Inventory shrinkage is a hidden enemy for online retailers. You won’t see it, but it exists in the background, slowly chipping away at your bottom line and causing unexpected stock-outs. In fact, it’s estimated that retail shrink costs businesses as much as $100 billion every financial year—a staggering sum that results in higher prices for everyone.

Many people imagine a busy, unsecured brick-and-mortar store to be a shoplifter’s gold mine—and yet, the majority of inventory shrinkage happens due to factors unrelated to customers. This means that online e-commerce stores must still understand how and why inventory shrinkage happens, or they risk losing stock right under their noses!

Looking to learn more about inventory shrinkage and how you can prevent it? You’ve come to the right place—as this article explains how to calculate inventory shrinkage, identify where it’s coming from, and implement 10 strategies to minimize your revenue loss. 

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What is inventory shrinkage?

So, how can we define inventory shrinkage in the broadest sense of the term?

From a financial perspective, it’s the stock that exists in your company’s accounting records but is actually missing from your current inventory. In other words, your inventory levels have shrunk somewhere in your supply chain—from your deliveries, warehouse, storefront, to your order fulfillment.

Since e-commerce stores don’t have in-person storefronts, it’s slightly easier to narrow down the causes of inventory shrinkage. But that doesn’t undermine the importance of such a role, since minimizing shrinkage is directly tied to your company’s bottom line.

What are the causes of inventory shrinkage?

Knowing what causes inventory shrinkage is key to preventing it. Here are the 5 most common causes of retail shrink:

• Customer theft: According to Gitnux, shoplifting is the most common cause of inventory shrinkage, accounting for 35% of global retail shrinkage. Of course, these figures are likely to be lower for an e-commerce store or dropshipping operation who are using mobile e-commerce software rather than physical locations.

• Employee theft: Sadly, your own employees may also be taking your stock without paying. Whether it’s a pattern of behavior or a one-off opportunistic grab, this accounts for 33% of retail shrinkage.

• Administrative errors: Digital systems are not immune to human mistakes. Simple errors like a cashier not scanning a barcode or an incorrect order entry can lead to discrepancies in stock levels. These mistakes account for roughly 20% of retail inventory shrinkage.

• Vendor fraud: Everyone in retail is looking to make a profit, and some suppliers turn to deceitful means to maximize this. 4% of shrinkage is down to suppliers deliberately sending less stock than what you paid for.

• Lost or damaged goods: The remaining 8% of inventory shrinkage is hard to track, but it’s mostly due to products getting misplaced or damaged in transit or in your warehouse.

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How to calculate inventory shrinkage

Calculating total inventory shrinkage is simple; you just need to work out 2 figures:

• Recorded inventory value: The expected value of your stock, as recorded in your accounting system.

• Actual inventory value: The actual value of your stock, as found out by stock level checks.

To work out the net cost of inventory shrinkage, simply subtract the recorded value from the actual value—the number you’ll get is the money lost to the five factors listed above. Alternatively, if you want to work out retail shrink rates as a percentage over time, follow the calculation method in the image below.

Obviously, this calculation won’t do much to identify the cause of your inventory shrinkage—that requires some extra sleuthing around your supply chain. Follow our 10 strategies below to help work out where your shrink is coming from and crack down on the causes of it.

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10 tips to prevent inventory shrinkage in e-commerce 

Implement an inventory management system

An inventory management system (IMS) is what provides a birds-eye view of your retail operation. Whether you calculate your expected vs actual inventory values in accounting spreadsheets or on a dedicated IMS and point-of-sale platform is up to the scale and budget of your operation.

For greater efficiency, it’s a good idea to integrate your IMS with your HR system—so you’ll know who’s clocked in and handling stock at each stage of the process. A communications tool like a VoIP phone service can help you reach out to warehouse workers or delivery drivers quickly and get to the bottom of unexplained shrinkage before the moment has passed.

Use tracking technology

Technology is what makes your inventory management system tick.

Firstly, you should create an SKU number and QR/barcode sticker for all of your products. Prompt your employees to scan these as they are brought into your warehouse or sent out on delivery. This creates a digital paper trail of where each package was at what time, which increases accountability and makes it easier to check CCTV cameras for any suspicious behavior.

