Fraud in Retail
August 2013
Fraud in Retail Retail Fraud – An overview Retail fraud has become a big concern for retailers recently, especially at a time when the global economy is facing the heat of recession and consumer spending behavior has been frugal. Retail fraud, often referred to as retail shrinkage or organized retail crime, and has added to difficulties of bleeding retailers who are already struggling to expand their top-line crimped by the economic recession. In general, retail fraud involves large-scale retail theft and fraudulent activity done with a motivation to obtain merchandise, cargo, cash and cash equivalent. Today, retail fraud is considered as the number one cause of profit loss in the retail industry worldwide, and has become difficult to mitigate due to the variety of ways in which it can originate. Retailers face a two-fold threat, from ‘shrinkage’– theft of goods by both customers and employee – on the one side, to the broad spectrum of economic crimes such as accounting fraud, corruption and bribery, and intellectual property infringement on the other.
Market size According to the Global Retail Theft Barometer (GRTB) 2011 study, retail fraud was estimated at USD119.1Bn globally in 2011, which represented about 1.45% of the total global retail sales. The developed markets of Europe and North America were the highest contributors towards the retail fraud loss, with USD48.6Bn and USD45.3Bn, respectively. Asia-Pacific contributed USD18.3Bn, followed by Latin America with USD6.1Bn, towards the global retail fraud loss in 2011. The fraud loss for the Middle East/Africa was minimal at USD0.8Bn. The GRTB 2011 retail fraud estimates saw the highest ever year-on-year (y-o-y) increase of 6.6%. Again, Europe and North America hosted the highest growth y-o-y, with 7.8% and 6%, respectively. Figure 1 below illustrates the market size and growth of retail fraud globally. Figure 1
Source: Global Retail Theft Barometer
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According to a survey conducted by National Retail Federation (NRF), retail fraud is estimated to have increased further in 2012. The NRF survey reveals that 96.0% of the retailers (US-based) have reported being victims of retail fraud during 2011-12, up from 94.5% during 2010-11. Additionally, around 66.1% of the retailers have seen an increase in retail fraud over the same time frame, up slightly from 64.1% in the previous year.
Sources of Retail Fraud Though retail fraud has multiple faces, the industry sources have put them in four different categories, namely – customer theft (shoplifters), employee theft, internal error and supplier or vendor fraud. Customer theft is the primary source that contributes the most toward the overall retail fraud globally. In 2011, customer theft, including shoplifting and organized retail crime, was estimated to have caused losses worth USD51.5Bn, hence representing the biggest chunk of 43.2% of total retail fraud. It was followed by employee theft, which contributes losses worth USD41.7Bn (35.0% of total retail fraud) to retailers globally. On the other hand, losses incurred due to internal error including mispricing, invoicing errors and administrative failure cost retailers USD19.4Bn in losses, representing 16.3% of total retail fraud. Figure 2
Source: Global Retail Theft Barometer
Highly Targeted Product Categories in Retail Fraud Retail fraud involves theft of various product categories but research shows that only CRAVED (Concealable, Removable, Available, Valuable, Enjoyable and Disposable) items are more often targeted during theft as they are high in demand and can be easily removed from stores to convert into cash and other valuables. Theft of such product categories is also dependent on the place (the retail format) where the offense is being executed. For instance, individual or
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groups target department and specialty stores specifically for items like designer clothing, handbags, lingerie and accessories. Thefts in a grocery and drug store are generally done to quickly grab infant formula, over-the-counter drugs, razor blades and other high-end health and beauty products. On the other hand, at the retail format like electronics and general merchandise stores, products targeted range from batteries to the latest gadgets like smartphones, tablets, cameras and MP3 players. Moreover, targeted products in retail fraud are also dependent on desirability. For instance, hot consumable products like cigarettes and alcohol are popular among thieves. Desirability of some products is also based on their current popularity (such as new movies, video games and music titles) or on their use in drug manufacturing activities (such as ephedrine-based cold medications and lithium batteries). In addition, the desirability of products may also be brandspecific. For instance, popular brands of razor blades, printer cartridges and designer clothing may be frequently targeted for theft and other competing brands may be ignored. Figure 3 illustrates the list of the types of the most commonly targeted products. Figure 3
Source: 2012 NRF Organized Crime Retail Survey
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In 2011, the apparel/clothing and fashion accessories segment suffered the highest loss (1.87% of its total global sales) due to retail fraud. This was followed by the cosmetics/perfume/health & beauty/pharmacy segment (1.79% of its total global sales). Figure 4 below highlights the top stolen product segments in 2010 and 2011, as per the GRTB survey. Figure 4
Source: Global Retail Theft Barometer
Online Retail Fraud – A Subset Online retail is fast becoming an important sales channel for retailers across the globe. In 2012, the global online retail sales have grown 21.1% y-o-y to top USD1Tn for the first time. In 2013, online retail sales are expected to grow 18.3% to reach USD1.3Tn worldwide. Similarly, online retail sales in North America grew 13.9% to a world-leading USD364.7Bn in 2012 – a base that is expected to increase 12.2% to USD409.1Bn in 2013.
