Shrink
Rap
A rogues’ gallery of characters is costing your
company vital inventory dollars.
dollars It
It’ss time to teach
them a new tune. By Craig Webb
60 / ProSales / March 2012
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L
ike a love that they’ve taken for granted, building
material dealers can be pretty cavalier about their
inventory. No wonder so much of it disappears. The
question is: Why don’t they care?
Shrinkage—the unpleasant shortfall between the
value of the inventory you thought was in stock versus what’s
actually there—is a topic that experts believe too many dealers
ignore, or deny, or dismiss with overly generous benchmarks.
That’s in part because fighting shrinkage requires that a dealer
confront a rogue’s gallery of characters: the thieving employee,
the shoplifting customer, the error-prone record-keeper, and the
reckless forklift driver. Shrinkage mainly is about a company’s
internal failures, and that’s never a happy topic to confront.
But confront it you must. We’re too far away from a housing
recovery for you to count on increased sales to paper over your
troubles, and with banks expected to stick to their miserly ways,
every dollar you can save through shrinkage control is extra money
to increase your cash flow and improve your profit statement.
“Shrink management is a culture,” declares Bill Hayward,
CEO of Hayward Lumber in Monterey, Calif., and a former
ProSales Dealer of the Year. “It takes years to get it in line and a
short period of time for it to get out of line. We take it very seriously because fixing the problem has a long tail, which equals
years of unnecessary loss.”
ILLUSTRATION: DAVID CLARK
What’s the Standard?
Experts and leading dealers differ on how much shrinkage is too
much, but all the numbers for pro-oriented firms tend to be lower
than what a more retail business can expect. According to the
University of Florida’s latest National Retail Security Survey
(NRSS)—generally regarded as the country’s most definitive
research on the subject—reports from 138 retail corporations
turned up an average loss from shrinkage in 2010 equaling 1.49%
of sales. But there’s huge variation by type of business; grocery
chains reported an average 3.12% shrink rate in 2010, while electronics/computer/appliance stores posted just a 0.36% loss rate.
NRSS polled only four companies in what it called the Home
Center/Hardware/Lumber/Garden category, and none were
named. But given the report’s focus on huge retailers (the average
sales for all survey participants was $18.2 billion), one could
assume these were big-box operations. For this group, average
shrinkage was 1.09%.
The overall NRSS rate of 1.49% is the second-lowest since
the survey began two decades ago. The survey’s authors speculate
this might be because companies with higher rates have gone out
of business and thus don’t take part in the polling any more.
However, LBM leaders that ProSales interviewed credit the
recession for what they say has been a decline in building supply
shrinkage. After all, they say, the less inventory you have, the
easier it is to count and the harder it is to lose.
Where your current shrinkage rate stands depends first on
whether you even track it. Paul Bumblauskas, an LBM consultant
who is also an accountant, recalls asking roughly 30 companies at
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roundtables whether they tallied their shrinkage numbers. He was
surprised when only about 15 said they did. Bumblauskas suspects that dealers who never bother to measure shrinkage could
be losing as much as 2% of their annual sales to the problem.
Among those who do, a ProSales sounding of experts suggests the benchmark drops to roughly 0.5% of sales. And for
those who do it well, alarms go off when the rate tops just 0.25%.
At a facility with $5 million in sales, dropping from a 2% shrinkage rate to 0.25% is worth $88,500.
Spotting Troublemakers
Much as you might hate to believe it, close to half of all the
shrinkage you’re seeing at your building supply company is
caused by your workers, according to NRSS results and anecdotal
evidence from LBM experts. In Champaign, Ill., a newspaper
recounted recently how, while revising financial statements for
her late father’s concrete supply company, a daughter found evidence that led to charges that the supply company’s bookkeeper
had been draining $100,000 a year from the firm for nearly a
decade. Bumblauskas recalls a dealer who put security cameras in
his store and then watched his credit manager steal a garden hose.
“The manager said he thought he was entitled given what he was
being paid,” Bumblauskas says.
“Lumberyard executives have high values, and they assume
their employees do too,” the consultant adds. “There are definitely
dealers with good, moral people working for them. So maybe
their shrink is 1.5% instead of 2%.” In other words, even good
companies can have bad shrinkage rates.
Next come burglars. NRSS survey participants identified outsiders as the cause of roughly 31% of all shrinkage. Dealers in
Texas have been particularly plagued by this in recent years. The
Lumbermen’s Association of Texas and Louisiana says that, since
spring 2009, it has tracked 88 incidents in which millions of dollars’ worth of goods were stolen, shingles being the No.1 item
taken.
While many thefts appear to be the work of pure outsiders,
NRSS research finds that roughly one out of every five cases of
internal theft also involves an outside connection.
