What Is Retail Shrinkage? Causes, Types and 8 Strategies to Reduce It

Think you’re running a tight ship? Think again. Every retailer, no matter how seasoned, faces the silent threat of inventory shrinkage. It’s the phantom thief that steals profits right from under your nose. 

From shoplifting to administrative errors, shrinkage erodes your bottom line and disrupts operations. Understanding the causes and implementing preventive measures is crucial for protecting your hard-earned revenue. 

In this blog post, we’ll delve into the world of retail shrinkage, equipping you with the knowledge and strategies to combat this pervasive challenge:

• What is retail shrinkage?
• Types of shrinkage
• Causes of retail shrinkage
• 8 strategies to reduce retail shrinkage
• A retail shrinkage case study

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Key takeaways

• What is shrinkage in retail? It’s the loss of inventory between purchase and sale, costing retailers billions annually due to discrepancies between recorded and actual stock.
• Types of shrinkage in retail include shoplifting, employee theft, administrative errors, vendor fraud and damaged/expired goods.
• Shrinkage directly impacts profitability by reducing cash flow, inflating COGS, distorting inventory data, creating operational inefficiencies, affecting pricing and eroding employee morale.
• Understanding what is shrinkage in retail and how it’s calculated ([(Recorded inventory – Actual inventory) / Recorded inventory] * 100) is crucial for identifying its impact.
• Proactive strategies like advanced surveillance, employee training, regular audits, strengthened store policies, anti-theft technology, robust vendor management, fostering accountability and partnering with security (and law enforcement when necessary) are vital to combat shrinkage.

What is retail shrinkage?

Retail shrinkage refers to the loss of inventory that occurs between the point of purchase from a supplier and the point of sale to a customer. In other words, when your inventory data doesn’t match your inventory reality, you’ve probably experienced shrinkage.

These inconsistencies might seem minor, but they can add up to significant profit loss over time. Shrinkage is one of the industry’s most persistent challenges, costing retailers $112.1 billion.

Shrinkage reduces overall profitability and can stem from several factors, including theft, damage, mismanagement or administrative errors.

Many retailers associate shrinkage solely with theft, but it’s often a mix of issues. Employee theft, shoplifting and organized retail crime are significant contributors, but administrative errors, supplier fraud and even product obsolescence also play key roles. 

Another misconception is that shrinkage is unavoidable. While some level of shrinkage is common, proactive measures like regular audits, improved inventory tracking systems and employee training can help mitigate losses.

Understanding and addressing shrinkage is vital for maintaining profitability. By knowing what shrinkage truly is and where it comes from, retailers can develop targeted strategies to minimize it and protect their bottom line.

How is shrinkage calculated?

Shrinkage is determined by comparing recorded inventory to actual inventory. The formula to determine your shrinkage percentage is straightforward:

((Recorded inventory – Actual inventory) / Recorded inventory) * 100

For example, if your inventory system shows 1,000 units but a physical count reveals only 950, your shrinkage rate is 5%.

((1,000 – 950) / 1,000) * 100 = 5%

What is the impact of shrinkage? 

The immediate and most obvious impact of shrinkage is on your profitability. Every item lost to shrinkage is an item you’ve paid for but can’t sell, directly reducing your gross profit margin. 

But the ripple effects extend far beyond this direct loss:

• Reduced cash flow: less product available for sale means less revenue coming in. This can strain your cash flow, making it difficult to cover operational expenses, invest in new inventory or even pay your staff.
• Inflated Costs of Goods Sold (COGS): when inventory goes missing, your COGS percentage effectively increases. This can make your business appear less efficient and less profitable on paper, potentially impacting investor confidence or loan applications.
• Inaccurate inventory data: Shrinkage distorts your inventory records, leading to a cascade of problems. You might reorder products you already have (but can’t find), leading to overstocking and increased holding costs. Conversely, you might under-order popular items, resulting in lost sales and customer dissatisfaction.
• Operational inefficiencies: constantly dealing with missing inventory can divert valuable time and resources away from strategic initiatives. Employees might spend hours searching for lost items, or managers might dedicate significant effort to investigating discrepancies rather than focusing on sales and customer service.
• Impact on pricing and competitiveness: to offset losses from shrinkage, some businesses might be tempted to increase prices. This can make them less competitive in the market, driving customers to rivals who can offer better value.
• Employee morale and trust: high levels of shrinkage, especially due to internal theft, can erode trust within your team. This can lead to a negative work environment and even impact employee retention.

How much is lost to shrinkage annually?

While the concept of shrinkage in retail might seem like an abstract accounting term, its financial impact on businesses worldwide is anything but. It represents a colossal drain on profits, forcing retailers to confront significant losses.

