You just started shipping with a new 3PL a few months ago, but now your goods are disappearing.
Everything was going swimmingly. You’d recently transferred warehouses and your new warehouse team seemed friendly enough. However, all of a sudden, your inventory shows as sold out. Upon some deeper digging, the warehouse did a cycle count and a whopping 5% of your goods are missing or unaccounted for in their warehouse management system.
You hop on the phone with your fulfillment team and they tell you the losses are due to inventory shrinkage.
As a business specializing in warehousing and fulfillment, we’re sorry to tell you that if you consistently see shrinkage rates higher than 1% at your warehouse, something is very wrong.
Retail shrinkage costs businesses almost $60 billion annually in the United States. While a substantial part of that statistic comes from retail theft, there are numerous ways it can happen in your ecommerce warehouse if you aren’t careful. Many of them are largely preventable.
We're going to discuss inventory shrinkage, why it happens, and how you can get your numbers down.
Why Does Inventory Shrinkage Happen?
Inventory shrinkage in warehouses is generally categorized under six main causes:
Theft – If you’ve seen the hit HBO TV show, The Sopranos, you’re probably familiar with the phrase “It fell off the truck.” Theft can occur at any point in the warehousing and fulfillment process where goods are touched by people. Normally, it happens internally by poorly vetted employees, but without a proper security system, you could fall prone to burglary as well.
Items may be stolen from the warehouse directly or during transportation to the
warehouse by a carrier employee. Some internal thieves might be extra savvy and
try to mask their actions as clerical errors.
Clerical errors – Disorganization is the slow killer of many businesses. Mistakes in paperwork, data entry, or mislabeling can all leave you with incorrect stock numbers. An employee meant to do a recount from 201 to 200, but instead typed 20. Now you think you’re almost OOS and accidentally overstock. Or, worse, they meant to do a recount from 200 to 201 and accidentally typed 2001. Now you oversell and have to cancel a bunch of orders, leaving unhappy customers and poor reviews.
Sender errors/fraud – Suppliers may either intentionally or unintentionally engage in short-shipping or sending fewer items than invoiced. You end up paying for items that were never sent. Shopify has a great guide for vendor fraud for more in-depth information.
Now, odds are your 3PL isn’t individually counting every unit you send. So, this is part
of the reason warehouses have a shrinkage allowance. Discrepancies do come up
and it’s not always them to blame, but you do want them to catch it quickly.
Damage – Sometimes, goods literally fall off the truck. You might have to discard inventory to damage during handling, storage, or transport if it has broken or become unsellable due to cosmetic infractions.
Misplacement – This type of shrinkage is often temporary because your inventory may not actually be lost. In this situation, someone may have simply put it in the wrong pallet location. They logged it in the system as moved to pallet B01-01-A, but they actually put it in B10-01-A. Once a picker notices it’s missing weeks or months later, they have to play hide and seek in a sea of corrugate to find it. When you have thousands of pallets all with identical cardboard boxes, it can be almost impossible to find.
Pick errors – If a customer received a red water bottle, but they ordered a blue one, the warehouse count is now off for both red and blue water bottles. If that customer never mentions it, you won’t know the count is off until a cycle count occurs and you’re now down a blue water bottle. If they do let you know, you have to decide whether to return it or let them keep it. Either way, you should let the warehouse know as they’ll need to cycle count to correct the inventory.
We know this sounds scary. No one likes losing inventory. We imagine you’d probably would like to know how to avoid each of these issues. Keep on reading! We’ve got a section on that below.
How to Calculate Inventory Shrinkage
First, you need to know how shrinkage is determined. You can calculate inventory shrinkage pretty quickly by yourself. That is, provided you possess an efficient system for physically counting inventory:
Determine your recorded inventory: This is the amount of inventory that should be available according to your accounting records and warehouse management system (WMS).
Perform a physical inventory count: Get in the warehouse and count out the actual inventory present on site.
Calculate the difference: Subtract the total of the physical inventory count from the recorded inventory to find the discrepancy.
Calculate the shrinkage rate. Use the following formula:
This formula gives you the shrinkage rate as a percentage, indicating how much inventory was lost relative to what was recorded.
