| Analyzing Physical Inventory Results |
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Tim Smyth, President Smyth Retail Systems, Inc. January 2006
While the first step is to identify the total amount of shrinkage, a true understanding of the number can only come by identifying the source of the shrinkage so that direct action can be taken to reduce the likelihood of reoccurrence in the future. This is perhaps the most difficult task as there can be so many causes of discrepancies and identifying the source is more of a process of elimination than identifying direct cause and effect.
In a National Retailer Security Survey in 2002 the source of shrinkage was identified as a percentage to sales:
As discussed earlier, this amounts to a total of over $30 billion dollars a year for the U.S. economy alone. The cost to the average consumer is about $450 a person, and, of course, the cost to retailers directly is much higher - and in fact can be the difference between profit and loss. The national average for shrinkage is about 1.7% of loss at cost to annual sales. For a store with $1,000,000 in annual sales, that is $17,000. It could easily be the difference in being profitable and experiencing a loss.
These are some rather startling numbers. But before we can really compare shrinkage to these standards, we must consider all the possible sources for discrepancies to get a better idea of how a particular store compares and what actions need to be taken to reduce shrinkage losses.
Frankly, the accuracy of such surveys can be questioned as it is difficult to identify the difference between internal and external theft. In both cases both units and dollars are missing unless a cashier is under ringing a sale, which is almost impossible with current automation tools. The only possible source of such numbers might be the ratio of confessions from those caught in the act, but those ratios don't necessarily apply to those not caught.
First and foremost, before any meaning can be derived from shrinkage numbers, confidence in the accuracy of the physical counts must be high. So the first task is to measure the success of a physical inventory count before we can interpret the results.
Confirming Physical Counts
Before comparing the Physical Inventory counts to book inventory and throwing our hands up in disgust, we need to carefully analyze the counting process itself not only to assure the validity of the data, but also as a key step in identifying or eliminating a great many possible sources for the discrepancies.
Verification Counts
Verification counts are second counts of each fixture already counted in detail. The verification count is a count of the total number of pieces for a display or fixture that can be compared to the extended detail count to assure that each detail count was recorded correctly.
How well did verification counts compare to the detail counts? Were all slips/fixtures recounted until the detail counts and verification counts balanced? Was any stock location missing? Were all the count sheets accounted for?
Using and comparing verification counts as an integral part of the counting process is the single most important way to ensure confidence in your count numbers. The pay-off for the comparatively minimal amount of additional effort is well rewarded.
A side benefit of comparing detail counts to verification counts is that if specific counters and verifiers are identified by name it becomes quickly apparent who on your count team is most diligent and who needs additional supervision during the count process.
Compare the current inventory to the last inventory Every discrepancy caused by an inaccurate count will require at least one more discrepancy to correct it. If a product was over counted in a previous physical inventory and posted, it will cause shrinkage in the subsequent count (if it was accurate). This can be identified by comparing discrepancies of the current inventory (overage and shrinkage) with the discrepancies from the last physical inventory. For this reason, it is important to save the results of each physical count so they can be analyzed with subsequent counts.
Administrative Discrepancies
Comparing multiple locations When multiple stores or stock locations are counted, discrepancies between locations should be compared. An overage in one location that is offset by a shortage in another location represents an unrecorded or mis-recorded transfer or stock allocation. While this is all well and good from an overall company point of view in that merchandise wasn't lost externally, it suggests that a review of distribution and transfer processes is in order to assure book inventories.
Discrepancies in sizes, colors or common prices When discrepancies are off-setting for the same style or similarly priced goods, the reason for the discrepancy might be unrecorded exchanges, or mis-tagged or mis-counted merchandise . For example, if you are over by a piece for a large size for a style and short for the same style in a medium size, it is possible that a customer exchanged one size for another but the sales associate didn't record the exchange to save time. Of course, it is also possible that sizes were mis-counted or mis-tagged when goods were received. While which one of these possibilities can't be differentiated, a review of your procedures is indicated and can help prevent such errors in the future.