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Seeing such a robust growth over the years, retailers rushed to capture time-to-market advantages in the fast-growing online environment. In this process, they overlooked some of the potential checks and balances for fraud management, which left online retail implementations with numerous vulnerabilities. Despite strong growth over the years, retailers have been continuously facing the problem of increasing online retail fraud, which is not only hitting their profit margins but also impacting the overall reputation of the business. According to a survey by CyberSource, North American retailers lost an average of 0.9% of total online sales in fraudulent activity in 2012, down from 1% in 2011. This translates to total revenue loss of about USD3.5Bn, up by 3% from USD3.4Bn in 2011 and 26% from USD2.7Bn in 2010. Moreover, the average percentage of online orders that proved fraudulent in 2012 was 0.8%, up from 0.6% in 2011. Figure 5
Source: CyberSource 2013 Online Fraud Report
Fraud Prevention Expenditure As the economic recession continues to punish retailers for poor performance, substandard and outdated fraud reduction techniques pose a serious threat to them. Today, retailers have stepped up the pace of innovation of their fraud prevention and detection activities to help minimize the loss and sustain their margins. New investments in new technologies such as enhanced data analytics are being directed by retailers into all elements of fraud framework to detect more fraud and improve margins in an increasingly-challenging economic environment. According to a GRTB study, global retailers’ spending on fraud prevention activities increased to USD28.3Bn in 2011, up by 5.6% y-o-y (see figure 6). The survey also highlights the breakdown of the cost incurred by retailers in loss prevention. More than half (56.1%) of the amount, i.e. USD15.9Bn, was spent on both the contract and direct employees in efforts such as pre-
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employment integrity screening and employee training for anti-fraud programs. About USD8.7Bn (20.9% of total expenditure) was spent on installation of latest security equipment like in-store video surveillance (CCTV) and Radio Frequency Identification (RFID) technology. Moreover, global retailers also spent USD2.4Bn (8.5% of total expenditure) on hiring or buying armed car collection vehicles for logistics purpose. Figure 6
Source: Global Retail Theft Barometer
Fraud Prevention Strategies Traditionally, retailers have focused on implementing manual control activities to help prevent potential losses from different types of fraud in the retail industry. However, despite spending hefty money on traditional and outdated loss prevention methods over the years, retailers are still not able to fill the gap that has been created due to fraud. Today, retailers need to implement a holistic fraud approach to counter the losses. While designing and implementing strong internal controls, retailers also need to continuously innovate ideas with the changing business landscape and evolving fraudulent techniques. Also, a well-versed analytical approach is required, which will provide a valuable understanding of the causes of fraud and help retailers develop loss prevention measures more effectively and efficiently. Some of the key fraud prevention strategies are discussed below. 1. Develop a Sound Ethical Culture Cultural assessment forms an important pillar to assess attitudes and business ethics, which often lays the foundation for a high or low fraud risk environment. Retailers, who have invested time to consider where they stand on ethical issues, have come to realize that high ethical standards bring long-term benefits not only at individual level but also at community level.
