Retailers say organized theft is biting into profits, but internal issues may really be to blame

 Retailers say organized theft is eating into profits, but internal problems may really be to blame

Retailers who have blamed organized theft for lower profits could be exaggerating the impact of crime to cover up internal flaws such as steep discounts and bloated inventories, experts told CNBC.Companies are quick to blame organized theft for reducing losses, but behind closed doors, the parallel issues of employee theft and self-checkout are their primary areas, experts say.

Foot Locker pointed to organized retail crime in part because of slimmer margins in May, when the retailer reported dismal quarterly results.This is the second part of a three-part series on organized retail crime. The stories will explore retailers' claims about how theft is affecting their business and the steps companies and politicians are taking to respond to the problem.

During recent earnings calls, major companies blamed disappointing results or shrinking margins in part on roving groups of organized gangs raiding their shelves. The problem could resurface as the big-box retailer begins reporting second-quarter results next week.

But behind closed doors, retailers face other problems they can better control, including theft by their own employees that contributes to losses, according to two sources who advise large retailers. They spoke on condition of anonymity because they are not authorized to speak publicly about clients.

Many retailers have invested in technology to better understand what's driving the shrinking or gap between a company's inventory and what it sells. Some companies have since identified employee theft as a major contributor to the losses, even as they publicly blame external theft, one of the sources said.

Losses from self-checkout theft have also become a major concern, the people said.While some retailers may experience higher attrition rates due to poor hiring practices and self-checkouts, others, such as Target and Foot Locker, could use retail crime as a crutch to gloss over internal problems, experts told CNBC.

"Shrink has gone up, but sometimes it's very difficult to unpack how much is due to theft and how much is due to internal issues and stumbles by retailers," Neil Saunders, retail analyst and managing director of GlobalData, told CNBC."It's a problem, we know that, it's taking money out of the margins, we know that, but the way it's reported is too opaque and it's partly used as an excuse for poor performance in general," Saunders said.

Theft as an inside job and the curse of the self-checkout

By the time shoppers didn't find deodorants and candy bars locked away in drugstores across America, employee theft had largely diminished, said Patrick Tormey, an adjunct professor at the Lehman College School of Business who has spent more than 40 years in the retail industry. The trend may not have changed much, despite what companies say publicly, according to experts.

"The topic that's coming back the most now is internal theft ... they realize that's where a lot of [losses] come from," said one source who advises retailers. "If it was an exterior theft, they would steal, say, 10 bucks worth of merchandise, but if it was an interior theft, it would be 40 bucks."There is no conclusive data to suggest that employees steal more merchandise than outsiders, but retailers have gotten better at identifying internal theft, the person said.

Retail workers have access to entire boxes of merchandise behind the scenes and it's "relatively easy" to take large amounts of merchandise without anyone noticing, one of the sources said. The theft can also go undetected for a long time because it is not as conspicuous as a shoplifter who is in the public eye, the person said.

Insider theft also occurs in warehouses and aisles where online orders are prepared, one of the people said. In some cases, the worker may know the person receiving the goods and may add more goods to the shipment, one of the people said.

"It's a bit like organized crime, but not mafia style, just a few people [working together]," the person said.Sonia Lapinsky, partner and managing director of AlixPartners' retail practice, told CNBC that retailers have struggled to properly staff stores in the past few years. They can't always find the right workers, and some have also felt pressure to cut staff to control costs, she said.

"People are notoriously multi-tasking these days, and they're just feeling the pressure and having to look everywhere for a job," Lapinsky said. "If it's not something they're necessarily loyal to, or see it as a long-term place, then there's probably a greater risk of theft as well."

David Johnston, vice president of asset protection and retail operations at the National Retail Federation, said employee theft has long been the biggest contributor to shrinking, and employees are sometimes involved in organized theft. However, he believes that internal theft is now "in second place" to external theft.

Retailers have another problem of their own making that can lead to more stolen goods. Automated teller machines also increase the risk of theft and have become a major source of losses, two company advisers told CNBC.Machines come with increased costs. At some stores with high theft rates, the losses outweigh the companies' investments in them, the people said.