Some businesses also use RFID tags on products and GPS trackers on delivery vehicles to provide geolocation data of where your products are at all times. This would further prevent stock from getting lost or stolen in the supply chain.

Host regular inventory audits

In basic terms, an inventory audit is known as a ‘stock check’. It means going around your warehouse and manually counting how many items you have of each product.

Obviously, this can be a time-consuming exercise, which is another strong reason why you’d adopt barcode scanning tech. Alternatively, you could just make sure your warehouse is organized in an intuitive way—with labels facing outward and similar products next to each other. You may want to do ‘cycle counts’ where portions of your inventory are counted in manageable chunks.

Carry out shipment audits

As well as reviewing your internal warehouse-keeping, another good practice is to carry out stock checks of delivered goods as soon as they arrive.

This helps you spot immediately if your suppliers have under-delivered, which not only helps you get to the bottom of where your goods are going missing, but also strengthens your claim should legal action be necessary. Accusing a vendor of e-commerce fraud because items are missing from a delivery six months ago is not likely to be met with as much credibility, for instance.

Introduce on-site security at your warehouses

It’s not a nice thing to think about, but you must also consider the possibility that your inventory shrink could be down to your staff pocketing products when they’re not being watched.

Now, you can’t just fire an employee for stealing because you have a hunch—employment lawyers would have a field day with wrongful dismissal claims if you tried that. Rather, you’ll need to gather evidence, perhaps by installing CCTV cameras and having a staff calendar to prove who’s on each shift.

To avoid any unauthorized personnel from entering your site, access control systems are pretty much an industry standard. A digital keycard system can be especially useful to see exactly who is entering stock areas and at what time, but if that’s out of your budget a plain old set of keys will do the trick. Beyond this, you could adopt security measures like alarms or overnight guards.

Simply having these systems in place will prove to your staff (and outsiders) that you’re serious about preventing theft on the premises. It would cut down on opportunistic behavior and give you the peace of mind that you’re not getting robbed as you sleep.

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Use ABC inventory analysis

ABC inventory analysis is a term used in inventory management for splitting your stock into high-value, medium-value, and low-value ranges. You could do this based on the monetary value of each product, or the rate at which they appear to be going missing.

The idea is that you should store your more valuable products in more secure locations. For instance, your highest-value items could be held in a locked room with limited access, while your medium-value items are held in the regular warehouse.

Cheap and bulky items, such as bubble wrap or cardboard, are far less likely to be targeted by thieves, and therefore you won’t need to keep these under lock-and-key. They can be stored wherever it's most convenient. 

Train your employees effectively

Your employees operate on the front lines against inventory shrink, so it’s crucial that they know how to deal with it. Train them to identify any suspicious behavior and shut all windows/lock all doors when they’re not in the warehouse. Use communications tools like a PBX phone system to ensure there’s no confusion about day-to-day responsibilities.

You should also consider screening your employees at the hiring stages—conducting background checks to see that they don’t have a history of stealing from their previous employers, for example.

Crack down on fake code promotion

Fake code promotion refers to the manipulation of discount codes to buy products for cheap or free. It’s worth setting alerts on your e-commerce site for any discounts above a certain threshold, so you can manually check their validity.

While we’re on this note, it’s worth calling your promo codes something unique, especially if they’re to be used by just one customer. Generic terms like “FREE10” or “5OFF” are easily guessed and can be abused by people trying to game the system. You could also add those fake coupon sites to your list of denylisted domain names.

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Key takeaways

In conclusion, inventory shrinkage is a threat to any retail operation, whether it’s a brick-and-mortar store or an e-commerce site. The National Retail Security Survey (NRSS) found the industry average to be at about 1.62% shrink for a company’s total inventory—so getting your levels below this may be a good benchmark to shoot for.

To prevent inventory shrinkage in e-commerce specifically, your warehouse is the focal point. Make sure that you invest a solid inventory management system and communications tools, and hire trained staff who know how to follow security protocols and report suspicious behavior.