A Root-Cause Analysis May Help Reduce Shrinkage

Many retailers may need to rethink their LP strategies in order to effectively reduce shrinkage.

reduce shrinkage

Most retailers have adopted omni-channel strategies to meet consumers’ demand to browse or buy whenever and wherever they choose. But enabling everything from mobile point of sale (POS) to in-store pickup of online purchases has made inventory control and product logistics far more difficult. The complex new retail environment is increasing a variety of risks, including the risks of internal and external theft, paperwork and operational errors, system issues, and vendor fraud.

The retail industry is struggling to manage the emerging risks it faces. As the industry transitions from bricks and mortar to “bricks and clicks,” the capabilities of existing systems are being stretched thin, and many retailers have not fully integrated the new technology required to manage loss and reduce shrinkage effectively in an omni-channel world.

To better understand the current state and emerging challenges of the retail industry, in the summer of 2015 PwC conducted an online survey of loss prevention (LP) professionals within US-based retail organizations, including big-box stores, specialty retailers, department stores, grocery chains, and drug stores. The survey results, highlighted below, suggest a need for many retailers to rethink their LP strategies, organizations, and practices. Among other things, retailers must embrace formal root-cause analysis and the use of data analytics to remain competitive in a dynamic, increasingly risky environment.

The Scope of Shrink and Loss

We asked LP professionals to report on their organizations’ shrink rates over the most recent twelve-month period. Among our survey respondents, the average retail shrink rate was 2 percent, and the average cost shrink rate was 1.2 percent.

LPM 0316 Feature 3 Graphic 1According to our survey respondents, internal and external theft are by far the main sources of shrink, accounting for 36.4 percent and 35.1 percent of the total, respectively. These results represent a significant shift in the industry. In the past, most retailers have reported that internal theft was significantly higher than external theft, due to employees’ access to cash registers, alarms, and inventory.

What accounts for the shift in the sources of shrink? Organized retail crime, facilitated by social networking, is likely the main driver of the relative increase in external theft. The emergence of omni-channel retail, which makes it more necessary to gain an enterprise-wide view of inventory and to accurately handle inventory tracking and management, is more likely the main factor driving internal theft, paperwork and operational errors, and system issues. (Organized retail crime likely also plays a role in driving shrink related to system issues, paperwork and operational errors, and vendor fraud.)

Another surprising finding is the significant percentage of shrink that is due to paperwork and operational errors (17.8 percent) and system issues (6.9 percent). Typically the industry doesn’t break out system issues as a potential root cause of shrink; rather, these issues are integrated into the category of paperwork and operational errors. But in our view, they deserve a separate category because the emergence of omni-channel has made systems themselves a significant issue in loss prevention. System errors are exacerbated by dynamic omni-channel customer fulfillment and reverse flow (returns) logistics.

We believe that the relative amount of shrink attributed to system issues by survey respondents (6.9 percent) is artificially low, the result of confusing operational errors with system errors—including errors that result when transitioning from manual to computerized processes, or integrating new systems as part of implementing an omni-channel strategy.

Identifying and Addressing Root Causes to Reduce Shrinkage

The vast majority of survey respondents (78 percent) use internal experts and historically reliable procedures to identify sources of shrink. More than half (59 percent) have developed a structured root cause analysis protocol that they use consistently, and the same percentage report using data analytics and end-to-end root cause analysis as their primary tool to identify shrink.

When asked how they address the root causes of shrink, the vast majority of respondents (83 percent) said they leverage historical best practices and activities that work consistently. Almost nine in 10 (87 percent) use historical best practices and targeted awareness programs and leverage key indicators of shrink to address root causes and find solutions. Just over two-thirds of respondents (65 percent) said they go one step further, leveraging data trends and predictive analytics to identify the root causes of shrink, and another 16 percent plan to adopt this strategy in the next 18 months.

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Implementing an Effective Root-Cause Analysis

The survey results suggest that retailers understand the importance of using root-cause analysis to identify and manage shrink in a complex retail environment. But in our observation, not all retail organizations conduct thorough, effective root-cause analyses. Doing so requires the following key steps:

  • Use cross-functional teams to develop hypotheses and analyze results.
  • Leverage data analytics and systems-process mapping to test hypotheses.
  • Develop a strategy to reduce shrinkage and corresponding mediation plan based on results.
  • Identify and decompose shrink drivers and quantify their impact over time.

Check out the full article, “Rethinking Loss Prevention and Shrink Management,” which was originally published in 2016, to learn best practices when it comes to collecting and analyzing data to address current LP risks. This excerpt was updated March 9, 2017. 

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