Supply Chain News: Inventory Metrics, Part 3: Shrinkage -- Into Thin Air

In the prior installment, we explored inventory accuracy (See Inventory Metrics, Part 2).  Clearly, there are clerical reasons which can cause differences in inventory balances.  These are typically related to transactions not being recorded, being recorded improperly or errors in count or input.  This is especially true in warehouses that use paper transactions versus RF-based transactions. 

A good process of cycle counting/audit/error correction as discussed in the earlier piece will generally highlight and resolve these kind of errors over time.  However, sometimes inventory seems to “disappear into thin air” and the cause is unknown or not readily apparent; this is often classified as “shrink.”  There can be a number of hard-to-track-down causes, but here are a few places to start your investigation.

Bill of Materials - A bill of material error can cause more or less inventory to be consumed.  Errors are easier to catch in the classic work order environment where product is picked for a job and excess stock or short stock transacted against the work order. However, in a process or back-flush environment, the errors may not be easily caught. Including a review of transactions of a first product build as part of your new product introduction process can catch many of these errors.

Unit of Measure- Misunderstanding the unit of measure when performing a transaction can be the cause of inventory errors.  We have all had experience with an order picker picking a case instead of a unit, or vice versa.   A telltale sign of a UPM error is that the error is a multiple of the UOM. 

Receiving – If the receiving department makes a mistake at the time of receiving, and the product is moved into storage or to the point of use, the error becomes hidden.  Errors may be entry errors, such as receiving against the wrong part number or entering the wrong quantity.  Mixed pallets of goods or small parcel receipts are particularly subject to this type of error.  Adding simple checks into the receiving process will help.

Hidden Loss - Few receiving departments count or even audit the supplier stated quantity on documents and packaging.  But suppliers do make errors.  If you track a lot of count errors, usually in small numbers, to a single supplier, it may be wise to add a receiving audit to the process.  

Variation – Many production processes are not consistent in the way they consume material.  For example, a furniture company we worked with cut patterns from leather hides. Depending on the hide and the skill of the person cutting the pattern from the hide, the number of usable pieces varied.  They tried a number of methods to reconcile inventory, but settled on a more frequent inventory count and adjustment. 

Theft - Shrinkage which is due to theft is obviously not going to be reported directly by those involved, and it is also one of the most difficult to detect and verify.  Thankfully, it is not a common occurrence in most companies. 

Unauthorized Use - Removal of stock by unauthorized personnel is not uncommon; perhaps it is a sales person who needs a sample for a customer, or a field service rep that needs spare parts for their truck. Mostly, this is an issue of training and process discipline. 

Spoilage - Perishable goods or other materials with short shelf lives may be removed due to spoilage or past-use date.  As with damaged and shrinkages, these should be properly categorized and tracked.

Damage – Materials that are damaged during storage or processing may not “disappear,” but do cause issues if not reported and transacted off the system.  Every employee needs to understand the process for reporting damage.   

While most missing inventory is usually found to have been reported improperly or placed in the wrong location, inventory which is actually missing costs more than you may think.  $1,000 worth of lost stock for an item with a 6% profit margin will require that you sell $16,667 worth of goods to recoup the lost cost. And that does not even consider the impact to customer service from delayed or cancelled orders.  So, reducing shrink and damage is important.  Whenever you find a count error, the first priority is to correct the system count and to recast to any shortage or even overage the adjustment may cause.  The next priority is to perform a complete investigation into the cause. The time and energy will be worth it. 

Best-in-class companies do manage their losses from shrink and damage better than disadvantaged companies.  Our recent WERC report on warehouse metrics included questions on shrink and damage.

Study respondents reported the following:

In the next installment of my series on Inventory Metrics, we will look at a couple of the generally accepted metrics for determining whether we are setting appropriate stocking levels – Inventory Days of Supply (DSO) and Inventory Turnover.

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