Acceptance of Unacceptable Losses

A shrinkage allowance adjusts a product’s pricing strategy to accommodate a specified normal acceptable percentage of transportation losses. I recently spoke with a vice-president of a major food company who mentioned that losses within the company’s shrinkage allowance were considered as “no losses,” since the price structure incorporated this allowable level and adequately compensated the company for the acceptable shrinkage. To borrow an expression from a colleague, Paul Clipp, who provides guidance for optimizing manufacturing systems, this constitutes “acceptance of unacceptable losses.”

Let us explore how this philosophy might translate in terms of profitability. If we follow a somewhat typical system, we can have six or more handling events, such as farm to truck, to elevator, to terminal (which is where a grain company would start), to barge, to export house, to vessel, to vessel discharge, to import company distribution, which could include ship to truck to warehouse to processing or distribution center, and so on. With a 0.25% loss per event, and not incorporating diminishing levels (the base quantity should change with each loss), these six events total a 1.5% accounted-for loss to the importing country. A similar 1.5% loss from distribution within the importing country would result in a total 3% accountable shrinkage.

With huge volumes traded, losses accumulate quickly. For example, the volume of corn and wheat exported by the United States in 2001 (the most recent data at the time of this writing) was 73 million metric tons. A 3% loss would equal more than 2 million tons, valued at $244 million. This is a significant loss for just two products. The energy value of the 2 million tons of grain is 7.5×10¹² kcal, which is sufficient to feed 9.8 million people for one year—a significant “allowable” level of food losses.

An insidious consequence of shrinkage allowances, or acceptance of these losses, is that they can actually promote losses. Unethical people can take advantage of acceptance of an unacceptable loss by removing product within the allowance with no fear of retribution. Shipping insurance which guarantees that 98% of the shipment will arrive intact, for example, often does just that—guarantees a 2% loss. The 2% can be skimmed for separate sale with little risk.

Technologies and programs have been developed to eliminate losses in manufacturing. Programs have been designed to identify critical points, measure performance, develop action plans for conditions which tended to produce out of specification product, and result in a more consistent and more profitable line. They include Total Quality Management (TQM), Six Sigma, and even Hazard Analysis and Critical Control Point (HAACP) programs. They differ in details, but all work by analyzing and reducing variability which affects product quality.

These concepts can be extended into the distribution system. An action plan to reduce losses, for example, could consist of a quality management system for the transportation/distribution processes, i.e., a management commitment to follow and measure the distribution environment and implement programs to reduce variability, enhance quality, and improve customer satisfaction with the elimination of defects. In other words, management should strive for zero losses and insist on reduced losses and fewer “defects.”

The “defects” in this case are damaged or out-of-specification food products which are unacceptable for sale or spilled or lost products which are unavailable for sale. Technologies exist such that we do not have to accept unacceptable losses. Improved unitization and containerization reduce losses. Stronger shipping cases offer greater compression strength, which can reduce crushing. New shipper designs, such as reinforced corners, inserts, and triangular folds, provide stronger column strength using less material than their predecessors. Primary containers, those in direct contact with food products, can also provide more protection with less material, using high-barrier materials. All of these developments offer improved performance which can save food.

Companies often believe that their distribution system is as efficient as economically feasible, i.e., that the cost to reduce losses will exceed the value of those losses. This is often the case, but not always.

Profitability results from selling products at a reasonable price. Products which become damaged during transport command a lower price, and products which are lost or returned result in zero income for their production and administration costs. Companies can improve profitability by reviewing distribution practices and all shrinkage allowances; observing the entire transportation and distribution system to determine how products respond and where disproportionate damage may occur; and looking for opportunities to match the best practices of technology with their existing processes and potentially better processes.

Profitability is enhanced with a system that assures that products are delivered to the ultimate consumer in good condition. This requires a company policy which will not allow for “acceptable losses.”

by Kenneth S. Marsh, a Professional Member of IFT, is President/Research Director, Kenneth S. Marsh & Associates, Ltd. and Executive Director of the Woodstock Institute for Science in Service to Humanity, 102B Ole Towne Square, Central, SC 29630.