Print Issue: April 2017
The world of retail has relied on the word “shrinkage” for more than 100 years to describe the losses companies experience as they go about their business. Shrinkage, however, is almost a euphemistic term describing a simple contraction in the size of the stock held by a company, without offering any real sense of what the cause might be.
In this way, the term is similar to “shoplifting”—a rather benign term often used by the industry to describe people actively engaging in criminal acts of theft in stores. For comparison’s sake, you rarely see burglars or robbers described as houselifters or purselifters.
Four buckets of loss tend to be included in survey descriptions of what shrinkage is: external theft, internal theft, administrative or process errors, and vendor fraud. The term “administrative error or process failures” is particularly vague; depending upon the type of retailer and the types of products sold, it can potentially cover an enormous array of types of loss, including damage, spoilage, product going out of date, and incorrect price adjustments.
A retailer selling food and using a shrinkage definition that includes food spoilage will have a different level of loss compared to a retailer selling clothing or auto parts; yet, many shrinkage surveys continue to combine this data together to generate an overall figure for the industry.
To date, there is no consistent, detailed definition or typology of shrinkage. It is a term that is used throughout the industry, but interpreted in different ways depending on the retail environment and the prevailing organizational culture and practices.
There is a constant desire to understand what the root causes of shrinkage are: Is it mainly external thieves? Is it the staff employed by retailers helping themselves to the stock? Is it due to organizational inefficiencies? Or is it caused by retail suppliers wrongly delivering on purpose or through error?
Surveys will often provide numbers that supposedly apportion the total shrinkage losses to each of these types of losses, with external theft frequently—but not exclusively—seen as causing the largest amount.
The reality is that what these reported shrinkage numbers are actually measuring is what respondents think the causes of shrinkage might be. They are much more a gauge of how the loss prevention industry is feeling than any true measure of the breakdown of losses within the retail industry.
This is because the vast majority of current shrinkage data collected by retailers is based on periodic audit data collected in stores and sometimes in parts of the distribution network. This data captures the difference between the value of stock retailers think they have and the amount that can be physically counted. The difference between the two is how most companies measure their shrinkage.
But all this data does is provide a value of how much stock is not there. What it does not do is offer an explanation as to why it has gone missing: Was the stock delivered to the retailer? Did a customer steal it? Was it damaged or stolen in the supply chain? Did an employee steal it?
The causes could be many and varied, but what is clear is that audit data is rarely good at explaining why discrepancies exist; it simply captures the value of losses where the cause is unknown. Attempts to apportion causes to this data will always involve a high degree of guesswork and personal prejudice.
Retailing has gone through some profound changes since shrinkage was first used back in the 19th century, not least the introduction of open displays, the growth of branding, greater consumer choice, introduction of credit cards and debit cards, the rise of online shopping, and the widespread use of various types of self-service checkout systems, to name a few.
Yet, throughout this time of enormous change, the retail industry has continued to use a term that vaguely captures the difference between expected and actual stock values as the core measure of loss in their businesses.
Given this, it’s time to reconsider how retail companies understand and measure the losses they experience and to develop a more consistent approach to enable future benchmarking activities to offer more meaningful and applicable information.
TOTAL RETAIL LOSS
Both the Retail Industry Leaders Association’s Asset Protection Leaders Council, based in the United States, and the ECR Community Shrinkage and On-shelf Availability Group, headquartered in Europe, supported a research project led by the author to explore how retailers currently view the problem of loss across their business and develop a new definition and typology that might better capture their impact.
The research, detailed in the report Beyond Shrinkage: Introducing Total Retail Loss, used several different methodologies: an extensive literature review; a questionnaire to a group of large European retailers; 100 face-to-face interviews with senior directors of 10 of the largest U.S. retailers; and a series of workshops and focus groups with loss prevention representatives from a range of European retailers and manufacturers.
Loss versus cost. One of the difficulties of benchmarking any retail business using shrinkage is understanding what categories of retail loss are included or excluded.
Some companies taking part in this research adopted strict criteria: shrinkage is only the value of their unknown losses based upon the difference between expected and actual values; anything else is regarded as known and, therefore, not included in the calculation.
Other companies were much more inclusive, incorporating other types of loss ranging from damages, wastage, spoilage, and price markdowns to the costs of burglaries and robberies.
Part of this definitional variance seemed to be based on how respondents interpreted the difference between what could be considered a “loss” compared with a “cost,” the latter being viewed as an everyday planned and necessary expenditure for the business to achieve its profit goals. Respondents varied considerably in how they interpreted the difference, although many made a key distinction between the value of the outcome and how this differentiated costs from losses.
