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Rethinking Loss Prevention and Shrink Management

The pace of change in the retail industry has accelerated dramatically over the past few years. The move to online shopping, emergence of mobile retail, and use of social media as part of the “daily fabric of shopping”—three of the disruptive forces highlighted in PwC’s Total Retail 2015: Retailers and the Age of Disruption published in February 2015—are among the factors making it more difficult to prevent, detect, and manage loss and shrink.

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 POS to in-store pickup of online purchases has made inventory management 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 shrink effectively in an omni-channel world.

- Digital Partner -

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.

LPM 0316 Feature 3 Graphic 1The 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.

Sources of Shrink and Loss

According 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 track and manage inventory, 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.

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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 of Shrink

The vast majority of survey respondents (78 percent) use internal experts and historically reliable procedures to identify sources of shrink. More thanLPM 0316 Feature 3 Graphic 2 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.

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:

- Digital Partner -
  • Use cross-functional teams to develop hypotheses and analyze results.
  • Leverage data analytics and systems-process mapping to test hypotheses.
  • Develop a shrink-reduction strategy and corresponding mediation plan based on results.
  • Identify and decompose shrink drivers and quantify their impact over time.
  • Develop dashboards and diagnostic tools to monitor and track root causes of shrink over time.

Collecting and Analyzing Data

In our view, how retailers collect and analyze data is the most important area of our survey. Leveraging data and analytics more effectively is the most critical step that LP professionals can take to address the current and emerging risks they face.

Analyzing data is essential to identifying risks early, when they can be addressed more effectively. For example, one major US retailer was able to reduce shrink by more than 70 percent over six years, from more than $950 million to less than $250 million, by focusing on high-risk stores and leveraging data analytics to identify potential losses and prioritize risks earlier in the risk cycle.

Analytics can also help to optimize scarce resources. For instance, predictive analytics can be used to reallocate LP personnel to stores whose risks are increasing, to proactively address and mitigate the risks before they become a major problem that impacts profitability.

Data Collection. Almost all of the LP professionals we surveyed (93 percent) indicate that their organizations collect key performance indicators (KPIs) and metrics that historically have had the greatest impact on operational excellence. Six in ten (60 percent) collect metrics on a more frequent basis, and they use trend data to determine how to deploy resources—an approach that’s much needed to optimize the use of reduced levels of staff.

Only 24 percent of survey respondents use real-time KPIs with advanced algorithms and predictive indicators programmed to recognize patterns (for example, those related to cash and inventory levels), but 34 percent plan to begin doing so within the next 18 months. The use of real-time KPIs can help retailers to identify and address risks earlier in the risk cycle, mitigating their potential impact.

LPM 0316 Feature 3 Graphic 3Analytical Tools and Resources. Nine in 10 of the LP professionals we surveyed (90 percent) still use a traditional tool—Microsoft Excel (pivot tables and formulas)—to analyze data, and 72 percent use analytics tools such as SAS and SPSS. Only one-third (34 percent) leverage sophisticated business information tools such as Tableau and QlikView to analyze data, although an additional 17 percent indicated they plan to adopt such tools in the next 18 months. And less than half of respondents (48 percent) use LP technology dynamically across the organization to define, detect, predict, and prevent shrink, although another 38 percent plan to begin doing so in the next 18 months. This result indicates that retailers are waking up to the need for rapid prediction and detection of shrink in a dynamic omni-channel environment.

Retailers that are ahead of the curve, using sophisticated, dynamic tools to manage loss and shrink, have an opportunity to leap ahead of competitors that continue to use traditional approaches to data analysis. That said, even the most sophisticated analytical tools will not be effective without the knowledge and resources required to understand the tools and utilize them effectively to perform sophisticated analytics. This is a lesson that some retailers have learned the hard way as they failed to realize the benefits of the powerful tools they purchased.

LPM 0316 Feature 3 Graphic 4

An Expanding LP Mandate

As the roster of retail risks has expanded, so has the mandate of LP professionals. Large percentages of survey respondents report that their LP organizations are involved in mitigating risks and losses for a variety of areas, including areas not typically addressed by LP professionals, such as supply chain (74 percent) and business continuity planning (81 percent).

The results of PwC’s retail industry survey highlight the need for retailers to reassess their LP strategies and capabilities to ensure they can remain competitive, much less move ahead. As we have discussed, retailers must deploy effective root-cause analyses and leverage data analytics and technology tools to identify and manage shrink and loss and to deploy scarce resources effectively in a complex, dynamic environment.

To better manage loss and shrink, many organizations are building advanced data analytics and other LP capabilities in-house or leveraging external organizations to augment their internal resources. Whatever approach they choose, retailers that recognize and address the evolving risks and challenges of the new retail environment will be better positioned for success.

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