Effectiveness of frequent inventory audits in retail stores: an empirical evaluation

• DOI: https://doi.org/10.1108/IJLM-07-2018-0184
• Pages: 21-41
• Date: 30 September 2019
• Published date: 30 September 2019
• Author: Rafay Ishfaq,Uzma Raja
• Subject Matter: Logistics,Management science & operations

Effectiveness of frequent

inventory audits in retail stores:

an empirical evaluation

Rafay Ishfaq

Department of Supply Chain Management,

Auburn University, Auburn, Alabama, USA, and

Uzma Raja

Department of Information Systems, Statistics and Management Science,

University of Alabama, Tuscaloosa, Alabama, USA

Abstract

Purpose –The purpose of this paper is to focus on the effectiveness of the inventory audit process to manage

operational issues related to inventory errors in retail stores. An evaluation framework is proposed based on

developing an error profile of store inventory using product attributes and inventory information.

Design/methodology/approach –A store inventory error profile is developed using data on price, sales,

popularity, replenishment cycle, inventory levels and inventory errors. A simulation model of store inventory

management system grounded in empirical data is used to evaluate the effectiveness of the inventory audit

process in a high SKU-variety retail store. The framework is tested using a large transaction data set

comprised of over 200,000 records for 7,400 SKUs.

Findings –The results show that store inventory exhibits different inventory error profile groups that would

determine the effectiveness of store inventory audits. The results also identify an interaction effect between

store inventory policies and replenishment process that moderates the effectiveness of inventory audits.

Research limitations/implications –The analysis is based on data collected from a single focal firm and

does not cover all the different segments of the retail industry. However, the evaluation framework presented

in the paper is fully generalizable to different retail settings offering opportunity for additional studies.

Practical implications –The findings about the role of different error profile groups and the interaction

effect of store audits with inventory and store replenishments would help retailers incorporate a more

effective inventory audit process in their stores.

Originality/value –This paper presents a novel approach that uses store inventory profiles to evaluate the

effectiveness of inventory audits. Unlike previous papers, it is the first empirical study in this area that is

based on inventory error data gathered from multiple audits that identify the interaction effect of inventory

policy and replenishments on the inventory audit process.

Keywords North America, Process management, Information technology, Simulation, Retail logistics

Paper type Research paper

Introduction

An efficient execution of retail supply chain strategy requires an effective management of

store inventory. To achieve this goal, retail firms invest in technology and business process

development (Ishfaq et al., 2016). A key element of such investments is ensuring information

quality through technology solutions that help correct errors in system inventory records.

Improving the quality of inventory records not only ensures proper utilization of available

inventory for in-store sales but also for e-commerce orders that retailers are increasingly

filling through their stores (Gibson et al., 2018).

While the importance of ensuring accurate inventory records is fully understood by supply

chain managers, controlling errors in inventory records remains an unfulfilled goal

Received 28 July 2018

Revised 8 March 2019

30 July 2019

Accepted 20 August 2019

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/0957-4093.htm

The authors thank Professor Bill Hardgrave (Auburn University) for his expert insights and valuable

discussions in developing this research. The authors also thank Justin Patton (Director RFID Lab,

Auburn University) for his efforts and assistance in collecting data for this paper. This research would

not have been possible without their involvement and support.

Frequent

inventory

audits in

retail stores

TheInternationalJournalof

LogisticsManagement

Vol.31 No. 1, 2020

pp.21-41

©EmeraldPublishingLimited

0957-4093

DOI10.1108/IJLM-07-2018-0184

21

(Goyal et al., 2016). In a recent empirical study, 65 percent of 370,000 inventory records (system

inventory) at multiple stores of a large retailer were found to be inaccurate (DeHoratius and

Raman, 2008). The actual number of items in stock (physical inventory) can be off by up to

30percentoftheretailer’s system inventory records in the corporate IT system (Kang and

Gershwin, 2005). According to recent estimates, sub-par performance due to inventory errors

costs US firms more than $46.8bn in lost profits each year (National Retail Federation, 2018).

To overcome the operational problems that arise from incorrect inventory records, firms

adopt reconciliation measures to correct system inventory records. Typically, managers

interveneby overriding systeminventory informationand making manual adjustments to the

replenishment process. This approach has resulted in firms stocking additional units in

inventory as safety stock to offset the downside of inventory errors that would otherwise result

in stockouts and lost sales (Moussaoui et al., 2016). A mitigation approach prevalent in practice

is to undertake routine physical inventory audits to update system records. High costs and

extensive labor/technology requirements are often cited as concerns regarding frequent

inventory audits. However, delays in correcting inventory errors greatly limit the potential

operational benefits of inventory audits, leading to inefficiency in supply chain processes

(Waller et al., 2006). Our study focuses on this issue by specifically addressing how retailers can

effectively utilize routine audits to manage the operational effects of inventory errors.

The practice of routine inventory audits has expanded in recent years due to the

adoption of relevant technologies, such as RFID (radio frequency tags embedded in

packages read by electronic readers) and bluetooth beacons (forming an Internet-of-Things

network to identify the location of inventory). Retailers such as American Apparel, Macy’s

and Mark & Spencer have reported counting store inventory up to 24 times a year

(Trebilcock, 2013). As more retailers adopt such technologies to conduct routine inventory

audits, managers are looking to use detailed inventory error data to devise strategies to

counter the operational effects of inventory errors.

Our paper presents an empirically grounded analysis of the inventory audit process to

study the corresponding effects on store performance in a high SKU-variety retail store

setting. In this context, we seek to develop an understanding of how inventory errors affect

different segments of store inventory and shed light on a key operational question for store

managers, i.e., how effective are frequent inventory audits? We explore this issue by

developing an inventory audit frameworkthat incorporates underlying error profiles of store

inventory. The framework utilizes relationships between inventory errors and product

attributes such as price, sales volume and SKU sales consistency, as well as store policies

regarding inventory and replenishments. By classifying store inventory into different error

groups, the framework prioritizes SKUs that would not require retailers to audit the entire

store, rather focus on items where inventory audits will be most effective.

This research study employs a multi-method approach (Mentzer and Flint, 1997; Sanders

and Wagner, 2011; Kull et al., 2013), using both empirical analysis and simulation evaluation to

investigate the subject matter. The empirical analysis uses a data set of 7,500 SKUs and over

200,000 transactional records of sales, inventory, store replenishments and inventory errors.

The data are collected from a large US retailer that is ranked among the top 20 national retailers,

according to the National Retail Federation list. Using robust statistical testing, store inventory

is analyzed to identify linkages between product attributes and their underlying inventory error

profiles. Empirical data are used with a system-dynamics model of retail store operations that

incorporates the sales process, inventory management system and store replenishments. The

model is used within a factorial research design to evaluate the effectiveness of the inventory

audit process in a high SKU retail store. Results are analyzed to show that store inventory

exhibits different error profiles that would determine the effectiveness of store inventory audits.

The results also identify an interaction effect between store inventory policies and

replenishment process that impacts the effectiveness of inventory audits.

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