“Costs—they bring value to the business; they are incurred because there is a perceived positive purpose in having them. They are part of the revenue generation process and without them, profits would be negatively impacted,” one respondent said. “Losses are things which, if they didn’t happen, there would be no negative impact upon profitability. They do not offer any real value to the business and simply act as a drain on profitability.”
It was also instructive to hear how some respondents adopted a process of normalizing what some considered to be losses into costs. One respondent explained that “we plan a lot of those costs [possible types of losses], so when we’re looking at it from a planning perspective, we have that built in—anything that we can account for and process and know what it is, we take more so as a cost rather than a loss when we’re defining it.”
Another respondent talked about how the planning and budgeting process enabled many losses to be redefined as costs. “If it goes above budget, then it becomes a loss; otherwise it is a cost,” the individual explained, while another respondent was blunter: “We try and convert as much of [losses] to costs; it’s then not on my agenda anymore. I deal with shrink.”
Definition. From the interviews with senior U.S. retail executives and feedback from the roundtables held in Europe, definitions of costs and losses were eventually developed.
Costs were defined as “expenditure on activities and investments that are considered to make some form of recognizable contribution to generating current or future retail income.”
Losses were defined as “events and outcomes that negatively impact retail profitability and make no positive, identifiable and intrinsic contribution to generating income.” Using these definitions, various types of events and activities could then begin to be categorized accordingly.
For example, incidents of customer theft can be considered a loss—the event and outcome play no intrinsic role in generating retail profits—because it makes no identifiable contribution and were it not to happen, the business would only benefit.
Alternatively, incidents of customer compensation, such as providing a disgruntled shopper with a discounted price, can be seen as a cost. In this case, the business is incurring the cost because it believes compensating the aggrieved consumer makes the individual more likely to shop with the business in the future. The policy of compensating is an investment in future profit generation and is categorized as a cost—not a loss.
Another example of a loss is workers’ compensation, where a retailer will cover the legal, medical, and other costs associated with an accident at work, such as falling off a ladder. There is no intrinsic value to the business if an employee is injured at work; if it had not happened, the business would only benefit by not having to pay for the consequences of the event. Therefore, workers’ compensation is a loss.
While some respondents to this research argued that workers’ compensation is a predictable problem that can be—and is—budgeted for, it still remains an event that the retailer would prefer not happen because it negatively impacts overall profitability.
In contrast, expenditure on loss prevention activities and approaches, such as employing security officers or installing tagging systems, can be seen as a cost. The retailer has committed to this expenditure because it feels there will be some form of payback from the investment: lower levels of loss, which in turn will boost profits. Whether this payback is measured or achieved is open to debate.
What these examples focus on is not whether an activity or event can be controlled or whether the incurred cost was planned, but its fundamental role in generating current or future retail income. If a clearly identifiable link can be made between an activity and the generation of retail income, then it should be regarded as a cost; all those activities and events where no link can be found should be viewed as a loss.
Categorizing losses. In developing the categories of the Total Retail Loss Typology, it was important to draw a distinction between the types of loss that can be measured in a way that is manageable for modern retail business, and those that cannot.
Additionally, it was important to consider the value of collecting data on a given loss indicator. Is it meaningful for the business to monitor a category of loss? Will its analysis offer potentially actionable outcomes that may help the business meet its objectives?
There is little point in developing a typology made up of a series of categories that are either impossible or implausibly difficult to measure or once measured offer little benefit to the business undertaking the exercise.
For example, most retailers would be keen to understand how often items are not scanned at a checkout. While it is theoretically possible to measure this, the reality for most retailers is that the ongoing cost would probably be prohibitive.
Determining whether proposed loss categories met the three M’s test (manageable, measurable, and meaningful) was an important part of creating a typology likely to achieve any form of adoption across a broad range of retail formats.
Typology. The research identified 31 types of known loss that are included in the Total Retail Loss Typology covering a wide range of losses across the retail enterprise and incorporating events and outcomes beyond just the loss of merchandise. The typology is broken down into four locations of loss: store, retail supply chain, e-commerce, and corporate. Each location then has a variety of subcategories divided between malicious and nonmalicious.
For example, a malicious corporate retail loss would be fraud; a nonmalicious corporate retail loss would be workers’ compensation, regulatory fines, or bad debt.