How to Limit Shrinkage in the Warehouse
It can be tough to track shrinkage without doing cycle counts regularly. Some inventory issues are easier to spot than others. But some clerical errors may persist for months before being noticed. And even if you’re doing regular cycle counts, that doesn’t prevent shrinkage, it only helps limit the damage.
While some shrinkage is inevitable, there are ways you can keep it to a minimum, starting with identifying a 3PL partner with solid practices that actively combat shrinkage.
Here are things you can look for in a warehouse that can give you some insight into how they limit shrinkage:
For theft – Look for enhanced security measures in the warehouse. Keller Logistics Groups suggests measures such as:
Surveillance cameras
Security personnel
Restricted access zones
For clerical errors – Make sure your provider audits their warehouse counts regularly. Annual cycle counts are not enough, and ad-hoc cycle counts should take place after any pick errors arise. Also, make sure your warehouse is doing as little manual data entry as possible and isn’t skimping on the tech. They should have:
Barcode scanners (this is the industry standard now)
An easy-to-navigate warehouse management system (WMS)
For vendor errors/fraud – If you have very expensive goods, see if your warehouse will individually QA each unit upon receiving them. For most products, the cost would outweigh the benefit, but with items like watches, it can make sense.
For anything else, you may want to request a special project from your warehouse
to randomly count every third box on your first few shipments from a new supplier
to verify there aren’t any major issues. Once you’ve established trust with your
supplier, it shouldn’t be top of your list. Your warehouse should always compare the
physical case/pallet count against the purchase order to make sure you have the
right SKUs and quantities no matter what. If you don’t start with good numbers, you
will have a minefield of issues ready to explode.
On your end, you’ll want to make sure you are properly labelling all inventory and
meeting the 3PL’s receiving guidelines so you limit the chance of a clerical error.
For damages – Your warehouse should have clear goods handling procedures. A walkthrough of their warehouse will help illuminate how they handle product. If goods are all over the place, not properly stored on pallets, and so on, it can quickly become clear how your inventory will be handled.
What is a common or expected shrinkage allowance with a 3PL?
When vetting 3PLs, you’ll want to understand what their shrinkage allowance is, what they’ll cover if they go over that allowance, and what their shrinkage numbers are for the past year. The 3PL can always provide you loaded numbers, but it can be a good litmus test to their integrity. If they tell you zero shrinkage, they are not telling the truth. For a 3PL (third-party logistics) warehouse, you should aim for as close to zero shrinkage as possible.
However, as mentioned, some shrinkage is inevitable. Shrinkage policies can vary slightly depending on the nature of your business, but the industry norm is between 1-3%. To our team at OTW Shipping, we believe anything over 1% is simply not acceptable and strive to keep those numbers well below 1%.
What to Do if Inventory Shrinkage is Too High at Your Warehouse
Outside of supplier issues, if shrinkage is unexpectedly high at your warehouse, you’ll want to obtain compensation and most likely file an inventory insurance claim to at least recoup some of your losses. This is why it is important to understand what the fine print is in your contract around shrinkage before signing.
If there is a one-time issue that the 3PL was able to identify and resolve without too much damage, then as long as they compensate you accordingly, you shouldn’t uproot your entire operation. However, if there seems to be a recurring issue with inventory constantly being off by considerable amounts, the best play would be to switch 3PL providers entirely.
Switch to OTW Shipping for Reduced Shrinkage
If you’re shipping anywhere in the continental US or internationally need a warehouse you can trust, you should give OTW Shipping a try. We use sophisticated software to proactively cycle count quarterly and raise flags for any potential inventory discrepancies before they become an issue, keeping our shrinkage allowance historically well below 1% and avoiding overselling and having to cancel orders.
Most 3PLs treat client relationships like transactions. We designed our business to feel like in-house fulfillment for your business. We want to give your growing ecommerce brand the same service large brands receive every single day!
When you ship with OTW, you get:
99.99% order accuracy
Transparent rates and custom quotes to fit your needs
2-day ground shipping to over 90% of the US
Access to a Slack-like channel where you can chat with our team directly
State-of-the-art warehouse management software
And much more
Interested in a quote? Get your personalized rates now.
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