Phantom Inventory: How to Identify, Reduce, and Prevent It

Phantom inventory, also known as ghost inventory, is a silent menace lurking within supply chain management for consumer brands and retailers. It is a puzzling and quite often vexing issue that has the potential to significantly disrupt businesses and impact their bottom line.

Phantom inventory refers to the stock (i.e., goods or inventory) that an enterprise resource planning (ERP) or point of sale (POS) system records as available, but in reality, does not exist and is falsely accounted for. This means that the system considers it to be on hand or in stock—whether it be in a brick-and-mortar store, warehouse, distribution center, or storage facility—when the product is actually sold out, missing, or out of stock.

What causes phantom inventory? Take your pick. It can arise from various factors such as theft, damage, deliberate fraud, misplaced or lost inventory, unreported sales, system and data entry errors, or lack of inventory control.

The consequences of phantom inventory may not be immediately apparent to consumer packaged goods (CPG) companies and their retailer partners, but they can have a profound impact on operational efficiency, sales, and profitability. The impact of phantom inventory also often goes well beyond immediate lost sales, leading to incorrect retail sales and inventory data, inaccurate demand forecasting and planning, and poor customer experiences. Ghost inventory also makes it difficult to make the right decisions regarding product merchandising, trade promotions, marketing campaigns, and store layouts.

As a key contributor to on-shelf availability problems by misleading you about stock levels, phantom inventory can be a major barrier to efficient retail replenishment. And the bigger the store and the more SKUs that are being stocked and sold, the harder it will be to identify, reduce, and prevent phantom inventory and its detrimental effects on current and future business.

When inventory levels don’t show the right picture, multiple facets of your business will be affected—not in a good way. Running your business and operating supply chain management systems and processes based on inaccurate retail data can result in minor inconveniences or utter disaster. In this article, we’ll delve into the causes and ramifications (costs) of phantom inventory and how CPGs and retailers can spot, minimize, and prevent the silent killer called phantom inventory to preserve their financial health.

WHAT CAUSES PHANTOM INVENTORY?

If you don’t want to be haunted by phantom inventory anymore and want to prevent potentially long-term damage to your bottom line and brand reputation, you need to first identify what causes it. Here are several of the more common sources of phantom inventory:

Retail Shrinkage

Retail shrinkage refers to loss of product or inventory from causes other than sales, including shoplifting, employee theft, return or vendor fraud, product damage, administrative (human) errors, and other unknown reasons.

According to the National Retail Federation, retail shrinkage was $112.1 billion in 2022, or 1.62% of total retail sales. That, alone, is enough of a reason to want to prevent ghost inventory as much as possible.

Lack of Inventory Audits, Accurate Inventory Audits

Sure, an individual occurrence of phantom inventory might seem minor, but it can compound before you know it and lead to bigger issues than you and your retailers really want to deal with. If you fail to properly monitor inventory levels and catch small mismatches in a timely manner, don’t be surprised when you have larger discrepancies that eat up valuable time and resources to resolve. Performing regular inventory audits will allow you to catch and prevent phantom inventory now—and not weeks or months later when it has already taken a toll on your business.

Additionally, errors will more than likely occur during data entry if it is a manual process, one that is laborious and repetitive. And if there are mistakes while inputting data into one system or application, it could possibly affect your entire inventory management system and processes. Inaccurate inventory levels, no matter where they are, lead to stockouts and lost sales across channels, regions, and/or stores, which can become a costly mistake for all parties involved.

Recording Sales Incorrectly

If a product is not correctly scanned during checkout, obviously, it won’t be accounted for in the real-time inventory for that product. This is typically the result of an in-store error by a sales associate or employee. For example, if you sell two polo shirts of the same type but different colors to a shopper and scan one of the shirts twice instead of individually because they are the same price, it will skew the stock levels for each color and create phantom inventory for the color that was not scanned.

Misplaced Inventory

Unsurprisingly, at an individual store level, products might end up in the wrong spot. It’s not that the inventory doesn’t exist—it’s just difficult to find. This can happen for a couple of reasons: customers leave products in a different part of the store after trying something on or changing their mind or they find a similar product but don’t put the original product back where they found it. Also, a retailer could leave a returned product in the back room or somewhere else instead of putting it back on the correct shelf.

To avoid misplacing products, retailers should regularly reorganize their sales floors at the end of each day or at the beginning of the next day, have a process for properly organizing their stockrooms, and ensure all staff consistently follow processes put in place to maximize on-shelf availability.

Receiving Errors

Whenever you have manual data entry, the likelihood of human error goes up. Receiving errors can occur for a variety of reasons. For example, an employee may record a higher or lower number of units, or they forgot to account for breakage or damaged goods during receival. Another scenario that can cause ghost inventory is when the product delivery doesn’t have all the expected SKUs and the store accepts the delivery without conducting a thorough inventory check.