According to the National Retail Federation, inventory shrink cost North American retailers over $112.1 billion in 2023, representing approximately 1.6% of total retail sales. 

A significant portion of these losses can be attributed to various factors, with external theft (including shoplifting and organized retail crime) and employee theft consistently being major contributors. The NRF’s 2023 report indicated that external theft accounted for an average of 36% of total loss, while employee theft was responsible for 29%.

Types of retail shrinkage

Not all shrink is theft—in fact, shrinkage comes from a variety of places. 

Shoplifting

Shoplifting is the classic culprit of retail shrinkage, and while it’s a costly problem, it doesn’t account for as much shrinkage as you might think. In fact, shoplifting only accounts for about a third of shrinkage,

Organized retail crime rings, opportunistic individuals and even seemingly harmless grazing (consuming products in-store without paying) all contribute to this drain on profits. Investing in security measures like surveillance cameras, security tags and attentive staff can help deter shoplifting and minimize losses.

Employee theft

It’s an uncomfortable truth, but sometimes the biggest threat comes from within; internal theft accounts for roughly another third of all types of shrinkage. Employee theft can take many forms, from pocketing cash to stealing merchandise or engaging in fraudulent returns. 

Red flags include discrepancies in cash drawers, unusual inventory adjustments or employees who consistently bypass security procedures. Implementing clear policies, thorough background checks and a culture of accountability can help prevent internal theft.

Administrative errors

We all make mistakes, but in retail, even small errors can add up to significant losses and shouldn’t be missed when you’re working out how to calculate shrinkage for your business. Paperwork mishaps, incorrect pricing or data entry errors in inventory management systems can lead to discrepancies between recorded and actual stock levels. 

Regular audits, staff training and robust inventory management software can help minimize these costly mistakes.

Vendor fraud

While most vendors are trustworthy, some may engage in fraudulent practices that contribute to shrinkage. This can include shorting deliveries, manipulating invoices or even colluding with employees for personal gain. 

Carefully vetting vendors, verifying deliveries against purchase orders and implementing checks and balances in your accounting processes can help prevent vendor fraud.

Damaged or expired goods

Sometimes, shrinkage is simply a matter of products becoming unsellable. Damage during shipping, improper storage or expiration dates can all lead to losses. 

Implementing proper handling procedures, rotating stock effectively and having a clear policy for damaged goods can minimize these losses. 

Causes of retail shrinkage

Lack of security measures

Inadequate security measures, such as poor surveillance systems, limited access control and weak loss prevention protocols, leave retailers vulnerable to theft and errors. Without sufficient cameras or alarm systems, shoplifting or employee theft often goes unnoticed. 

Additionally, unrestricted access to inventory areas makes it easier for stock to go missing. Investing in modern security technologies and implementing strict access controls can significantly reduce shrinkage.

Poor inventory management

Inefficient inventory management systems contribute to shrinkage by creating discrepancies between recorded and actual stock. Issues like untracked deliveries, incorrect stock counts and unrecorded sales result in losses that may go undetected. 

Inadequate employee training

Employees play a crucial role in preventing shrinkage, but without proper training, they may inadvertently contribute to losses. 

For example, mishandling merchandise, failing to follow cash handling procedures or being unaware of loss prevention protocols can result in shrinkage. 

Regular training programs that focus on these areas empower staff to identify and address potential risks, improving overall store security.

Ineffective store policies

Weak or outdated store policies can exacerbate shrinkage. Policies that fail to address inventory checks, security protocols or return procedures leave gaps that thieves and fraudsters can exploit. 

Regularly reviewing and updating policies, such as return rules or bag checks, ensures that the store operates efficiently and minimizes risks.

Customer behavior

Certain consumer behaviors, like return fraud or wardrobing (buying items to use and then returning them), directly contribute to shrinkage. These activities often exploit lenient return policies, resulting in financial losses for retailers. 

Clear return policies, combined with tools like electronic tagging and customer profiling, can help deter fraudulent behavior.

8 strategies to reduce retail shrinkage

1. Implement advanced surveillance systems
2. Employee training and awareness programs
3. Regular inventory audits
4. Strengthen store policies
5. Invest in anti-theft technology
6. Vendor management and verification
7. Create a culture of accountability
8. Partner with law enforcement

1. Implement advanced surveillance systems

As an experienced retailer, you probably know first hand that traditional CCTV has its limitations. 

Upgrade to modern surveillance systems with AI-powered analytics that can detect suspicious behavior, identify high-risk areas and even alert staff in real-time. This proactive approach not only deters theft but also provides valuable data for optimizing store layout and security protocols.

2. Employee training and awareness programs

Your employees are your first line of defense against shrinkage. 

