What is shrinkage?

Shrinkage is a term used to describe the difference between a store’s actual inventory and its recorded inventory. It most commonly refers to retail businesses, but in truth, any business that holds physical inventory will encounter shrinkage at some point.

Understanding shrinkage

Shrinkage describes a discrepancy between the actual inventory and recorded inventory of a business

According to the 2021 National Retail Security Survey, the average shrinkage rate for United States retail businesses was 1.6%. With total retail sales of $5.15 trillion in 2021, the losses attributable to shrinkage equate to approximately $88 billion.

What causes shrinkage?

Shrinkage is caused by many factors, such as:

  • Theft – whether that be internal (employee theft) or shoplifting from a customer. The former is common in the hospitality industry where employees manipulate point-of-sale (POS) systems for their own benefit. 
  • Damage – any damage to an item that prevents it from being sold is also a form of shrinkage. It may occur while the item is in transit or as it is being handled. For example, an employee drops a bottle of wine when stacking shelves in a liquor store.
  • Vendor fraud – as the number of goods in a shipment increases, so too does the chance of shrinkage from vendor fraud. A wholesale wine business that receives 798 cases of wine instead of 800 is less likely to notice the difference. Many vendors take advantage of a buyer’s carelessness or inability to count large order quantities.  
  • Spoilage – when perishable items are not sold before their due date, they must be thrown away. Unsurprisingly, this form of shrinkage is prevalent in supermarkets, restaurants, and other food establishments.
  • Human error – an often overlooked source of shrinkage is human error. A waiter that pours more than the standard 6 ounces of wine into a glass is causing a loss of inventory that costs the restaurant money. The same idea applies to any situation where food or drink is improperly portioned before the sale.

How can shrinkage be mitigated?

For most businesses, shrinkage is a fact of life. There will always be products that are stolen, damaged, spoiled, or otherwise unaccounted for. 

Nevertheless, there are some strategies a business can use to bring its shrinkage rate down:

  • Utilize frequent cycle counting – this is a principle of good stock management that involves counting a small subset of the total inventory on a regular basis. Focusing on a particular section of a store enables the business to better reconcile its inventory and identify shrinkage patterns as they occur. 
  • Implement shoplifting deterrents – deterring in-store theft starts with training staff to be on the lookout for suspicious behavior. A visible security system is also a worthwhile investment. Beyond these measures, electronic security tags can also be placed on high-risk items. Many supermarkets, for example, place security tags on meat, batteries, razor blades, and premium alcohol.
  • Create a desirable company culture – since internal theft tends to be caused by employees who are unhappy, unmotivated, or undertrained, establishing a culture of trust to improve morale is key. Some companies have also reduced theft by ensuring that at least two individuals are in a store at any one time. Point-of-sale theft can also be mitigated by having a supervisor or manager sign off on any refund or voided sale request.
  • Automate inventory management to eliminate instances of shrinkage that arise from human error, integrated inventory management, and POS system is the answer. These systems allow inventory personnel to monitor shrinkage rates and avoid administrative errors that result when manually entering counts.

Key takeaways:

  • Shrinkage describes a discrepancy between the actual inventory and recorded inventory of a business.
  • Shrinkage is caused by several factors that are not entirely avoidable. These include employee theft, customer theft, vendor fraud, spoilage, and human error.
  • To ensure shrinkage rates remain at acceptable levels, businesses can automate inventory management systems, implement shoplifting deterrents, create a culture conducive to trust, and utilize frequent but targeted cycle counting.
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