THE EFFECTS OF PHANTOM INVENTORY'S SILENT ASSAULT

As previously mentioned, running your business and operating your supply chain based on inaccurate inventory data and POS data can lead to minor consequences or catastrophic business decisions.  

Lost Revenue and Profitability Implications

In the highly competitive retail environment where tight margins can easily and often decide the success or failure of a CPG or retailer, accurate inventory accounting is critical. Phantom inventory, even at its lowest level, introduces uncertainty and inaccuracies into projected sales, gross revenue, and profitability. 
Whether products are being sold through brick-and-mortar locations or via virtual shelves in an online storefront, if a product isn’t “on the shelf,” shoppers can’t buy it and it can’t generate any sales or revenue for anyone. On top of that, if you’re under the assumption that you have adequate stock in inventory, but you don’t, then brands and stores can lose more than an immediate sale and revenue. They can lose additional revenue because the consumer who would have bought the product if it had been available becomes frustrated and buys a competitor’s product or purchases the product from a competing retailer.

Making matters worse, if inventory records indicate a product is in stock, but it’s getting zero sales, it could possibly take weeks to determine there is a phantom inventory issue and adequately replenish that stock. And if you’re using automatic reordering then the new order won’t be triggered if you have phantom inventory in the system, thus leading to a stockout.

Ghost inventory issues can also cause retailers to buy more products from suppliers because they think they are undersupplied, resulting in excess stocking costs and a hit on cash flow. Furthermore, companies may also encounter financial losses due to penalty expenses such as late delivery fees and lost business opportunities.

Overall, the longer phantom inventory goes unnoticed, the greater the potential loss of sales, revenue, and profitability.

Bad, Incorrect Data

Inaccurate inventory data about what you have in stock can lead to extremely poor decision-making, especially when it takes a long time to discover you have a phantom inventory issue. Imagine you have a hot-selling item and then the product suddenly stops flying off the shelves. Obviously, there’s a problem and you need to quickly figure out what it is to prevent lost sales and revenue.

Maybe you assume shoppers don’t think it’s the best product for them anymore. Or maybe it’s now too expensive or a competitor has introduced a better product into the marketplace. Now what do you do? If you’re the manufacturer, perhaps you will change your marketing strategy, invest in market research, or launch a new campaign. If you’re the retailer you might cancel future orders, adjust pricing for other products, or even change your store layout. However, none of these options is the solution to the real problem. The problem is the product isn’t selling because shoppers can’t find it on the physical or virtual shelves.

Inaccurate Demand Forecasting

Demand forecasting is a critical component of supply chain and retail replenishment success for CPGs, and inventory data plays a major role in ensuring long-term success. But if you’re using inaccurate or incomplete inventory data, you will not be able forecast effectively nor properly meet consumer demand. Without clean, complete, trustworthy data, you also won’t be able to budget accurately, maintain positive cash flow, or promote the right products at the right time in the right location. Phantom inventory will hide the true demand for products and you will lack the necessary insights to accurately forecast and meet demand.

Poor Customer Experiences and Decreased Satisfaction

Phantom inventory can negatively affect businesses in many ways and have long-term implications, but the consumer feels the impact more immediately in terms of a poor shopping experience.

Imagine you’re a customer who’s excited about purchasing your product, but when they get to the store they’re faced with an empty shelf where the product should be. Now all they’re left with is disappointment and frustration. The same can occur if an individual is shopping online, goes all the way through checkout, assumes they’ll receive the product—only to find out it’s not in stock and their money will be refunded. Either scenario results in a missed opportunity to delight new and existing customers, as well as potentially losing a life-long customer.

Ghost inventory can also lead to lost repeat sales, cancelled or delayed orders, loss of consumer trust, and damaged brand reputation, especially in this era of social media and influencers where negative word-of-mouth can have a domino effect.

Strained Retailer-Supplier Relationships

To maintain smooth, mutually beneficial relationships, retailers and CPGs need to be on the same page with their sales, marketing, and promotional plans—and they must also be collaborative in their problem solving. Phantom inventory incidents can hurt both the supplier and the retailer; therefore, the two parties should work together to identify, reduce, and prevent phantom inventory. When stock is short because of phantom inventory, a retailer might place last-minute orders with manufacturers, putting a strain on the manufacturer’s ability to fulfill those orders and possibly damaging the relationship.

Operational Efficiency and Effectiveness

When a retailer mistakes phantom inventory for actual stocked product, it can negatively affect operational efficiency, as time and resources can be wasted trying to locate non-existent inventory. Ghost inventory can also lead to misinformed decisions about production, leading to either overstocks or understocks, each with their own repercussions.

How to Identify and Prevent Phantom Inventory

Phantom inventory can cause a multitude of problems and be extremely costly. Therefore, it’s crucial that suppliers and retailers make identifying and resolving phantom inventory issues a priority—and do it as quickly as possible.

