Rethink Shrink | The impact of a bad count

The supply chain disruptions affecting the UK retail market prompted me to have another think about shrink. There are many elements of retail shrink, or rather their knock-on effects, that are barely discussed and yet they represent a significant opportunity to reduce costs as well as recover the all-important margin. Fixing these problems will in turn deliver a more rounded customer service and help meet ESG objectives that are of growing reputational importance.

Currently, shrinkage is defined as the unaccountable inventory lost as the result of a huge number of related processes that make up the complex food supply chain process. For example, this could be anything from incorrect stock adjustments, booking-in errors, self-checkout mistakes, theft, vendor master data inaccuracies, damage, and cashier errors.

Altogether the cost of shrink to a retailer typically sits at between 1.5% to 2% of total turnover, and although eradicating shrink entirely is an impossibility, we are seeing many of our customers set a target of reducing it to below 1%. Setting the target is the easy part, achieving it is another thing – therefore many retailers are investing in innovative solutions to focus attention on those process components that are driving shrink.

Traditionally, shrink has been largely the exclusive domain of Loss Prevention – teams within retailers who look after areas like store process compliance. Yet, this narrow view fails to consider the costs associated with shrink that sit away from the Loss Prevention P&L line. It is important, therefore, to consider a much broader definition of shrink and its impact, one where the loss may currently be greater but where the opportunity to recover margin and boost sales is also far higher.

Let’s consider one area of shrink that is caused by a poor process that leverages inherently flawed data that subsequently impacts availability through inaccurate forecasting – phantom inventory. Phantom inventory is that stock which appears to be available either in the supply chain or in the store but is not, typically due to issues in accounting, transit, and stock counts.

The phantom inventory issue is significant. For many years, the true stock accuracy figure in food retail could be as low as 35%. Granted, some of the inaccuracies are minor, but it is important to acknowledge the broad challenge that retailers face to keep their records accurate and that is a cost that goes beyond the Loss Prevention team, who can often be more focused on targeting theft, whether through the front or back door. Whilst the inventory write-off will be felt by this group, the resultant impact of an inaccurate count on forecasting accuracy and product availability will generate an even greater cost and lost opportunity. Therefore, the objective is not just about minimising shrink, but about solving the root causes – in this case, inventory record accuracy.

Exploring ways to achieve a more accurate inventory record has two main challenges. The first is technical; the data needed to express perpetual inventory is affected by multiple stages within the supply chain process, each happening in a different place and at different times which makes it difficult to pinpoint the source of an issue. This compounds the other challenge, an operational one, that multiple teams across different departments all hold a unique piece of the puzzle but with no visibility of the full picture so they lack the ability to take meaningful action.

Operational management’s ability to tackle this depends on whether they can find the underlying driver of phantom inventory across the end-to-end process, rather than focusing purely on shrink prevention actions alone, as well as enabling the process owners to take action that matters through improved data visibility. Sound simple enough? Well, UK grocery retailers are trading in the golden quarter of poor availability due to externalities like Brexit, long-tail Covid impacts and political instability – without considering the impact of the inventory record accuracy. Retailers should explore executing shrink driver analysis to guide them to the root causes of shrink, with a view to becoming more proactive instead of reactive in their shrink strategies.

Traditional shrink is a fact of life as are, for the time being, supply chain disruptions; the shrink currently hiding behind optimistic availability figures however can be addressed right now, if only initially to reveal the true nature of the problem so that phantom inventory can be stripped out and stock levels reset to true. Then the work can really begin to more efficiently match stock to demand.