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There are many terms for inventory shrinkage: warehouse shrinkage, product shrinkage, loss of product. They all amount to the same thing — your merchandise is missing from the warehouse shelves.

For businesses that sell physical things, some amount of shrinkage is unavoidable. At point of sale, stores can experience retail shrinkage from breakage and shoplifting. ECommerce businesses experience inventory shrinkage when items are damaged on warehouse shelves or disappear during shipping or receiving.

It’s important to understand your shrinkage rate because it affects your bottom line. Here’s everything you need to know to calculate and prevent inventory shrinkage.

warehouse inventory

Warehouse shrinkage definition

The best way to explain inventory shrinkage is an example. Let’s say you sent 100 units of one SKU to your fulfillment warehouse. When you look at your inventory, it shows only 95 units. You check whether those units have sold already; they haven’t. Your five units are the victims of warehouse shrinkage.

Inventory shrinkage is recorded when there is a difference between the amount of inventory you had on your accounting books and the physical count of inventory in the warehouse. This may appear as a discrepancy between products recorded as shipped from your manufacturer and what is noted as received in the fulfillment center. Or warehouse shrinkage can occur when inventory is logged in at the receiving dock but isn’t found on the shelves. Often, product shrinkage comes to light when you are physically counting stock.

Most third-party logistics warehouses have a shrinkage allowance in their contracts. The allowance is how much of your inventory can go missing before they have to reimburse you for it. Shrinkage allowances often range between 2% and 10%.

What is inventory shrinkage?

Causes of inventory shrinkage

Warehouse shrinkage happens for a variety of reasons. However, most of them boil down to these three main categories of shrinkage.

Employee Theft

No one likes to think the worst of their employees. But the truth is that people sometimes steal stuff. You can reduce employee theft through careful hiring practices. In addition, security measures such as checking backpacks on the way out of work can reduce this source of product shrinkage.

Lost Shipments

One of the most common reasons for inventory shrinkage is also one of the most challenging to prevent: misplaced goods. A truck backs up to a busy receiving dock. The warehouse crew unloads it quickly to make space for the next shipment. Pallets of goods are moved out of the way to create space on the dock. Most of the products end up on the right shelves, labeled with matching SKUs. One pallet loses its shipping label. Busy warehouse workers move it out of the way, unsure what to do with it. When someone discovers that products are missing, no one knows where they are.

Another type of loss happens when products are placed on the wrong shelf. When a picker goes to fill an order, they don’t find the product at the spot for that SKU. In a large fulfillment warehouse, finding products that are misplaced can be like looking for a needle in a haystack.

There are ways to prevent inventory shrinkage due to loss, but they aren’t easy to implement. More on this in the next section.

Damage

Products can get damaged in shipping, on the loading dock, or during the picking and packing process. Because eCommerce goods pass through many hands on the way to the end customer, damage is likely to be part of your shrinkage factor.

How do you calculate inventory shrinkage?

To understand the cost of shrinkage to your business, you need to understand how to calculate shrinkage. Understanding your shrinkage percentage will help you with inventory management.

Here is an inventory shrinkage formula:

(Inventory recorded – inventory actually on warehouse shelves) / Inventory recorded

Using the example from the last section:

100 units – 95 units = 5 units

5 units/100 units = 5% product shrinkage

Use this shrinkage calculation to track your shrinkage rate over time. Understanding and anticipating lost products is essential for realistic inventory management.

To properly calculate your cost of goods sold, you need to add your shrinkage factor. For example, let’s say the products in the example above cost $10 each to manufacture and ship to your eCommerce fulfillment warehouse. Your shrinkage rate is 5%. Five percent of $10 is $.50. So your actual cost of goods sold is $10.50.

Shrinkage in business can take a bite out of your bottom line. Calculating inventory shrinkage is your first step. Understanding the causes of losses and how to prevent them will boost your profits.

Ways to reduce warehouse shrinkage

Fortunately, business owners don’t have to be held hostage to shrinkage. Here are ways to prevent inventory shrinkage in your own warehouse. If you outsource your fulfillment, make sure your fulfillment company has implemented these and other measures to reduce warehouse shrinkage.

How to prevent inventory shrinkage

Reduce dock-to-stock time

The shrinkage factor isn’t the only reason it’s a good idea to shorten the time it takes to log your shipments into stock. Products sitting on the loading dock aren’t available for sale, so they aren’t making you money. You could even end up with backorders of goods that you have in stock because of receiving delays. Plus, the sooner your products are on the shelves, the less the chance for loss of product.

Receiving inventory

Create checks and double checks for your receiving processes

Create systems to back up your warehouse systems. While one check on inventory can fail, redundant systems with multiple checks as products move into the warehouse will catch many mistakes. 

Improve employee training

Some problems with inventory management stem from lack of training. Make sure all your employees understand your processes and implement them properly. While training time may seem unproductive, it will improve your bottom line if it reduces your shrinkage rate.

Employee training to avoid inventory shrinkage

Create employee incentives

Give your employees a reason to work harder for you. Offer rewards when the shrinkage rate goes down. Incentives are a great way to improve performance.

Mark SKUs clearly

Make sure your SKUs are boldly marked and easy to find, both on the shelves and on the products. This will prevent the loss of product that happens when a stocker puts an item in the wrong spot.

SKU scanner

Set up 24/7 security systems

Strong security systems can prevent theft. Include camera monitoring as part of your system to give you eyes on all areas of the warehouse at all times. Warehouse footage can do more than reveal an employee with sticky fingers. You can also find the moment when a mistake happened. When you understand the root causes of product damage and loss, you can put systems in place to reduce inventory shrinkage.

How your third-party logistics provider can help you prevent inventory shrinkage

The assumption built into the shrinkage factor in third party contracts is that you would damage or lose a certain amount of inventory if you handled your order fulfillment in-house as opposed to in a 3PL process. At Red Stag Fulfillment, we are fulfillment professionals, and we think that means we should be held to a higher standard. That’s why we have a zero shrinkage allowance. If we break or lose an item, we pay you for the wholesale cost.

The best fulfillment services companies will have low or no shrinkage allowances. So, when you outsource your fulfillment operations, you may be able to reduce your shrinkage rate. Placing your order fulfillment in the hands of professionals could actually save you money.

What is product shrinkage costing your business? Talk with your 3PL about ways to prevent inventory shrinkage. Your bottom line will thank you.

Clear SKUs prevent inventory shrinkage