However, the term does not encompass every form of loss that a retailer could conceivably experience. The word “total” is being used in this context to represent a much broader and more detailed interpretation of what can be regarded as a retail loss, rather than necessarily claiming to reflect the entirety of events and activities that could constitute a loss. In the future, the scope and range of the Total Retail Loss Typology will change to accommodate new forms of loss, and this is welcomed.
The typology is designed to enable the calculation of the value of retail losses, not necessarily the number of events; where an associated value cannot be calculated or there is no loss of value associated with an incident, it should not be included.
For instance, if shop thieves are apprehended leaving a retail store and the goods they were attempting to steal are successfully recovered and can be sold at full value at a later date, there is no financial loss associated with the incident. The retailer may still want to record that the attempted theft took place and was successfully dealt with, but that it would not be recorded in the Total Retail Loss Typology.
The proposed Total Retail Loss Typology is a radical departure from how most retail companies have understood and defined the problem of loss within their companies, moving away from a definition focused primarily on unknown stock loss to one that encompasses a broader range of risks across a wider spectrum of locations.
While there is a simple elegance about the approach adopted in the past, based upon the four traditional buckets of shrinkage, it is increasingly recognized that these broad brush and ambiguously defined categories are no longer capable of accurately capturing the increasingly complex risk picture now found in modern retailing. Instead, the Total Retail Loss Typology has the potential to benefit retail organizations by managing complexity, encouraging transparency, creating opportunities, and maximizing loss prevention.
Managing complexity. The retail landscape in which shrinkage was first described has been transformed by innovation and change. Simply relying upon the traditional four buckets of estimated losses to fully reflect and properly convey the scale, nature, and impact of retail losses is no longer appropriate, particularly as the retail environment becomes more dynamic and fast changing.
Encouraging transparency. The ambiguous nature of most shrinkage calculations and the difficulty of understanding its root causes generate a lack of accountability, particularly within retail stores.
Store managers question the reliability of the number, especially where there is a pervasive sense that the supply chain may be foisting losses upon stores that are actually caused by inefficiencies. Unknown store losses can conveniently be blamed upon short shipments or roaming bands of organized thieves, rather than being apportioned to actual events taking place in the store.
Losses can also be moved between different categories, depending upon the performance measures in place—wastage can quickly become shrinkage if the former is identified as a key performance indicator.
By measuring a broader range of categories of loss, it becomes much more difficult to play this game; most losses will be measured somewhere, improving transparency and accountability throughout the organization.
Creating opportunities. A recurring theme from the research was the lack of prioritization and urgency associated with categories of loss that had already been measured or for which a budget had been allocated.
Many respondents were quick to view these factors as a cost; therefore, not requiring any remedial action by the business. In effect, the process of capturing the loss or planning for it through budget allocation rendered them immune from concern over the actual loss.
By adopting a systematic approach and agreeing on the definition of a retail loss and bringing these together under a single typology, opportunities may arise to minimize the overall impact of loss upon the business.
Maximizing loss prevention. Dealing with an unknown loss, which is what most loss prevention practitioners typically focus on, is probably one of the hardest challenges faced by a management team in retail. This requires the team to develop a high level of analytical and problem solving capacity.
Trying to solve problems where the cause is typically unknown is also at the hard end of the management spectrum. It requires creative thinking, imaginative use of data, and considerable experience. Imagine if these capabilities were used on the broader range of known problems encapsulated in the Total Retail Loss Typology. The impact could be profound.
Using resources. By generating a broader, more detailed understanding of how losses are impacting a retail organization, it may be possible to take a more strategic approach to the allocation and use of existing resources.
The Total Retail Loss Typology could offer value in how businesses not only respond to existing loss-related challenges, but also use it to review the implication of any future business decisions.
The interplay between sales and losses needs to be viewed in the round and not as a series of cross-functional trade-offs where losses and profits are allocated separately, driving behaviors that are unlikely to benefit the business.
It’s within this context that the Total Retail Loss Typology has been developed—to enable retail organizations to better understand the nature, scale, and extent of losses across the entire business, and to use this information to make more informed choices about how to grow profits and improve customer satisfaction.
As the pace of change in retail continues to intensify, it’s time for the loss prevention industry to begin to move away from a notion of loss developed in the 19th century to one that better reflects and recognizes the complexities and challenges found in the 21st century.
Adrian Beck is a professor of criminology in the Department of Criminology at the University of Leicester in Leicester, United Kingdom. Beck undertook the study Beyond Shrinkage: Introducing Total Retail Loss commissioned by the Retail Industry Leaders Association’s Asset Protection Leaders Council and is an academic advisor to the ECR Community Shrinkage and On-Shelf Availability Group.