As retail earnings kick off this week, investors are keeping a close eye on the retail industry to assess the extent to which organized retail crime continues to plague the sector.

Organized retail crime has become a prominent issue in recent earnings seasons, with major retailers like Target Corp. raising concerns. In August, Target's CEO Brian Cornell expressed his dismay over the "unacceptable amount" of retail theft and organized retail crime, highlighting the impact it has on inventory shrinkage.

While theft is a significant factor contributing to retail shrinkage, industry analysts argue that there are other underlying causes. Dylan Carden, an analyst from William Blair, emphasizes that retailers have been facing rising shrink concerns and related margin challenges throughout 2022 and 2023. He explains that the increase in shrinkage during 2022 was primarily due to the normalization of shrink rates following the pandemic. Temporary closures and subsequent restrictions on in-store shopping led to a substantial decrease in shrinkage during that time.

The National Retail Federation's 2023 Retail Security Survey, released in September, reveals that the average shrink rate in fiscal year 2022 rose to 1.6% from 1.4% in fiscal year 2021. When calculated as a percentage of total retail sales in 2022, this shrinkage translates to losses amounting to $112.1 billion, according to the NRF.

Carden predicts that shrink rates will remain high in 2023, coinciding with the growth of organized retail crime. However, he believes there is a disconnect between the expected increase in shrinkage and the attention it receives. Carden suggests that while theft may contribute to elevated shrinkage, companies may also be using this opportunity to divert attention from margin pressure by focusing on higher promotional activities and weaker inventory management in recent quarters. He also suggests that some store closures claimed to be related to shrinkage are actually a result of underperformance at those locations.

For example, Target's recent announcement regarding the closure of nine stores across four states has faced scrutiny due to local crime rates and foot-traffic data.

Overall, as the retail earnings season unfolds, it is crucial to closely monitor the impact of organized retail crime on the sector. While theft plays a significant role in shrinkage, it is important to consider other contributing factors in order to gain a comprehensive understanding of the challenges faced by retailers today.

Unraveling the Puzzle of Retail Shrinkage

In the world of retail, a complex puzzle is emerging that involves crime data, foot traffic, and the phenomenon of shrinkage. While theft is often seen as the main cause of shrinkage, industry experts argue that there are multiple factors at play. Melodie van der Baan, CEO of Max Retail, a company specializing in helping retailers sell excess inventory, emphasizes the importance of understanding what shrinkage truly means.

According to van der Baan, shrinkage goes beyond theft and can be attributed to various elements. One significant factor is stock that cannot be restocked. She highlights the issue of returned merchandise that is damaged or unsuitable for resale, such as undergarments and beauty items. Van der Baan questions whether this unsellable merchandise contributes significantly to the overall rate of shrinkage, emphasizing that theft is not the sole culprit.

The COVID-19 pandemic has also had a profound impact on consumer behavior, which further complicates the picture. Van der Baan notes a rise in the return business, as people seek instant gratification. This shift in behavior adds another layer of complexity to the puzzle.

A recent report by the NRF and Appriss Retail sheds light on the scale of merchandise returns and their financial implications for retailers. The report reveals that for every $1 billion in sales, retailers experience $165 million in returns. Furthermore, retailers lose $10.40 for every $100 worth of accepted merchandise due to return fraud.

Interestingly, the average rate of return has remained relatively steady from 2021 to 2022 at 16.5%. This data underscores the enduring challenge retailers face when it comes to managing returns effectively.

As major retail players gear up to announce their third-quarter results, there is heightened scrutiny on these industry dynamics. Home Depot Inc., Target, Walmart Inc., and BJ's Wholesale Club Holdings Inc. are all in the spotlight, as investors assess their performance and strategy in light of the ongoing shrinkage puzzle.

Conclusion

As the retail landscape evolves, understanding and addressing the complexity of shrinkage becomes increasingly crucial. By recognizing the various factors contributing to shrinkage, retailers can develop strategies to mitigate its impact. The rise of return business and the challenge of dealing with unsellable merchandise highlight the need for innovation and adaptation in the retail sector.

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