Unrealized Potential: Missed Sales Opportunities & Profit Protection

Maximizing Operating Budgets: Post-Pandemic & Beyond

The current global pandemic crisis and its associated economic impact is prompting many companies to reduce costs and explore new ways of doing business. A Gartner, Inc. survey of 317 chief financial officers (CFOs) and other finance leaders revealed that due to COVID-19, 62% of respondents are planning some cuts to selling, general and administrative (SG&A) budgets in their organizations this year. As retailers have temporarily closed locations, reduced growth plans, furloughed employees and considered skipping on rent, operating budgets have also been thrown onto the chopping block. As all aspects of spending are being evaluated and operating budgets are expected to reduce by 25-30%, companies are pressured to ensure every dollar spent experiences a return on investment; loss prevention budgets included. While shrinkage contributes substantially to a company’s losses, simply reducing losses through a reactive approach will not survive the new levels of scrutiny in a post-pandemic environment.

What is Profit Protection?

Profit protection comprises a collection of methods and instruments to reduce shrinkage, which contributes substantially to retail losses. To date, much of the loss prevention world has been dominated by a focus on external theft characterized by a reactive security-oriented approach. Many definitions of shrinkage, shortage, or loss of inventory exist, but perhaps the best definition of shrinkage is “intended sales income that was not and cannot be realized” (Beck and Peacock 2009, 28).

In other words, a company did not receive the income originally expected from the goods it purchased. The National Retail Federation (NRF) estimates that retailers suffer $46.8 billion annually in loss due to shrink. These losses take into account the cost of the lost/damaged inventory, but do not take into account the potential impact this loss has on revenue and profit. In order to be successful, companies must not only find ways to reduce losses of goods, but must also seek opportunities to achieve unrealized potential by reducing missed opportunities for sales.

The Underestimated Cost of Losses

While losses themselves have a significant impact on the bottom line, the consequences of losing product that was intended to be sold are further reaching:

Cost of out-of-stock: The extent of global out of stocks has been estimated to affect more than 80% of consumers globally. Shrinkage can cause out-of-stocks when demand for the product is not satisfied. Shoppers cancel or delay the purchase, substitute the product or leave the store when confronted with an out-of-stock.

Every company has expenses which take away from their overall earning potential. Let’s examine the underestimated cost of loss with a company revenue sample size of $100. When a company receives a $100 payment from a customer in exchange for goods or services, only $4.50 is considered to be profit, due to the total operating costs of the organization, which cuts into the overall profit margin. The example below illustrates where money goes for all of the fixed and variable expenses that a company pays for “behind the scenes.”

1. Product is sold totaling $100 in total revenue
2. Gross margin is calculated by subtracting cost of goods
   1. For example, if the organization has a 45% profit margin, $55 goes to pay for the sold product
3. Advertising enticed the shopper to come into the location and buy the product
   1. If the organization spends 10% on advertising, $10 goes to pay for it
4. The shopper came into a store to purchase the product. Property expenses include rent/lease expense, utilities, etc.
   1. If the organization has a 14% property expense, $14 goes to pay the expense
5. The retail store location is supported by a variety of corporate functions and regional managers in IT infrastructure, logistics, human resources, etc. These expenses are considered regional or corporate overhead
   1. If the organization has a 4.5% regional/corporate overhead expense, $4.50 goes to pay for that expense
6. Finally, an associate helped the shopper and processed the transaction. This is another major expense a company incurs known as associate expense
   1. If the organization has a 12% associate expense, $12 goes to pay that expense

The total expense for these major categories totals $95.50 or 95.5% of the $100 revenue, which means this organization makes only $4.50 true profit on every $100 sold. To calculate the potential revenue impact based on shrink, you would take the overall profit model ($4.50 on every $100) to determine how many sales would need to be generated to make up for the total losses caused by shrink.

Imagine that this same retail location experienced $100 in total shrink. Using the example above, it would take the retail location 22.2 sales at $100 each to make $100 in overall profit. This translates to $2,222 in total revenue needed to cover the overall shrink loss. In an organization that has $1b in revenue and $10m in shrink (1% shrink rate), the underestimated cost of loss becomes a staggering $222m in unrealized sales potential.

Building an Effective Profit Protection Program to Reduce Unrealized Sales Potential

An effective profit protection program emphasizes the many and varied components that make up shrinkage, most of which have little or nothing to do with catching thieves. Profit protection professionals must fully understand the various retail processes using the data available in retail to develop solutions that may be more about effective and robust retail procedures than they are about tagging goods and arresting shoplifters. A profit protection approach to loss recognizes that shrinkage is much more than just theft. The fundamentals of a successful profit protection program should include:

Total Company Loss Analysis

Determine total losses/percent to revenue to examine impact to the bottom line and uncover unrealized sales potential and underestimated impact of loss to understand the full consequences of shrink

Shrink Root Cause Analysis

• Establish which part(s) of the organization is impacting losses
• Stores/supply chain/corporate/e-commerce
• Uncover how much of the losses were known vs. unknown
• Determine how much loss was malicious vs. non-malicious

Determine an Informed Strategy

Strategy should be specific and data driven to effectively address the root cause of shrink, based on the above factors. Only once root cause analysis has uncovered what is truly driving total company losses do we develop a strategy to implement based on specific findings. There is no all-in-one strategy that works for every organization

Implement Resources Based on Informed Strategy

The specific type of resource should be determined based on the informed strategy. Consider using the following tools as part of a specific strategy tailored fit to your company’s needs:

Business Performance Improvement:

Deploy profit protection personnel to execute the identified risk measures that hinder business operations and affect the client’s bottom line. This includes process improvements for financial processes, integrating risk considerations into performance management activities, and reducing working capital. Implementing these processes result in improvements to cash flow, control and optimization of costs and risk management

Operational Audits:

On-site auditing programs provide actionable insights into your store’s operations. Use these reports to track trends, improve employee policy compliance and gain a full view into your operation

Predictive Analytics Modeling:

Analysis of historical and current trends provides insight into potential areas of loss throughout the organization, allowing for the implementation of preventive measures, stopping the loss before it starts

Physical Safety & Security Programs:

Creating a safe work environment can help businesses avoid paying out expensive workers’ compensation claims and creates a more efficient and productive workforce

Training & Awareness:

A major cause of losses can be attributed to a lack of training & awareness programs aimed at operational efficiency and theft deterrence

Investigations:

When losses are “unknown” and suspected to be “malicious”, internal and external theft investigations should be utilized to nip the problem in the bud

Conclusion

While the totality of the economic impact caused by the current pandemic crisis is unknown, we know companies will continue to look for ways to increase profitability and growth. In the short term, expect to see a 25-30% reduction in operating budgets. This will create challenges for loss prevention (LP) departments if organizational leadership views their LP team simply as security guards who catch thieves and regard shrink only as a line on the profit and loss statement.

An effective profit protection model views shrink as a resolutely complex and interwoven problem transcending company and departmental boundaries that requires a multi-faceted and coordinated approach to its successful management. The underestimated cost of losses is far greater than simply the loss itself, as other operating expenses are often not included in the equation.

Understanding the full picture will enable companies to view losses as unrealized potential for sales growth, a figure far more significant than the loss itself. This paradigm shift in viewing shrink as unrealized potential, coupled with utilizing a results and data-driven profit protection model to effectively minimize losses, will ensure the full picture of what a profit protection team has to offer every organization.