The art and science of reducing retail shrink

| Podcast

It’s been in the news in recent months, and it’s a complex and multifaceted topic: retail shrink is not, as some people might think, synonymous with theft. On this episode of the McKinsey on Consumer and Retail podcast, hosted by Monica Toriello, two retail experts discuss shrink—not just as a problem for retailers to solve, but as an opportunity to improve both the bottom line and customer experience. The following is an edited transcript of the conversation. Subscribe to the podcast.

Monica Toriello: Hi, everyone. We’re back with one more episode before 2023 comes to a close. Our topic today is a timely and important one for retailers: retail shrink or, as it’s also known, shrinkage. It’s an issue that has a significant impact on retailers’ bottom lines. In 2022, US retailers lost more than $110 billion from shrink, according to the National Retail Federation (NRF)—and, of course, shrink is a problem not just in the US market but globally as well. Here with us today to discuss retail shrink—and some of the solutions for addressing it—are two people who have worked alongside many retailers on this problem.

Mark Ibbotson has been a McKinsey senior adviser for the past two years. Prior to that, he spent seven years at Walmart, most recently as the executive vice president in charge of central operations and real estate. In that role, Mark’s responsibilities included innovation, process improvement, and asset protection and safety. Before joining Walmart, he was COO at Asda.

Bill Mutell is a McKinsey partner based in Atlanta. Bill has advised grocers, drugstore retailers, restaurant chains, and other types of retail companies on a range of sales and operations topics. He has also cowritten a number of articles on store operations, including an article on shrink.

Bill and Mark, thanks for joining us today. Let’s start by defining terms. Some people think of retail shrink or shrinkage as synonymous with theft and shoplifting. But “shrink” is a much broader term, right? Define retail shrink for us: What does it encompass? And how do retailers measure it?

Bill Mutell: Theft is, as you mentioned, one part of shrink. But another part of shrink, as some retailers define it, is waste and spoilage—so when things go bad because you’ve ordered too much or because the traffic hasn’t met the demand levels you were expecting.

One of the first things we do when we sit down with retailers around the world is simply ask the question that you just did: “How do you define shrink within your company?” What we find is that the definition varies quite a bit. Some retailers, for example, include things like markdowns. Another piece of this is called “paper shrink,” which is the difference between what your book inventory says you have and what you actually have. That can come from a lot of different places: variances in suppliers, variances in weights and measures of things as they come through the retail channel, variances in how products are sold. So we often find that retailers don’t have a consistent definition of shrink, which is why there’s a lot of confusion and skepticism in the industry when retailers point to shrink as one of the reasons for missing their bottom-line targets.

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Mark Ibbotson: There is total retail loss: “What’s the difference between what I expect and what I get?” Everything that Bill just mentioned is in that number. For me, the definition of shrink is unknown loss: “I don’t know where I lost it.” Waste and markdowns are known loss: “I know what happened.” But some retailers define shrink as both unknown and known loss. This is where, as Bill points out, people become skeptical and the issue becomes misunderstood. There are some big numbers out there. First off, setting a standard would be a very positive thing: how we measure and quantify shrink.

Theft is a big part of shrink. The rule of thumb, traditionally, was that 50 percent of your shrink number—your unknown loss—was theft and 50 percent was process errors, book stock errors, price change errors. That balance, after COVID-19, is probably closer to 60-40 now, but to blame just theft is probably a little bit simplistic. It’s a nebulous problem: it’s in the store, it’s in the supply chain, it’s in e-commerce, and it’s in the corporate office. You have to look at those four big buckets and then, from there, define your strategy.

‘All stores are not created equal’

Monica Toriello: The NRF says that just over a third—36 percent—of US retail shrink in 2022 was due to external theft, whether that’s shoplifting or organized retail crime. Some of the measures that retailers have taken to address this issue are very visible, right? In some drugstores, if you want deodorant or razor blades, you have to ask an employee to unlock the display case for you. Some stores are increasing security staff. Some have gotten rid of self-checkout. What are you seeing that’s working? What are some of the effective solutions that retailers are implementing to combat theft?

Mark Ibbotson: All stores are not created equal. You need to rate your stores for risk: there are tougher places to trade in and there are easier places. The first task is to understand where you trade and what you trade, then you build up a security and risk rating for those products and stores. And the first thing you do is harden the target. For tough stores in tough areas, you think about security, cameras, lighting; you think about the store environment; you think about gates. For me, the last option is locking it up, because once you lock it up, you tend to put a lot of friction in the sale.

The overall environment in which you are trading should reflect your strategy for shrink and theft, and you should build your whole approach on a store-by-store basis. At the same time, there are other strategies that you can employ to mitigate other areas. So you then get down to, “If I minimize my process errors and my markdowns, then hopefully I’ll have a bigger bucket to work with in that solid security space.”