Conduct regular employee training sessions that cover loss prevention strategies, security protocols and how to identify and respond to suspicious activity. Make the training interactive with real-life scenarios and role-playing to reinforce best practices and empower your team to be vigilant.

3. Regular inventory audits

Don’t wait for annual inventory counts to uncover shrinkage. Implement frequent cycle counts to identify discrepancies early on. Use technology like barcode scanners or RFID to expedite the process and minimize disruptions. Analyze audit data to identify trends and pinpoint areas where shrinkage is most prevalent, allowing you to focus your prevention efforts effectively.

Case study: how Goodwill used Lightspeed to combat shrinkage

Goodwill needed a better way to manage its pricing strategy, streamline inventory tracking across all locations and get a modern point of sale that would help their staff feel supported. They had no visibility over inventory shrinkage, and so couldn’t pinpoint any theft or admin errors.

Then they switched to Lightspeed, with better data and easier processes for inventory audits. 

Detailed sales reports and automated processes enabled managers to prevent employee theft far better than before. Within the first day of using Lightspeed, two stores caught long-time employees who had been engaged in theft—a blind spot they’d previously been unaware of.

4. Strengthen store policies

Clearly define and enforce policies related to employee purchases, returns, discounts and cash handling procedures. 

Regularly review and update your policies to address emerging trends and loopholes. Ensure all employees understand and adhere to these policies to create a consistent and secure environment.

5. Invest in anti-theft technology

Explore technology solutions like RFID tags, electronic article surveillance (EAS) systems and advanced POS systems with built-in data and reporting to help identify fraud. These tools can deter theft, track inventory in real-time, and provide alerts for suspicious transactions, helping you stay one step ahead of potential losses.

6. Vendor management and verification

Thoroughly vet new vendors and establish clear expectations for deliveries, invoicing and returns. Implement checks and balances to verify incoming shipments against purchase orders and invoices. Maintain open communication with vendors and address any discrepancies promptly to prevent fraudulent activity.

7. Create a culture of accountability

Foster a workplace culture where transparency and accountability are valued. Encourage employees to report suspicious activity without fear of reprisal. 

Implement a clear code of conduct and communicate the consequences of theft or fraud. Recognize and reward employees who demonstrate integrity and contribute to loss prevention efforts.

8. Partner with security and, if needed, law enforcement

When facing excessive shrinkage in retail from shoplifting, consider investing in robust in-store security. Dedicated in-store security provides constant presence, immediate deterrence and rapid incident response, proving more impactful for daily shrinkage reduction.

Internal security teams can observe patterns, identify offenders and understand vulnerabilities, allowing for tailored, proactive loss prevention. 

While serious organized cases benefit from police rapport, relying solely on external agencies for pervasive shoplifting is reactive. Investing in trained personnel and advanced security technology empowers businesses to directly control assets and significantly reduce shrinkage.

Don’t ignore shrinkage

Retail shrinkage quietly chips away at profits, disrupts operations and creates inefficiencies that impact both short-term and long-term business success. 

By investing in advanced security measures, robust inventory tracking systems and a culture of accountability, retailers can mitigate shrinkage and protect their bottom line. With the right approach, shrinkage can go from being an unavoidable expense to a manageable problem, allowing retailers to focus on growth and customer satisfaction.

Need a POS to help you on that journey? Lightspeed might be the answer. Watch a demo to learn more.

Frequently asked questions about retail shrinkage

How does retail shrinkage impact my business?

Retail shrinkage directly affects your bottom line by reducing the amount of sellable inventory and increasing operational costs. 

Whether caused by theft, administrative errors or fraud, shrinkage eats into your profits and may necessitate higher pricing to offset losses, potentially driving away customers. It can also strain resources by requiring frequent inventory audits, additional security measures and employee training. 

What is the difference between shoplifting and employee theft?

Shoplifting occurs when customers steal merchandise without paying, often concealing items or using distractions to evade detection. Employee theft, on the other hand, involves staff taking inventory, cash or other resources from the business. 

While shoplifting typically happens during store hours, employee theft may occur at any time and often involves insider knowledge of security gaps. Both forms of theft significantly contribute to inventory shrinkage and require targeted prevention strategies.

How can technology help reduce retail shrinkage?

Technology plays a key role in reducing retail shrinkage by improving security and inventory accuracy. 

Surveillance systems and AI-powered cameras can detect suspicious activity in real time, while advanced inventory management software tracks stock levels and flags discrepancies. POS systems with integrated analytics help identify patterns in returns, discounts and sales anomalies, reducing opportunities for fraud. Technologies like RFID and QR codes enable precise inventory tracking, ensuring accountability and minimizing losses.