Often, evil intent has nothing to do with shrinkage. Rather,
it’s a case of poor bookkeeping. The NRSS survey found administrative errors were behind roughly one out of every seven cases
of shrinkage among all retailers, but for the Home Center/
Hardware/Lumber/Garden companies in the poll, it was nearly
one out of five. LBM experts agree this is a particular problem for
dealers, and usually for two reasons: Failure to count and failure
to report.
It’s still common at lots of building supply companies nationwide to take inventory just once annually. That means there’s only
one day a year in which a dealer knows what it has (and hasn’t),
with the usual result being an inability to track down the reasons
for the shortfalls. What’s worse, an annual inventory might turn
up so many problems—each requiring a separate investigation—
that there’s neither time nor desire enough to tackle all of them.
March 2012 / ProSales / 61
Rethinking Shrinkage
62 / ProSales / March 2012
bill, it’s money,” says Larry Adams, president of the Southern
Building Material Association (SBMA). The moral: Count it
before you dump it.
Johan van Tilburg, owner of Knoxville, Tenn.-based Tindell’s,
another former ProSales Dealer of the Year, takes that maxim to
heart on his company’s financial statements by making separate
inventory adjustments based on five different reasons:
– Over/under counting, in which his goal is to have actual
inventories within 0.5% of what’s booked.
– Damaged goods, so he can see how careful the yard crews
are.
– Conversions, in which a product is altered (such as cutting
off the damaged end of a 16-foot stud to make it a 12-footer) and
thus needs to be booked differently, as well as cases where the
wrong goods were shipped so the inventory needs fixing.
– Close-outs, particularly special orders that went bad and
need to be tossed.
– Credits, including returns from the jobsite that the
customer didn’t get credit on but can be sold to someone else.
Van Tilburg also isn’t satisfied just knowing how his overall
inventory value compares with what’s in the computer.
‘All Variances Are Bad’
“If you go for a net number and offset what’s over with what’s
short, then you can potentially get a false sense of security,” he
says. “All variances are bad … 100 2x4s that you are short cannot
be offset by four kitchen cabinets that you are over in physical
inventory, only in dollars. … You should also look at units.
Measuring it this way allows you to determine exactly where your
shrink/gain is—you could be 99.5% accurate company-wide in
dollars but only 94% in units.”
Beyond cycle counts, consultant Jon Davis recommends
bringing
g g back gate guards. Others suggest installing security cameeras. Bum
mblauskas wrote an entire article for ProSales on curbiing emplooyee theft. (See “Practicing Internal Controls,” June/July
22010.) Buut even Bumblauskas recognizes there’s a point at which
s
spending
money on controlling shrinkage isn’t worth it.
Here’’s his formula: Take your current shrinkage rate—and if
yyou don’tt know it, assume it’s 1.5%. Deduct the amount of your
ggoal: say,, 0.5 percentage point. In this example, the answer is 1%.
M
Multiply
that times your sales. For instance, if you take in $5
million inn revenue, 1% of that is $50,000. That’s how much you
m
ccould gaiin from improved shrinkage controls. Now divide that
nnumber bby three. In our case, the answer is nearly $17,000. That’s
hhow manyy dollars’ worth of resources you should consider investiing to reaach your target.
Leonn Huneycutt of Locust Lumber knows a relatively modest
eexpense ccan generate big results. Two years ago, he made a deal
with yardd workers at his facility in Locust, N.C.: Every week,
w
eeach worrker will get a $50 bonus if the worker gets through the
week withhout making a mistake or damaging goods. If the worker
w
makes ann error and it can be tracked back to him, he loses the $50.
m
IIf the worrker makes two mistakes, he not only loses his $50 but a
pportion off everyone else’s bonus also gets deducted.
Honeeycutt says he has noticed a marked reduction in mistakes
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ILLUSTRATIONS: DAVID CLARK
Some dealers might comfort themselves by discovering cases
in which they actually had more inventory than expected, but
that’s a false gift, the experts say. First, if you have more stock on
hand than you thought, it means you bought more than you
needed—and thus are paying finance charges for every day those
materials remain in your yard. Second, having unexpected extra
inventory increases the possibility that the products will get old
and, if they remain unsold, become can“We should all be
didates for the “dog goods” pile.
One of your best ways to fight back
measuring real shrink,
is to start cycle counting. That’s a process
not the difference
in which you periodically count a small
between the reserves
part of your inventory, such as your bestselling or most valuable SKUs. One rule
taken to cover shrink
of thumb is to cycle count fast-moving
and physical inventory items at least monthly and slow-moving
value. Write-ups are
items twice a year. Cycle counting
nice, but they can cover enables you to keep steady track on how
you’re doing and alerts you to problems
up a lot of sins.”
sooner than an annual check.