Bill Mutell: There’s another side to this as well: how the leadership in the store and in the field is given incentives. What really moves the needle for them oftentimes is an unspoken and implicit lever that retailers haven’t explored thoroughly. At many retailers, sales are obviously a big part of someone’s scorecard and how people are evaluated and what people work toward. But bottom-line measures, as well as making some of them explicit, are another way to think about adjusting or changing behavior in the store in a systemic way.

Mark Ibbotson: You can achieve a quick win by getting your people—your merchants, your DC [distribution center] staff, your store security teams—to understand the levers they can pull to influence these numbers. We’ve got inflation, albeit it is cooling. Whether inflation is causing shrink or causing people to steal more is an interesting factor. Understanding this problem is a big deal, and I would encourage anybody to spend more time in training and in understanding shrink so they can start moving some of the bigger buckets quickly.

Bill Mutell: Monica, you mentioned a statistic from NRF that suggested that about 36 percent of total shrinkage might be external theft, and Mark had mentioned a number that was around 60-40. Those two statistics actually tend to agree with each other, because the other piece of Mark’s 60 percent is something we haven’t spoken about, which is employee theft. That’s often an area that’s overlooked at many retailers.

A new ‘golden age’ of customer experience

Monica Toriello: You’re right: about 29 percent of shrink in 2022, according to the NRF, was employee theft. You’ve both talked about reducing shrink by offering incentives and training people differently. Say more about that. What types of incentives are retailers introducing? How are they changing their training programs?

Bill Mutell: I’ll start with an example from a retailer outside the US. One of the things they do is set scorecards and incentives for all employees in the store. A lot of retailers offer some form of employee discount. But when you take a topic like shrink—which really involves the decisions and the vigilance of everyone in the store—and you make it one of the scorecard metrics for the store, that presents an opportunity for everyone to be involved. And it presents an opportunity, as the shrink numbers get better, to reinforce or move the target in order to continually improve. Stores that perform better might receive a better discount.

What gets us really excited about this topic is that we could be entering a new golden age, or a renaissance, from a customer experience standpoint and a store associate standpoint. If we think about what processes need to be reset, which ones need to be revisited, where the opportunities are for digitization, and what incentives are involved, we could be looking at a new set of standards and a new opportunity for many retailers to get back to some of the best practices that they’ve long prided themselves on but haven’t necessarily been able to fulfill for one reason or another.

Mark Ibbotson: Bill and I talk a lot about this. We see the opportunity for technology to liberate store associates to serve and sell. What are AI and technology not going to do? They’re not going to encourage humanity: that point of good service, that “please” and “thank you,” that demonstration of a product, and so on. Bill, those are great words: this could indeed herald a golden age when, as this vacuum is created by digitization and technology, we retrain people on service and sales. It’s an exciting prospect.

Monica Toriello: Let’s talk a bit about technology and then we’ll talk some more about people. Stores have implemented many kinds of new technology, both to become more efficient and to improve the customer experience. Sometimes those two objectives turn out to be at odds with each other; self-checkout might be one example. What are some of the most promising technologies you’ve seen for reducing retail shrink?

Mark Ibbotson: Self-checkout is interesting. It’s been around a long, long time. An elegant, friction-free self-checkout can be as quick as anything and is embraced across the world. What you have to do is make sure that it’s managed properly. Someone should man it; I like to think of that person as a “host” rather than a “cashier.” They’re the host of that area, and their job is to provide service. A lot of retailers will tell you that in a self-serve supermarket, for example, that host might be the only interaction a customer has had that day.

So you’ve got to make sure that these are well-trained, service-oriented people who are embracing the opportunity to talk and interact with people. And they need to be fully trained on de-escalation if things become a little bit tetchy, a little bit awkward. Self-checkout has been around for a long time, but you should always offer an alternative.

You asked about technology. There are some very elegant solutions that involve self-checkout, such as smart gates that will let you out of the area once you’ve paid. We see a lot of that in Europe at the moment, where you pay and you’re given a QR code that then lets you exit the area. It’s not right for every store in your portfolio, but it might be right for some.

There are smart cameras that look for any unusual behavior or malicious intent: if a customer skip-scans or doesn’t scan items, the checkout shuts down immediately and pings a message to the self-checkout host, who is trained to say, “Ah, you’ve made a mistake,” or, “You might want to think about rescanning that for payment.” I’ve seen a big US grocer deploy that, and it actually saw an increase in sales because there were a lot of genuine mistakes whereby people missed scanning something. And if somebody is being dishonest, they quickly learn that this store has deployed a piece of technology that will make it difficult to steal, and they generally choose not to try that again.