"You're creating a problem where there wasn't one," said one of the people.Shrinking References Reach 'Feverish Height'Retailers began to blame organized theft for lower profits as the industry's performance began to suffer.Janine Stichter, a retail analyst and managing director at BTIG, has been covering the retail industry since 2008. In fact, she didn't hear companies talking about their revenue shrinking until a year and a half ago — right around the time the economy started to soften, she said.

"It's really kind of a fever," Stichter said.

Home Depot, Best Buy and Walgreens were among the first retailers to talk about the thefts. A number of companies now say they have cut their margins, some for the first time in years."I think there's a bit of a slowdown right now," GlobalData's Saunders said. "I think one of the things that happens is someone mentions it and then it becomes a bit of a buzzword and then everyone pays attention to it and all of a sudden it starts to get called out."

In May, Target jolted investors when it said it would lose $1 billion this year from inventory losses caused by stolen goods. Two days later, Foot Locker said a "theft-related decrease" contributed to a 4 percentage point decline in gross margin."This has been a multi-year dynamic in the industry. We're not immune to it. It's growing. You've heard Target and others talk about it. And so it has an increased impact on Foot Locker," CEO Mary Dillon said on a call with analysts. "We've seen a significant increase in shoplifting and usually through that lens of organized retail crime."

The message came as Foot Locker reported dismal results for the quarter. It was the first time in more than 14 years that it has called for a cut in its earnings, according to records available on FactSet. The retailer said its merchandise margins fell 2.5 percentage points due to "higher events" and an increase in theft-related declines.

Three analysts who cover Foot Locker told CNBC that the vast majority of that decline likely came from promotions. At the time, the company was struggling with high inventories and weak sales, forcing it to rely on discounts to boost sales.Foot Locker did not respond to repeated questions from CNBC about how much of its margin hit came from promotions and how much was expected to decrease.

Tormey, the Lehman College professor, said retailers throw around the words shrinking and theft so often that investors "chalk it up as a sign of the times," allowing companies to use it as a "crutch" for poor merchandising, warehouses. design and other internal defects."It's just a quick aspirin for a headache, so to speak," Tormey said. "It's much harder to pin down the exact numbers to use, and people just nod their heads, 'Oh, yeah, that's a shame,' without really , did your employees rip you off? shoplifting? Was it seller misconduct "You know, you're a sloppy salesman?"

In the past two decades, Target didn't mention shrinking margins during earnings until August 2022, when the company and other retailers were buried in inventory they had trouble unloading, according to FactSet.At the time, Target's stock rose 36% year-over-year and its profits fell nearly 90% in the quarter ending in July. The company reduced items significantly to eliminate excess merchandise that was no longer in demand.

When Target explained why its gross margin fell nearly 9 percentage points year-over-year, it blamed a higher markdown rate, lower-than-expected discretionary sales and higher churn.The following quarter, when inventories began to decline but were still up 14%, Target mentioned organized retail theft during its earnings call for the first time in its recent history. It said the cuts contributed to a drop in profits of about 50%.

"As previously mentioned, this is an industry-wide problem that is often caused by criminal networks, and we are working with many stakeholders to find an industry-wide solution," Target CFO Michael Fiddelke told analysts. "For example, because stolen goods are often sold online, Target strongly supports legislation to increase accountability and prevent criminals from selling stolen goods through online marketplaces."

While the theft hit Target's bottom line, it is also dealing with high attrition from other parts of its business. Spoiled food from retail grocery aisles and their inventory practices can impact profits.When companies deal with higher-than-usual inventory, more items can be lost or damaged. As Target grows its e-commerce business and pickup and delivery options, there's more room for error as merchandise moves.

"Target is not always the best at managing its own inventory. It tends to have a lot of inventory in stores, it tends to have a supply chain that's very fragmented, and it's very easy for things to be misallocated and misplaced." it was counted on,” Saunders said. "I'm sure there's a lot of things along with their number where Target just lost stuff, broke stuff, put stuff in the wrong stores, put it in the wrong place and couldn't find it."

In response, Target said its clearances vary widely by location and do not correlate with inventory levels. The retailer said he sees a relationship between shrinking levels and stores with higher security and crime, rather than overall store inventory levels.