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As communities and retailers grapple with escalating theft and violence, some continue to falsely suggest that organized retail crime losses are overstated due to a retailer’s reported inventory shrink.
Shrink, or shrinkage, measures inventory loss by comparing a retailer’s book inventory to the physical inventory on hand. Calculated as a percentage to sales, shrink is a metric used by a retailer to understand their current state of inventory loss. However, those who understand shrink know it is not a direct or sole indicator of theft.
Shrink calculation encompasses diverse types of losses, not just theft. While it does include external theft (like shoplifting), employee theft and vendor fraud, shrink also accounts for non-theft-related losses such as administrative errors, damages, expired goods or spoilage.
Usually calculated at the store level, shrink helps retailers identify high-loss locations to further investigate how losses occurred. Also calculated at a corporate level, that number helps gauge loss as part of their profit and loss statements. A shrink percentage, either at an individual store or at the corporate level, does not identify the amount of specific category of loss, including theft.
Various retailers employ different approaches to determine shrinkage, depending on their accounting practices, merchandise mix, and how losses are reported in their profit and loss statements. Some calculate at cost, others at retail. Some include non-theft items like damages or promotional adjustments, while others do not. Inventory counts can occur annually, quarterly or more frequently, leading to different posting times for shrink.
These differences in calculation highlight the unique and complex inventory environments of modern retail. NRF recognized that reporting an average annual inventory shrink percentage was no longer an accurate benchmark for retailers and ceased publishing an industry figure in 2023.
Losses from supply chain theft (cargo theft) and payment fraud (gift card, credit card fraud) typically appear in different sections of a retailer’s P&L statement.
Supply chain theft may be recorded in the cost of goods sold, occurring before items are officially accepted into inventory. Thefts involving credit and gift cards often result in chargebacks or financial losses, which are reported in a different section of a P&L. This means that relying solely on shrink percentage can result in underreporting the true impact of theft and organized retail crime.
Depending on a retailer’s sales volume or inventor mix, high levels of theft can result in a low percentage of shrink. This is known as the “Denominator Effect.” Here are two examples:
Imagine a large retailer selling billions of dollars in low-value, high-volume items. Even if a large quantity of these items is stolen, the dollar loss might be small relative to overall sales, resulting in a low shrink percentage. Conversely, a smaller number of high-value items stolen can significantly impact the dollar value of shrinkage, making the percentage appear much higher.
A retailer with extremely high sales volume could experience substantial dollar amounts of theft, but this amount could be dwarfed by their total sales, leading to a low shrinkage percentage. The percentage masks the actual scale of the problem.
For instance, if two stores each lose $2 million to theft or loss:
A store with $100 million in annual sales would have a 2% shrink rate.
A store with $1 billion in sales would only show a 0.2% shrink rate for the exact same $2 million loss.
The absolute dollar loss remains the same, but the percentage shrinks, potentially leading management to underestimate the problem, even as ORC groups continue to plague the location with repeated thefts and high dollar loss.
In recent years, some retail CEOs have reported stable shrink rates while also noting increases in theft and ORC. This may seem contradictory, but it is not.
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Shrink includes non-theft losses — such as process errors or training gaps — which retailers can often control through operational improvements. These gains can offset rising theft losses, meaning a low shrink rate does not necessarily indicate less theft.
It is important to distinguish between shrink and theft. While shrink is a useful measure of overall inventory loss, it is not a reliable indicator of ORC activity across the industry.