Unrecorded markdowns
When shrinkage of retail dollars is greater than shrinkage in units (based on average price) it is an indication that markdowns weren't all recorded. This is more common for open merchandise - class level inventory systems where SKU pricing controls aren't used. For example, if an item is sold for a marked-down price but the markdown wasn't recorded, shrinkage will be created because the amount of the markdown wasn't deducted from the total retail book inventory. This is easily identified by comparing the average retail of shrinkage to the average retail of your on-hand inventory. If the average shrinkage is higher than the average on-hand value for the class, it is a clear indication that markdowns weren't properly taken.
Markdown procedures should be reviewed carefully. For example, do the sales associates understand the difference between back-office/batch markdowns and POS markdowns when they are recording sales? If your marking methodology isn't distinct it can be hard to know when markdowns have already been taken for batch markdowns as opposed to when they are to be recorded at point of sale when the merchandise is sold.
Identifying specific discrepancies Each discrepancy needs to be investigated. Audits of all receipts, transfers and sales, including after inventory counts can often identify paper work errors and omissions. Investigation should include unapplied returns, in process merchandise such as layaways, approvals, etc. When dealing with items of limited quantities such as luxury goods and high-end fashions, reviewing missing inventory with your sales associates can even help identify unrecorded sales.
Internal Theft
Internal shrinkage is typically the largest source of shrinkage for retailers, representing 48.5% of all shrinkage as a national average. While retailers invest significantly on external controls such as security sensors, they won't prevent internal shrinkage.
After minimizing of all possible administrative shrinkage and errors, attention can be turned to identifying potential internal sources for shrinkage. Good internal controls provide the most effective way to reduce internal theft and it is important to consider the quality of current internal controls and how they can be improved as you try to reconcile shrinkage to possible sources within your staff.
If a preponderance of shrinkage is for a specific size, it often indicates not only internal theft, but can be helpful in identifying suspects. While not iron clad proof, it can point you in the right direction for improving control of employee sales.
Likewise, consider which items are missing compared to the known wardrobe of your staff. Good controls should require that only management be involved for employee sales so you can ensure that detailed SKU history be maintained for all employee sales (and discounts). By having detailed history of employee sales, a savvy management team will instantly recognize their own merchandise when it is worn or used by employees; a quick check of the employee's purchase history can confirm the validity of the purchase. If these controls are well enforced, reconciling suspicious possessions can be compared to missing merchandise.
Consideration as to the type of merchandise that is missing should also be considered. While high value or easily resalable merchandise will appeal to internal and external thieves, merchandise that is easily convertible to cash should be carefully considered. More than a few retailers will invest time visiting flea markets and watching for their merchandise showing up at other resale locations such as pawn shops, E-Bay, and the like. On occasion they have been known to find their own people behind such sales.
Good controls over store access are also important. Receiving room procedures should be tightly controlled to make sure goods only come in and don't go out the back door. Freight logs are helpful especially if recorded by someone other than receiving room personnel. Access to the back door should be controlled whenever possible. Inter-store transfers and customer shipments must be controlled to insure that all merchandise is accounted for. Even trash disposal should be controlled to make sure merchandise isn't walking out to the dumpster. Boxes should be crushed and clear trash bags can be helpful. Sales staff should not have access to the receiving area to prevent customer special orders from being opened before processing.
Security cameras can also be helpful for internal as well as external pilferage. They can be positioned at cash wraps, all exits, and the receiving room. The physiological deterrence factor alone can be of benefit, but the ability to review them is probably the best proof for prosecution.
Independent retailers have a significant advantage over big box retailers in controlling all shrinkage, but especially internal theft because they are closer to the floor and more involved in day to day operations and generally their stores are better staffed. Occasionally the largest source of internal shrinkage for the independent retailer tends to be merchandise that ownership takes for personal use. It is understandable that some owners may take their own personal items "under the covers" to avoid the tax bite. However, owners must be conscious of the example they establish for the rest of the staff: If it's OK for the owners to take merchandise for personal use, why isn't it OK for the staff to follow suit? The bottom line is that personal inventory withdrawals often end up costing more than they save. Setting the right example by processing ALL employee sales through the system is an important example to set. Instead, clothing allowances based on management position instill proper controls and are in the long term best interest of the company even if the benefits are taxable. I am reminded of a story a prominent retail consultant told of the retailer who experienced a frightening shrinkage as the result of a physical count. The retailer was a close personal friend of the consultant and when the call for help came in the retailer's voice was unsteady and full of emotion. The retailer, after performing all the audit functions of which he was aware, had come to the conclusion that it was an internal issue and only his trusted assistant store manger could be responsible. A visit was scheduled and after about six hours of intensive analysis the consultant identified the culprit. It was the store owner who had made a significant sale to a jobber of out-of-season merchandise and pocketed the proceeds. He had failed to properly record the transaction in the computer system.