Unfortunately, solving phantom inventory problems isn’t always easy given the potentially large number of SKU-store combinations and the range of root causes that need to be addressed. However, with a holistic, collaborative, and proactive approach, CPGs and retailers can minimize the impact of ghost inventory and prevent it from causing long-term damage to their businesses. Preferably using timely, accurate data and advanced data management technology that can ensure faster resolution.

Conduct Regular Inventory Audits

Although it can be a tedious process, especially if you offer a wide range of products, regular inventory audits and reconciliation can help keep your data reliable, demand forecasting accurate, shelves stocked, and safety stock up to date. By counting your physical inventory and comparing it with digital records, you can identify discrepancies between your physical count and your digital records and rectify any issues.

It also helps you catch phantom inventory days or weeks after it happens, rather than months down the line.

Analyze Your POS Data at the Item and Store Level

To stay on top of phantom inventory and reduce its impact, brands must regularly identify and address product voids by accessing and comparing the most recent and accurate POS data and by cross-referencing various data sets. This exercise should be done weekly.

Your POS and inventory data, when tracked and analyzed at an SKU-store level, is your best bet for proactively addressing phantom stock issues. It can give you the most complete picture of a phantom inventory occurrence—highlighting the day or week it occurred, which products are in question, the storage location that’s part of the problem, and more.

POS inventory data tracks the inventory you received and sold, as well as returns and exchanges. It tells you how many units of an item you have on hand and where they are stored. POS sales data shows you the number of products and units sold over various periods of time, revealing when demand for a product peaks and dips, and it feeds into your inventory reports for easy product reordering. By reviewing inventory and sales data side by side, you can see when the discrepancy started and then track back to the day or week in question and review supplier deliveries, store footage to determine if there was shoplifting, or records of inventory being moved to another location.

Retail Velocity’s VELOCITY^® retail data platform is built to detect phantom inventory issues, prevent them, and ensure optimal on-shelf availability and effective replenishment practices.

For example:

If a CPG notices that a retailer’s replenishment system has a perpetual inventory that seems too high for an item at a store, or if a CPG notices zero scans or downward trending sales but a retailer still shows inventory on hand, the CPG should consider there is a possible phantom inventory issue and should alert the retailer merchandiser so they can audit and correct inventory.

When using VELOCITY, a CPG can automatically collect, track, and analyze cleansed, harmonized daily store-SKU POS data (i.e., units sold) and accurately identify when a store has unusually high inventory when the item has consecutive days of zero scans for a set period or when sales for the item drop. Also, by monitoring ship quantity (minimum order quantity), the CPG can eliminate the possibility of product being in the back room (i.e., misplace product vs. phantom inventory).

To resolve the phantom inventory issue, the CPG can alert the store and the store can then have someone—store personnel, a merchandiser from the vendor, or a third-party merchandising organization—physically count the inventory on the shelf, in other areas of the store (e.g., end caps, displays, center aisle, checkout, etc.), and in the stock room. Once the CPG receives the correct on-hand inventory from the person taking the physical count and knows whether the inventory was adjusted, the CPG can confirm or invalidate the resolution by monitoring units on hand and the daily units sold for a select time frame after the physical count was taken. On-hand inventory should change and units selling should increase. Also, by using VELOCITY and daily item- and store-level data, the CPG can identify if replenishment lead-time is insufficient and then recommend specific store orders to stock the store.

In VELOCITY, a supplier can access both sales velocity and inventory reports at a store level, and alerts can identify the errors in a retailer’s perpetual inventory positions that adversely affect store replenishment, such as ghost inventory and even negative inventory counts. CPG brands and retailers can also identify problems caused by missing facings, poor distribution center supply, and cases lost in back rooms.

Armed with the most precise, near real-time retail data, suppliers can work proactively with retailer partners to mitigate phantom inventory problems. Also, it makes good sense to run a pre- and post-analysis of sales at the item-store combinations where you addressed phantom inventory. If you have properly resolved the ghost inventory issue, you should see sales begin again once the out-of-stock store locations have been replenished. It is also beneficial to share your analysis with your buyers to build trust.

Conclusion

Phantom inventory is a formidable adversary—one that can negatively impact revenue, consumer satisfaction, brand loyalty, and retailer relationships—significantly. But CPG companies and retailers can defeat it together and prevent it from haunting their business.

By better understanding the root causes of phantom inventory and employing proactive measures using a sophisticated data platform and technology like VELOCITY^®, you can reduce out-of-stocks, maintain strong retailer relationships, and gain a strategic advantage by ensuring accurate inventory counts and on-shelf availability. Moreover, you can prevent operational inefficiencies and stave off hidden costs that can erode profitability.

If you’d like to learn more about how VELOCITY^® can help you identify phantom inventory issues and exorcise those costly demons, please contact us today.