The “failure to report” problem can
—Paul Hylbert, former
rear
its head in several other ways.
president, ProBuild
Suppose a customer orders 2x4x10s
and your yard crew can’t find them, so it puts 2x4x12s on the
truck instead. If that change doesn’t get put on the books, you’ll
end up on inventory day with a surplus of 10-footers, a shortage
of 12-footers, and a dent in your inventory’s valuation.
Similarly, it’s common for crew members who damage goods
to throw the stuff into a bin without telling anyone it’s no longer
available for sale, experts say. Accidents happen, it’s true, but it’s
better for all concerned if the consequences get recorded. You
can’t manage what you don’t measure.
“You need to teach ppeople
p that a ppiece of sheetrock is a dollar
by the yard crews and driveers. And while
Locust Lumber strives to make this bonus
plan a fun incentive, Huneyycutt notes that
peer pressure helps: “If som
meone makes
too many mistakes, everyboody is going
to be on his case,” he says.
Should you want to dupplicate this,
Huneycutt’s one caution is to
make certain you have a sttrong
yard manager administerinng
it, someone who won’t geet
accused of playing favorittes. “It
takes a fairly unbiased peerson to
oversee it,” Huneycutt says.
Sometimes the invenntory mistakes
aren’t your fault at all but raather are due to
vendor or distributor mistak
akes—or worse.
Respondents to the NRSS suurvey attributed
4% of their losses to vendoor fraud, but the
four respondents in the Home Center/
Hardware/Lumber/Garden category said
vendor fraud accounted foor 7% of their
losses.
Several experts suggestted you counter
vendor fraud by having the receiving crews
check deliveries based on whhat was ordered,
Reckless employees
p y
can create so much havoc that one dealer
not what’s on the shipper’s manifest.
if t
pays each worker a $50 bonus if he can go the week without
The assumption that shrinkage isn’t
much of a problem now because business is
making a mistake or damaging any goods.
slow and inventories are low doesn’t bode
well for those who look forward to busier days. “When times are ers, any cash pickups?” he asks. “Are all tickets signed by yard
good you develop bad habits,” says the SBMA’s Adams. “That’s employees [as per policy] or did somebody load themselves?”
Myron Andersen, president of Builders., a Dealer of the Year
when special orders are done incorrectly, when merchandise is
damaged because our people are like ants on an anthill, running based in Kearney, Neb., differed from NRSS when he said most of
into each other. … Sometimes when we have a pickup in business, his company’s shrink is due to damaged goods, not theft. By that
we get so excited we start getting away from basic things that we measure, he says Builders.’ average shrink over the past five years
should be thinking about all the time. And the truth is, that’s when has been 0.5%. But Andersen also has two people working fulltime just managing inventory, and he sets aside a 0.75% reserve to
we should be spending more time.”
Most experts hope dealers will use this year—a time in which cover differences in inventory valuations. That’s usually enough to
housing starts and thus business is expected to show modest give his balance sheet a boost at the end of Builders.’ fiscal year.
growth—as an opportunity to stick to better practices despite the
Paul Hylbert, the former president of ProBuild and now
speedup as well as get rid of trash on the balance sheet, such as chairman and CEO of Kodiak Building Partners private equity
those dog products that have gone unsold for five years.
fund, sides with Andersen and against Bumblauskas on whether
mistakes cause more shrinkage than theft. He shares van Tilburg’s
How To Investigate
view that no shrink is acceptable. But he also believes one needs
At Tindell’s, van Tilburg always has the wrench out, looking to to avoid putting lipstick on this pig through accounting practices
keep money from dribbling away. “Any shrinkage warrants inves- such as inventory reserves.
tigation,” he says. “Any and all adjustments/write offs have to be
“It’s important not to be lulled into satisfaction because at
investigated and signed off by a manager and then a monthly year end an accounting ‘gain’ is recorded,” he says. “We should
all be measuring real shrink, not the difference between the
review is held with the vice president of operations.”
His store examines shrinkage problems by reviewing all tick- reserves taken to cover shrink and physical inventory value.
ets pertaining to that time period, including cycle counts for the Write-ups are nice, but they can cover up a lot of sins.”
Regardless of how you run things, these experts suggest one
item involved that occurred both before and after the adjustment
was made. Then, if it doesn’t see any clerical errors, van Tilburg thing is certain: Shrinkage is as eternal a struggle as sin. And
starts sniffing out theft. “Who was in the yard—any new custom- when times turn good, the opportunities to stray increase. ■
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March 2012 / ProSales / 63