Internal shrinkage is best controlled with good management and proper system controls with all members of management setting s good example. A well disciplined operation with tight accounting controls not only quickly identifies theft when it occurs but by remaining vigilant provides a psychological deterrent to internal theft the more the staff understands that tools are in place to identify theft. But good controls aren't derived from an edict alone; they must be implemented by the entire team. An important part of effective teamwork is having fun and enjoying the work. By sharing the disciplines and responsibilities the entire staff will take personal pride in working together with their business friends to run a profitable organization.
Shoplifting
Shoplifting is often only identifiable through a process of elimination. Internal paper errors and internal shrinkage must first be minimized before truly identifying most external theft. High value and easily marketable items will lead shrinkage for external as well as internal theft, but as with internal theft, personal use items are also commonly stolen. However, there are specific tell tale signs of shoplifting.
If part of your inventory preparation included cleaning up and looking in discreet locations for merchandise tags and packaging, such as behind mirrors and in dressing room cushions, you can often identify the specific SKUs that are missing. Dressing room doors should extend only from shoulder height to the knees.
Likewise, throughout the year, finding empty hangars can also indicate the possibility of stolen goods. By taking spot inventories to correct identifiable pilferage you won't bring back the inventory, but you can at least reduce the possible sources of shrinkage when a complete inventory is taken and possibly highlight the need for some preventive action.
Returns should be carefully controlled to minimize both internal and external theft. While employees can disguise pilferage through invalid returns (and voids), they can be easily spotted and controlled. If returns spike during certain slow floor hours, or when certain people are on the floor, employee theft can be indicated. Both of these transactions should require management or other employee confirmation during the transaction process so no one person is solely responsible for such transactions.
Perhaps the best prevention of internal abuse of return transactions is to require the identification of a customer for each return with at least a phone number. Periodically, or even routinely, management should call customers to confirm that the return was handled courteously and that the customer was satisfied. The stated purpose of the call should be to assure the customer isn't upset with the store's product or service, but also serves the purpose of identifying if employees are creating returns for their own benefit.
Of course, security systems such as sensor tags will cut down on theft, though it won't prevent it. The biggest drawback to such systems is the cost. Not only are such systems costly to implement the maintenance cost is high as all merchandise must be tagged when received and removed when sold. It definitely slows down the cahier function. And nothing is more frustrating for a customer than arriving home with a new garment to find a security tag on their purchase. We believe that often times security systems are prematurely purchased before other sources of shrinkage are carefully considered and the results aren't as beneficial as anticipated. They also imply a mistrust of the store's customers which may be harmful. Security systems should be considered a last resort unless a store is in a location where shoplifting is high or if the merchandise is particularly susceptible to shoplifting.
Well balanced merchandising strategies also help control theft. Not only is cash flow restrained by over buying, but having excess inventory obstructs views across the store and creates many isolated spots in the store where theft can occur. Of course, a well lit store with lots of mirrors not only aids in merchandising but can also be a theft deterrent. Mirrors, on the other hand, are used by shoplifters to see if they are being observed. Your primary objective is to sell merchandise; theirs is to steal. Your staff may be pros at their job but the shoplifter is a pro at theirs. And by all means make certain your staff knows what to do and what not to do if they observe someone stealing merchandise.
Beyond any doubt, the single best prevention to shoplifting is to provide good customer service. By providing attentive personal service, customers don't have the opportunity to pocket or hide merchandise. An independent retailer's focus on providing good customer service gains him/her a prime competitive advantage and the best weapon in reducing external theft.
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