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A well-documented code of ethics or an anti-fraud policy is not always sufficient to prevent fraud. The most important thing is that the ethical behavior needs to be embedded within the culture of an organization that should start from senior management, as employees are more likely do or follow what their superiors are doing rather than following what an ethics policy quotes. To demonstrate such commitment, the organization should allocate resources within the system to communicate ethics and values to all employees, suppliers and business partners, and provide training programs where necessary. In addition to above, retailers should also ensure that the senior management is committed to controlling the risks of fraud. Senior management should be assigned with fraud prevention responsibilities, as this sends a positive message to employees that the organization is serious about fraud and ensures that tackling fraud will be considered at senior levels. Moreover, regular monitoring of policies and codes should be done by appropriate people within the system (such as management and/or internal audit), and the documents themselves should also be reviewed and amended at regular intervals. Figure 7
2. Technology and Data Analytics It is not always possible for retailers to achieve their fraud risk management goals through simple rule-based solutions, such as real-time POS transactional monitoring. That is why a better understanding and knowledge of specific fraud-related issues is required to help retailers focus their efforts and implement a tailor-made technology solution. Retailers must try and discover their specific areas of exposure by leveraging the rich data environment common in retail companies. This includes data from daily transactions and activities such as purchasing, accounts payable, POS, sales projections, warehouse movements, employee shift records, returns and store-level video and audio recordings.
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A detailed and regular sample-based analysis should be performed on the data collected. This help retailers in (a) identifying fraudulent activities within the system, (b) developing appropriate priorities for case management and investigation and (c) reducing the false positive rate of the companies detection and prevention strategy. For instance, a food service franchisor who becomes victim to underreporting of sales by its franchisees can use analytics in place of carrying out random audits to identify the problem. The food service franchisor can create a predictive model by analyzing external data such as population base served and proximity to competitors, to reach to an expected reporting figure for each franchisee. The franchisees whose reported figures vary most from expected figures can then be subject to internal audits. Moreover, retailers should also implement a third-party solution to enhance their current toolset. This will help them gain access to the solution provider’s fraud management domain expertise too. In such a setup, a retailer should not only get aligned to the strength of the solution, but also focus on the expertise and experience of the provider’s key personnel. 3. Continuous Monitoring Fraudsters continuously monitor and adjust their activities to try to circumvent various fraud prevention and detection measures set by retailers. If a retailer wants to fight fraud, he/she needs to think the same way as a fraudster, i.e. the retailer should be aware of the upcoming activities of fraudsters, which will help him/her to react quickly in a better way and help save significant sums of money. A continuous monitoring under such process may include: Keeping a close watch on product and inventory movement for unusual patterns that will help indicate shrink and store associate theft before it becomes significant Watching out for exceptional trends in logistics to alert management when unusual items are being processed before the assets leave the premises. This may include a number of invoices from suppliers over a period, unusual sequencing of invoice numbers, and the amount of money spent for goods and services purchased from a particular vendor Developing a model that will predict the number of product returns per shift. This will help quantify returns properly, in a case when numbers exceed a set threshold for returns by product or by individual A continuous monitoring for potential fraudulent activities helps keep a manager’s time better focused on areas of concern. This way, fraud management can become proactive rather than reactive, hence helping retailers reduce losses and improve margins. 4. Effective Control Mechanism After witnessing various large and public frauds that have caused huge negative financial and non-financial losses, retailers have begun to build their own control mechanism. At the same time, retailers with established control activities can also benefit from reviewing the existing environment and processes, to ensure they are supported with the leading edge. A strong
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internal control mechanism is considered ‘the most valuable fraud prevention device by a wide margin’. Having a sound internal control mechanism is a requirement under the Companies Act and various corporate governance codes. Also, the overall responsibility of internal control mechanism should be at the highest level (i.e. Directors). The companies should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets. This includes various procedures designed to minimize the risk of fraud. One of the ways of evaluating the control environment is by conducting a series of facilitated stakeholder workshops. This can help in (a) assessing the likelihood and potential impact of different types of fraud in the business, (b) assessing the ability of the current control environment to mitigate risks adequately, and (c) identifying limitations in the control environment, including potential management override.
Conclusion Frauds cost retailers billions of dollars in damages due to loss of products and can hit a retailer’s hard-earned assets and reputation. They can also cause huge customer churn, which can take years to regain. Though retailers have historically neglected fraud management, amid growing business volumes, the retail industry is now investing in better tools and processes to make fraud mechanism more robust and proactive. However, it is also important to understand that handling fraud management is a balancing act between risk acceptance and customer experience. A retailer needs to decide the level of fraud risk that it is willing to accept in order to minimize interference with the shopping experience of its loyal customers. Implementing sophisticated tools and automating fraud detection alone will not help retailers fight fraud. Retailers also need to establish well-defined internal processes to make fraud management an enterprise-wide responsibility and a key component of strategic initiatives. This will additionally help detect a broader range of exposure, including previously unknown risks, and will also uncover new patterns of fraud.
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