What is [.blue]inventory shrinkage[.blue] & how to prevent it

Managing inventory is part and parcel of maintaining profitability and competitiveness as an online business. A critical element of this process is accounting for shrinkage.  

Inventory shrinkage can directly hurt your bottom line, hamper customer satisfaction, and undermine operational efficiency. To effectively combat inventory shrinkage, it is important to understand what it is, how it can happen, its importance for eCommerce businesses, and practical steps you can take to prevent it.  

What is inventory shrinkage?

Put simply, inventory shrinkage refers to the unplanned loss of inventory between its recorded quantity and its actual physical count. Usually, it indicates that something has gone wrong within your supply chain and for every piece of inventory that goes unaccounted for, you are not only losing the product itself but the potential profits that come with it (you can’t sell something you don’t have!).

What are the main causes of inventory shrinkage?

Inventory shrinkage can occur for various reasons, with the main ones being:

• Theft – This could be consumer theft from someone coming into your brick-and-mortar store (if you have one) and stealing a product. Sadly, theft can also result from employees stealing from your inventory if they have direct access to it.  

• Admin error – This can include miscounting products, using the wrong units of measurement for your inventory count, or any other human errors that can lead to inadequate record-keeping of stock.

• Supplier fraud or error – Beware that a supplier may be intentionally deceiving your business for personal gain by delivering less inventory than what was ordered or supplying inferior-quality goods.

• Shipping damage – Improperly packaged orders can result in products becoming damaged enroute to your customer, which is why it is vital to have a robust order fulfilment process in place to minimise this risk.  

• Expiration – This encompasses specific products like food and beverages that spoil if not used or purchased before the specified expiration date and, therefore, require disposal. Another way inventory can expire is when it becomes dead stock, such as when certain fashion items go out of style.  

• Operational issues – Inefficient internal processes, poor inventory management practices, lack of stock level visibility, and inaccurate demand forecasting can contribute substantially to inventory shrinkage.

How do I calculate inventory shrinkage?

Whether inventory shrinkage occurs because of theft, admin error, shipping damage or another reason, it is in the best interest of your business to prevent it. This starts by calculating your shrinkage rate, particularly as an accurate calculation can hint at a possible cause. For instance, if your inventory shrinkage is consistently low, a sudden spike is likely to due to an admin error. However, if your shrinkage is often high, it is possible that there is a more concerning cause for it such as theft or operational issues.  

You can use the following formula to calculate your inventory shrinkage rate:

[.blue]Inventory Shrinkage Rate = (Recorded Inventory – Actual Inventory) / Recorded Inventory[.blue]

Let’s say you are a beauty and cosmetics brand with a recorded inventory value of £100,000. Your cost of goods sold (COGS) is £50,000. Your inventory’s accounting value should be £50,000 (£100,000 - £50,000). However, due to shrinkage, your actual inventory value is £80,000.

You can use the inventory shrinkage rate to calculate how much value you have lost:

[.blue]Inventory Shrinkage Rate = (£100,000 – £80,000) / £100,000[.blue]

This equals 0.20, multiplied by 100 to show inventory shrinkage as a percentage. In this case, your inventory shrinkage rate is 20%, meaning you have lost 20% of your inventory value to shrinkage.

Why does inventory shrinkage matter?

Inventory represents one of the biggest expenses for any eCommerce business – it is quite literally money sitting in a warehouse until a customer buys it. Therefore, any inventory shrinkage is a lost sale and directly impacts the accuracy of your financial reports, leading to inflated costs and reduced profitability. Customer retention and brand reputation can also be damaged due to delayed shipments, order cancellations, and backorders that may arise from inventory discrepancies. Furthermore, shrinkage may disrupt your supply chain, causing inefficient order picking and increasing the time required to reconcile inventory. All these factors can ultimately hinder your company’s ability to grow.

How can I prevent inventory shrinkage?

Fortunately, no business need be held hostage to inventory shrinkage. There are several measures you can take to prevent it:

Track inventory using tech

Conducting cyclic counts of your inventory is vital to minimise shrinkage, but it is best practice to use an inventory management system like Zendportal to keep track and monitor your inventory health in real-time, so you always know how much stock you are holding – not to mention take advantage of data-driven demand forecasting tools to optimise inventory replenishment and reduce the likelihood of shrinkage from excess overstock.

Enhance security measures

Protect your inventory by implementing robust security measures, including surveillance equipment, access control systems, and secure storage areas. Don’t forget to check any items that are due for disposal, as this is often used as an opportunity for offending staff to steal inventory. Similarly, avoid using opaque bags and bins that can potentially obscure items from view and encourage the reporting of suspicious activities to deter theft.

Conduct regular audits

If you suspect that staff may be stealing from your inventory, it is often useful to conduct surprise audits to avoid alerting offending staff and giving them a chance to prepare in advance. Regular audits enable you to compare physical stock levels with recorded data, so that you can identify and rectify shrinkage issues quickly, as well as assess the efficacy of your shrinkage reduction efforts.

Train and educate staff

Employee awareness and training play a vital role in shrinkage reduction. Train your team on best practices for inventory handling, security protocols, and accurate record-keeping. Foster a culture of accountability to ensure everyone understands the importance of minimising shrinkage, particularly as it can directly and indirectly affect promotions, wages, profit shares, and more.

Work with a 3PL provider

Partnering with a reputable third-party logistics (3PL) provider like Zendbox could be the key to unlocking shrinkage reduction. The right 3PL will have the expertise and resources to help you cost-effectively manage inventory and ensure you avoid losing any stock and, thus, missing out on sales opportunities. Working with the right 3PL provider can also free up your time to focus on core business operations.

Protect your business from inventory shrinkage

Inventory shrinkage can significantly impact the success of any eCommerce business. By understanding the concept, recognising its importance, and implementing effective strategies to prevent shrinkage, you can minimise the financial, operational and customer satisfaction implications. Proactivity is central to addressing this critical area of inventory management, so you gain better control and visibility over your stock and drive greater profitability for rapid growth.  

Check out our blog hub for more tips on how to optimise your inventory. If you’re looking for a 3PL partner you can trust to streamline your eCommerce fulfilment operations, simply fill out our form to get started.