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What Is Inventory Shrinkage and How to Prevent It

Inventory shrinkage is a major problem for retailers.

The more inventory that goes missing, the harder it becomes to make sales and stay afloat financially. This means taking steps like reducing your lost items as much as possible.


What Is Inventory Shrinkage?

Inventory shrinkage is losing inventory because of factors other than sales. It is the difference between inventory levels on paper and actual levels of inventory.

If the inventory management system indicates you have 10 pairs of shoes in stock, but the reality is that only 9 are on hand and no sales can account for a lost pair, then there has been shrinkage.

When a retailer loses inventory, they lose money and also face damage to their reputation. Click To Tweet

When you have lost inventory due to shrinkage, the expenses that go into acquiring those items are also thrown out.

The inventory you have on hand, by the way, represents more than just the cost of acquiring it. All of your stock sitting in a warehouse is potential cash flow waiting for someone else’s purchase. If your inventory dwindles, then you’ll be left with fewer assets available to pay sales staff and make new purchases.


What Causes Inventory Shrinkage?


When it comes to inventory shrinkage, there is not one specific cause. You can combat it by determining where the problem is coming from.

Inventory shrinkage is the result of a number of different causes that can include:


Price tag swapping, which involves the shoplifter paying less than what an item costs because a different SKU number was recorded in their purchase, also falls into this category. The NRF’s National Retail Security Survey 2020 found that while average dollar loss per incident has decreased compared to previous years due to technological advancements and improvements on retail security infrastructure, this still remains one of the key contributors to shrinkage.

The Employee Theft

This is a significant cause of shrinkage. Fraudulent returns, theft, and neglecting to scan items for family and friends can cause problems in business if they’re not dealt with quickly.

Human Error

Poor inventory management is frustrating and can lead to shrinkage. On its own, it’s hard to measure the cost of lost items due to human errors–but it does mean less profit because you were likely forecasting more revenue than your actual numbers.

Vendor Error and Theft

Some dishonest vendors might steal from you by not delivering your full order. However, this is not a large contributing factor, and many times, vendors will work with you on correcting mistakes.


Sometimes, accidents can happen. Some goods can get broken or damaged unintentionally or due to wear-and-tear.


How to Calculate Inventory Shrinkage

Whenever you sell an item, the value of your inventory is reduced by its price. Conversely, whenever you place a new order for stock (which raises the worth of your inventory), any discrepancies between what has been sold and ordered will be considered “shrinkage.”

If you keep track of your inventory and find that it is worth $200,000 according to the records and you do an inventory count only to discover that there are actually only $197,000 worth of items on hand, this means that the inventory has shrunk by $3,000.

To calculate retail shrinkage, the formula is:

Retail shrink = Retail value of recorded inventory levels – a retail value of actual inventory levels

If you want to calculate retail shrinkage as a percentage, follow this formula:

Retail shrink percentage = Total losses ÷ total sales


What’s an acceptable inventory shrinkage rate?


The National Retail Security Survey revealed in 2020 that the average shrink rate in retail has risen to an all-time high, after years of remaining steady. The fact that retailers are losing more to shrinkage than ever before is not new, but what exactly is this all-time high?

It is 1.62%.

Shrinkage is a costly problem that impacts every company. An average of 1.62% shrinkage translates to $61 billion in losses. As such, you should limit the shrinkage to a minimum.


How to Prevent Inventory Shrinkage


Accidental damage is unavoidable, so it’s important to be aware of the issue and protect your inventory accordingly. Here are some ways to prevent shrinkage as much as possible.

Employ frequent cycle counting

If you’re not carefully monitoring inventory levels, you can be taken by surprise with the shrinkage rates that were never an issue before. Take appropriate measures before this turns into a huge problem. Click To Tweet

Counting full physical inventories takes too much time and so most retailers only count their entire stock once or twice per year.

To combat inventory shrinkage, keep track of the supply with frequent cycle counting. Cycle counting means that you count a small number of your products on an ongoing basis. For example by doing weekly counts with 10 different SKUs or picking 20 particular SKUs and monitoring their stock levels over the course of one month.

Here’s how to do it:

  • Focus on a particular area of your store.
  • Count the SKUs in that section.
  • Compare it to the stock levels in the inventory management software.

There are a number of ways to deal with inventory shrinkage.

  1. Reconcile your store’s inventory at the end of each day and compare it against that morning’s physical count.
  2. If you notice discrepancies, do not ignore them; instead, call someone in management or head office right away.

Cycle counting does not work as a loss prevention strategy in and of itself, but it can help you identify where shrinkage may be happening. If your cycle count indicates that there is an issue with theft or other types of losses at the store level, then this should tell you to increase security measures.

You can implement anti-shoplifting measures, at this point. 

When we’re considering shrinkage, it’s important to implement measures to prevent shoplifting. If you want your employees to deter shoplifters as well as potential thieves, they should greet every customer in order for it to become clear that there are staff members who are aware of what’s going on.

Loss prevention tools, also, can include training your staff, security cameras, and fingerprint scanners.

  • Electronic security tags are usually plastic with an alarm that will sound when the tagged merchandise is carried out of the store.
  • Installing security cameras in your store is a great way to deter shoplifting. To avoid giving away any blindspots, consider hidden surveillance cameras. Security footage can also be used as evidence if employees do happen to steal from the company.

You can also mitigate employee theft.

Unhappy and under-trained employees are risks for theft. One of the best ways to mitigate employee theft is by talking with employees. You have a better chance at trust and morale which will cut down on internal problems like stealing.

Another option would be:

  • When two employees are working, they should always be in the same area of the store. If there is a customer return or sale that needs to be voided, another employee (preferably one with managerial authority) must also sign off on it.
  • If you want to create an anonymous tip line, make sure employees can remain anonymous. If they witness theft or some other bad behavior and the perpetrator is not found out by co-workers, more people will come forward.

There are all-in-one systems that you can use.

One of the best ways to cut down on human entry error is by removing humans from inventory management. With a fully connected system, you can worry less about mismatched numbers.

The system integrates with your inventory, so it’s easier to make decisions about what you need and where. You can also refer back easily when there are questions or problems.

If you use a POS system, it’s easy to see how much inventory and cycles have been counted. This means that if your store is experiencing shrinkage rates of more than one percent per month or has low cycle counts, then you can take action before the problem gets worse.

Create an Inventory Shrinkage Action Plan

It’s time to do something about inventory shrinkage.

  • If you’re not already using a system that is fully connected to your inventory and point of sale, then it’s time for an upgrade.
  • Evaluate your current loss prevention measures and see if there are ways to improve them. If you haven’t already, consider implementing electronic tags or security cameras.
  • When you are hiring employees, always be sure to have at least two people working simultaneously. 
  • Establish an anonymous theft tip line and inform employees that they will not be punished for reporting on each other. Emphasize how truly anonymous the system is.
  • Keep your employees happy so they are less likely to steal from you.
  • To ensure that you’re taking accurate inventory, create a schedule for how many SKUs to count each week.