If you were paying attention to retailers' earnings reports in 2023, you undoubtedly heard the term “shrink” cited as a key factor contributing to margin erosion and poor earnings performance. Shrink is the industry term for inventory loss often attributed to theft, damage, or errors. Once simply considered a cost of doing business, shrink resulted in retail profit losses exceeding a staggering $100 billion in 2022.
What’s more problematic, the trend of shrink appears to be far from reversing course, with losses more than doubling over the past five years. In an industry where margins and profitability are already under significant pressure, the rise in retail shrink is capturing the attention of all levels within retail organizations.
Retail executives are signaling a crisis in shrink and investors are taking note. Despite recognition of the growing problem, retailers, in many cases, are struggling to devise a comprehensive approach to regain control over the current situation. The lack of a clear strategy to combat escalating shrink, or even a demonstrated confidence in understanding its root causes, suggests that shrink losses will remain at heightened levels.
Consumers’ perception vs. retailers’ reality
It's safe to say that most consumers likely never heard the word "shrink" until recently. However, with its newfound prevalence on social media, media coverage, and disclosures in retail earnings calls, the incremental pervasiveness of the topic is clear. Ultimately, consumers, while not necessarily well-versed in the intricacies of shrink, grasp the fundamental connection between growing retail losses and their inevitable repercussion–increased prices. This exposure has led to a largely negative perception and left those outside of the business world wondering what is being done to stop the seemingly growing issue.
The challenge lies in aligning negative perceptions with the reality that retailers face. One reason for the inability to demonstrate current mitigation efforts may be working is that published retail metrics are lagging. Data is typically sourced from the previous full year, which clearly doesn't align with present-day online or offline content. Additionally, a notable 6% of reported shrink data in 2022 falls into the category of "unknown," presenting an opportunity that is within reach for retailers to better quantify sources of shrink and to paint a more accurate picture for investors, industry analysts, media, retail employees, and the general public.
Time will unveil whether the heightened awareness that various stakeholders encountered in 2023 is merely viral hype or signals a notable increase in retail shrinkage year over year.
Beyond shoplifting
Amidst the increase in viral social media content and media reports spotlighting theft, it is essential to acknowledge that shrink is a multifaceted challenge that extends beyond customer theft. Shrink encapsulates all forms of loss throughout the inventory-to-cash conversion process, occurring across the entire value chain–from freight and distribution to the store level. This multifaceted challenge also involves various players, including employees, customers, and third parties.
To form a comprehensive picture of shrink, retailers must first take a step back and take stock of each of the sources and drivers within their organization. Organizations should think about the types of shrink–where it occurs, whether it is caused by internal or external parties, if it’s intentional harm such as fraud or theft, or if it’s unintentional loss such as accidents and errors. Through this exercise, retailers will develop their “shrink profile,” a way to classify the various types of loss at a granular level that can then provide better insights into underlying causes.
You can’t manage what you can’t measure
Moving beyond broad assumptions of where shrink is likely coming from, retailers should undertake a data-driven approach to measure the areas where losses are actually occurring as doing so enables the deployment of targeted mitigation techniques with the greatest potential impact. Given that brands are distinct, with unique product offerings, geographic footprints, market dynamics, operational systems, data landscapes, etc., the root causes of shrink vary widely, often necessitating tailored solutions working in concert to effectively address the challenge.
Without specific insight into the numerous sources of shrink for their business, retailers are left to leverage a disconnected network of siloed, off-the-shelf shrink solutions that often have custom purposes. This patchwork of solutions is not clearly and deliberately linked to the underlying root causes, leading to diminishing effectiveness across an enterprise issue and limited transparency into a tool’s return on investment.
Frequently employed tactics of today are often blunt instruments that may help reduce shrink, yet they may also result in unintended consequences. For example, select retailers are testing private label-only stores since it is a working supposition that national brands are more desirable for resale by organized retail crime groups. While this approach may in fact reduce shrink in that location, it also may drive paying customers to nearby competitors or the brand’s other local stores, converting a loss problem into a possible sales and customer loyalty problem.
With a unified view from multiple data sources retailers already have at the ready, a retailer could not just pinpoint the national brands most frequently stolen but also could collectively mine point-of-sale transaction data and employee schedules, along with unstructured data, such as camera footage to glean insights as to the time of day when intentional harm is most prevalent and the customer and employee traffic patterns around the most frequently stolen goods.
Putting more context around the problem through the lens of aggregated data allows for more precise solutions, such as moving, removing, replacing or locking specific products; identifying bad actors; increasing coverage at specific times; or modifying hours. With all of the new technologies available and predictive modeling tools to assist in decision-making, a holistic data-driven model that pulls information from across the organization to pinpoint individual origins of shrink is not just possible, its pragmatic.
Connecting the dots
The closer you get to diagnosing the distinct root-cause issues at a granular level, the more precise and targeted your mitigation techniques can be, which translates into less disruption to the customer experience and less costly investments in extreme countermeasures. When EY teams work with clients on the complex problem of shrink, we first leverage structured and unstructured data that already exists across the organization and look at it in new ways.
Our recommended approach includes these four critical steps:
- Aggregate: Start by aggregating information spread across the organization and joining discrete data points to identify the major sources of shrink through a holistic lens.
- Analyze: Perform deep and fulsome analysis into instances of major loss categories through data-mining patterns, anomalies, weaknesses, and at-risk activities to develop actionable intelligence.
- Address: Use intelligence to inform the mix of mitigation techniques and tools corresponding to your actual shrink profile.
- Monitor: Actively monitor shrink loss and the interplay of mitigation activities to quantify the impact and continue to make informed adjustments to your approach.
The heightened loss from shrink requires a strategic holistic approach based on a thorough understanding of the unique shrink problems a company is experiencing. Only then can mitigation techniques, working in concert with each other and actively monitored for effectiveness, be employed to make a meaningful difference in reducing shrink.
Jennifer Fagan is EY’s retail partner. The views reflected in this article are the views of the author and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
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