Again, not all solutions are right for all stores, but those are some good examples. But I would say the best and most secure way is to make sure your self-checkout area is manned with well-trained people who know how to make an intervention and are trained on de-escalation of any tensions that might occur.

Marrying art with science

Monica Toriello: Are there common mistakes you see retailers making as they try to battle shrink? Are there things that retailers should systematically be doing that they’re just not doing?

Bill Mutell: One of the more common mistakes we see is that people think they’re doing everything perfectly already. When we sit down with retailers and ask questions about process compliance or, “Have you thought about this or that?” the answer is, more often than not, “We’re doing that already, and we feel like we’re doing that well.” Shrink is a topic wherein there’s a lot more room, frankly, to be self-aware about where you’re performing well and where you’re not. The more realistic you are with yourself about that up front, the easier it will be to address these things and move the needle.

Mark Ibbotson: At some point, you’ve got to admit you have a problem. There will be stores in tough areas doing a fantastic job: How are they doing it? What’s their approach? Then you start to take action. Start working on the big areas: the accurate recording of waste, and solid discipline in your markdown process, in your process for making price changes, and in the way you monitor your book stock. Where are the big problem areas? That’s where you start. It sounds so obvious, but quite often you are frozen by the enormity of this issue. We can give you direction—based on data, based on fact, based on experience—for where to start.

Bill Mutell: We’ve talked quite a bit about the art: good merchandising and good execution in stores. But there’s a science element to this as well, and what you really want to do is marry the two together. When we’re working with retailers, what we’ll often do, before we even put a team on the ground, is begin stitching together disparate sources of information. That means building a repository of data and processes, collected through interviews and things like that, so that we have a good idea of how goods flow through the retailer. When you do that and you marry it with best practices and the ability to prioritize based on the data and the business case, that’s often the best way to start. The idea is that you measure and track it so that you’re not simply squeezing a balloon and pushing the problem to somewhere else in the value chain.

There’s a decent amount of listening that needs to come with this. Often, clients are very proud of the processes and the standards that make their stores unique. The goal of any diagnostic or performance improvement isn’t to eliminate those things and to standardize them across retailers; rather, it’s to celebrate those things and think about what other changes can be made to amplify those benefits for the customer or for the associate.

A CEO-level opportunity

Monica Toriello: You’ve both alluded to the need for cross-functional collaboration. What’s the ideal team configuration, if there is one, for fighting shrink? And how is it different from how retailers have traditionally attacked the issue?

Bill Mutell: It’s natural for retailers to think of this as a store-operations-centered problem. But the best retailers inherently look at shrink cross-functionally. Therefore, it’s best moderated by someone who’s relatively objective on this issue. At a lot of retailers, a great function for this responsibility is finance. The finance function is doing some of the measuring, but they’re not necessarily the ones who have to execute many of the major actions. When finance—or an organization or function like finance, or a transformation office—is leading this, it often facilitates a lot more “group therapy” or cross-collaboration between people to get things done. Mark, I’m curious what you might say about it.

Mark Ibbotson: I’m an operator, but I’m open to any function leading. You have one leader, whom I’d suggest should report straight to the COO or, better still, the CEO. The team—whether that’s virtual or line—must include, as you said, someone from the finance team, merchandising, operations, logistics. It should be a cross-functional team that’s led by operations—that’s my personal preference. Operators tend to have the thick skin that’s needed for this.

Monica Toriello: What advice would you give to a CEO who asks you, “What is the single most important thing my company should do right now to reduce shrink?”

Bill Mutell: If a CEO asked me that question, I would ask them the following question: “What is the customer experience and customer value proposition that you are trying to consistently deploy in all of your retail environments?” And then I would ask them to think about how to address shrink in service of that answer. It’s easy to lose sight of what makes you unique or what experience you’re trying to deliver as a retailer. The mandate that we’re hearing a lot is an “and” mandate: “we need to provide a great customer experience and profitable, sustainable growth.” I would suggest that CEOs pursue an “and” approach and think about shrink in the context of the customer experience they’re trying to deliver.

Mark Ibbotson: Personally, I would raise the profile inside the company. I would assess the strategy and the team in place, and I would give them the right resources and the right air cover to really tackle this issue. That requires the CEO to create an environment in which shrink is seen as a cross-functional opportunity. The higher the profile of the team you have in place, the better served you’ll be in the battle against shrink. Ensure that your team is meeting regularly and cross-functionally to tackle these issues.

If you look at the size of this problem, it’s probably the last “free money” on the table. It’s tough, but you can make a big difference in your bottom line, because any improvement in shrink will drop immediately to the bottom line.

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