Understanding and Managing Shrinkage

uWhen discussing business matters with my dealer clients, most of the conversations center around finding ways to grow their revenue and increase profit margins. Ideally, we cover both. They’re both worthy objectives, and it’s something clients look to me to help them achieve. But they’re also only part of the puzzle.

As important as growing revenue and gross margin is, it’s equally important to manage your expenses, whether they’re fixed, variable or the worst kind of expense: inventory shrinkage. Shrink is the net difference between the value of your inventory on your books and the value of the inventory that you actually have. While it’s theoretically possible for your inventory to grow past its book value, that’s just a mental exercise. In the real world, your inventory is either bang on or has shrunk.

Shrinkage is a painfully easy way to erase your profitability, which is why it’s so important to control it. If you’ve been around, you’ll have at least a few horror stories to inflict on friends and acquaintances. I’ll share some of mine along the way.

Inventory shrink comes in two forms: Our actual losses of inventory through internal or external theft and soft losses through terrible paperwork.

I’m not going to spend a lot of time on theft, beyond the mention of it. Here at rAVe, most readers work at AV installation companies where external theft is rare. You’re not a retailer so you don’t have the same exposure they do. You have the same security concerns about your warehousing, but that’s about it. Furthermore, if your inventory management processes are solid, the opportunities for internal employee theft is greatly reduced.

The source of most shrinkage is errors in managing inventory, including shipping/receiving errors, and not correctly booking inventory to sales. 

Just for some context on how bad it can be, I briefly worked for a national department store chain. While I was there, in a single year their furniture business had to book shrinkage of $26 million dollars due to improperly booked transfers between stores and regional distribution centers. That was just furniture. Shrink in their major appliances, mattresses and electronics business were bad, too.

In order to tackle shrinkage, there are three important things to implement: 

The first is rigorous inventory management processes, from receiving through to allocation and consumption. Booking inventory in and out of your warehouse, from big-ticket items to small consumables, has to be diligent.

The second is to follow up with regular, smaller cyclical inventory counts monthly or quarterly, in addition to your big annual inventory count for year-end.

Lastly, and most importantly, enact significant bonuses in compensation plans for personnel who are responsible for inventory management. Align their incentives with the company goal of reducing shrink is critical.

At one of my old jobs, I qualified for a quarterly and annual bonus if I kept my store’s shrink to under 1%. They were significant bonuses: Mortgage payment sized. In my time there my shrink never exceeded that. So take it from me incentives work.