
In the retail world, shrinkage is a part of life—but that doesn’t mean you have to settle for throwing away your sales each year.
Any way you add it up, it’s a big issue for retailers, especially those with tight margins already. Electronic item tags, high-tech surveillance and facial recognition, you name it—retailers continue to search for a one-and-done slam-dunk way to curb inventory loss.
But the reality is that an effective loss prevention plan is your best bet to limit your retail store’s losses. It's the only way to effectively fight problems like shoplifting and employee theft.