Issue: Over-Aggressive Retail Efforts to Avoid Shrinkage are Bad Branding and Worse Business
Commentary by: David Vinjamuri

Somewhere in Eddie Lampert’s offices in Greenwich, Connecticut (or possibly in the Sear/Kmart corporate offices in Illinois), a financial analyst has been hard at work figuring out the most efficient way to eliminate shrinkage. Shrinkage combines employee theft with consumer theft, and includes tag-switching and other scams which cost the retailer revenue. At Kmart and other retailers around the country, harsh anti-shrinkage measures have made a very small dent in the actual amount of shrinkage in stores (it only barely declined from 1.59% of total retail sales in 2005 to 1.57% last year), while increasingly alienating consumers and hurting their own brands. But the gross numbers ($40.5 billion of shrinkage last year) command attention and attract cost cutters like pie attracts ants at a picnic.

Efforts to improve the bottom line (revenue) by focusing on the middle line (cost) at the expense of the top-line (sales) are very typical in companies and industries controlled by managers whose primary training is in finance and accounting. Public companies, whose ability to raise capital may be dependent on the stock market (and thus dependent on the opinions of often brand-illiterate stock analysts) are very likely to pursue many middle-line business strategies with dubious medium to longterm value to the enterprise. Ask any corporate veteran who has survived a few rounds of layoffs about the experience and he will tell you that employment levels almost always return to the pre-layoff level in a year or two. In the meantime, morale and productivity usually decline, the best workers head for other companies and the most seasoned employees opt for early retirement. In the past few years, as more companies come under the sway of private equity, and thus the control of financial analysts, these various middle-line strategies have multiplied.

A Wall Street Journal article by Laura Landro today illustrates the very real danger for brands that pursue cost reduction while ignoring the damaging efforts on consumers. Shrinkage is difficult to combat because the perpetrators live little evidence. Only by catching someone who has just purchased items after switching or repricing the tags or who has just left the store can retailers stop the theft. Catching outright shoplifters caught on video only reveals the tip of the iceburg - for a store to get to the more common and higher value crimes it has to look for people switching tags or boxes.

The problem with this type of enforcement is that it requires behavioral targeting and - just like those security checks on last-minute ticket buyers at the airport - ends up netting innocents along with real criminals. Ms. Landro was one of those caught when she was unable to find a box for the flip-flops she was purchasing. When she grabbed a nearby box with the wrong items inside (children’s shoes) and assumed it was the correct box for the flip-flops and then proceeded to the register, she unwittingly became a victim of Kmart’s aggressive enforcement policies. She was detained by a security guard, questioned harshly and banned from the store. She was told she would be fined and her credit card and driver’s license were temporarily seized.

Most interestingly, from a branding point of view, nobody at Kmart apologized to Ms. Landro at any moment, even after learning that she was a journalist. In fact, the chain maintains it has ‘done the right thing’ - meaning that it did not break the law. Not breaking the law when dealing with a loyal brand user might be called ground zero for brand practices.

What did Kmart get for its zealous anti-shrinkage efforts? It may recover the $8 or so that Laura Landro deprived them of when she walked out the door. But even a short term valuation on this transaction reveals that Kmart made a mistake. Laura Landro purchased over $800 at the store that day. Even at Kmart’s anemic margins, the store will lose more that it has gained if she skips just one repeated shopping trip than if she had walked away unmolested. Unsurprisingly, Ms. Landro has vowed never to return to Kmart.

As Ms. Landro was a Wall Street journal feature writer, the damage to Kmart goes well beyond her isolated incident. Her story will be read by thousands of Journal subscribers, not just potential customers but bankers, suppliers and others who Mr. Lampert depends on for the livelihood of his business at Kmart. It is very difficult to calculate the damage that a simple act of overaggressive policing on Kmart’s part may have caused. It is impossible to calculate the cumulative damage to brand equity that thousands of these incidents a year cause to Kmart and other retailers.

Ms. Landro is not the typical consumer and it is true that most of Kmart’s actions may prevent real and intentional theft. But the value to the brand of such enforcement past the obvious is dubious, and the cost is potentially huge. The culprit is this middle line thinking. And it is pervasive in the retail sector. Consumers owe the worst packaging in the world to middle-line thinking - the hard plastic containers that encase high price items in supermarkets and electronics stores. Why are these items so hard to open? So that thieves will find it harder to remove security devices from them. To stop this type of pilferage, even respectable chains like Best Buy and Circuit City routinely injure their own loyal customers (this packaging is difficult to open even with good scissors, and often results in cuts for the consumer). They never stop to consider the added revenue they might realize from being known for easy returns, great packaging and unsuspicious customer service.

Kmart may rightly say that its shrinkage prevention policies prevent millions of dollars in losses to the company. Yet the enduring damage to the brand done to Kmart by enraged customers like Laura Landro costs tens of millions in lost sales. Some retailers know better. Nordstrom long ago realized that a looser approach to returns (another area commonly used to defraud retailers with mis-returns) netted them positive ROI as customers were more willing to risk larger purchases and might even purchase again when making a return. Indeed, Nordstrom has accepted tires for refund, even though the chain has never sold them.

The lesson here is that incomplete analysis can be worse that common sense or gut-level instincts. Chains can quantify the cost of shrinkage, but they cannot easily quantify the cost of apprehending customers who have unintentionally cheated the company for small amounts of money. Or even completely innocent customers who merely engage in some behavior that looks suspicious to the retailer. So these retailers choose to minimize the costs they can measure. In doing so, they ignore common sense (would any mom-and-pop shop have detained a customer over an $8 mistake on an $800 purchase?). It is bad branding and bad business.