Measuring and Managing Shrink October 2012 WIS Share Forum KPMG LLP

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 1 Inventory Accuracy and Shrink Identification, quantification and remediation of shrink is a challenge ‒ Shrink in on the rise ‒ Requires a holistic approach ‒ Traditional tools and focus are not enough ‒ Growing percentage of shrink is not associated with physical loss ‒ Limited shrink reporting ‒ Root causes of shrink are not well understood ‒ Framework to identify, quantify and remediate shrink

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 2 Shrink is on the Rise ‒ Rising inventories ‒ SKU proliferation ‒ Method of inventory valuation ‒ Master data issues ‒ Definition of cost ‒ Misaligned processes and systems ‒ Major system replacement or upgrades

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 3 Requires a Holistic Approach Shrink Physical Shrink Paper Shrink Stores In-transit Distribution Center Warehouse Vendor Systems Processes Accounting Transaction Processing Interfaces Conversions Global Imports DC, Cross Docks and Stores Returns Master Data Inventory Management Account Payables Inventory Accounting Inventory Control

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 4 Traditional tools while effective are not enough Examples of Shrink Tools ILLUSTRATIVE Deter Human Resource Program Integrity Screening Background Checks Loss Prevention Shrink Binder Newsletters/Videos Detect Monitoring Program Mgmt/Compliance Reporting and Score carding Daily Transaction Reports Cash Handling Refunds, Voids, etc. Shrink Management Tool – Store Profile Control High Risk Product Program Improve Supply Chain Processes (DCs, Receiving, Storage, Handling, etc.) In-store display Anti-theft Fixture Source Tagging Pre-Employment Screening Training/Job AidesEmployee Awareness Shrink Mgmt ToolException ReportingCompliance Reporting HRP IdentificationHigh Risk StoresRisk Analysis Model

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 5 Inventory Accuracy and Shrink Growing percentage of shrink is not associated with physical loss ‒ Reported shrink (known shrink) is understated and a significant cause of controllable shrink. ‒ Inventory valuation is subject to volatility in reporting based on the cost compliment calculation, retail valuation for center store and cost based valuation for perishables ‒ Master Data – often retailers do not have a single item master database which drives several issues contributing to shrink including item setup errors, system update errors, and late cost changes ‒ Receiving Accuracy - Receipt accuracy is likely contributing to shrink and out of period adjustments

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 6 Process Shrink ‒ How effective are your physical inventory processes? ‒ Do you see significant margin or inventory valuation swings in your fresh departments ‒ Do you have detailed process maps related to inventory movement? ‒ Are your processes, controls and systems in synch?

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 7 Strengthening basic fundamentals Accurate Receiving and Payables PO Controls ASN Accuracy Manual Receiving Controls Vendor Compliance Next Steps Implementation timeframe: 6 months or less  Vendors do not oversship against the purchase order quantity  Vendor sends accurate ASN’s  Verify receipt to the PO quantity  Input accurate receiving information on a timely basis  Pay for what you receive – order  Balance direct import GL inventory and liability accounts  Company X translates EDI transactions accurately into the ASN tables  Improve and govern ASN compliance with vendors and ODP systems  Minimize changes to PO quantities  Close out old purchase orders in warehouse system  Receive shipments accurately against the purchase order  Minimize key strokes  Receive against the purchase order  Match net receipt transactions with purchase order and invoice (3 way match)  Automation of journal entries in direct import accounting  Reengineer financial controls for vendor settlements, store receipt adjustments and returns Implementation timeframe: 6 months or greater

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 8 System Shrink ‒ Have you recently implemented any new systems? ‒ Does you organization have a current systems Map? ‒ Are automated balancing routines established between systems? ‒ Who is responsible and are error logs worked daily? ‒ Do business owners have to sign off on all system design changes? ‒ Has your organization completed transaction testing?

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 9 Inventory System Interface Diagram

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 10 Accounting Shrink ‒ How is your inventory valued? ‒ How is cost of goods calculated? ‒ Effectiveness of physical inventory’s reconciliation? ‒ Has your organization trace transactions to the GL account? ‒ How many manual accounting processes are in place? ‒ Are all AP processes reconciled on a regular basis?

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 11 Summary Findings Key Influencers: 1.Changes in receiving, production and shipping policy at the cross docks due to new scanning technology 2.Increased volume of non-flow through freight not designed to support cross dock business rules Split shipments (Batch v. flow) Vendor consolidation Packaging Multi-cross dock deconsolidation 3.Increased volume of global imports managed by a broken global accounting process Markouts without Receipt Adj. # of occurrences False Overages # of occurrences Receipt Adj. after AP match # of occurrences

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 12 Shrink Reporting Shrink reporting lacks consistency in the method that it is collected, posted and reported How effective is your reporting related to: ‒ What accounting method do you use to report shrink ‒ Know shrink and waste ‒ Inventory adjustments ‒ PO, receipt, invoice & payments ‒ ASN exception reporting and receiving accuracy ‒ Vendor compliance ‒ Non-match reporting (RTV, PO Order Qty, Receipts, Wrong or missing PO)

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 13 Shrink Reporting Improving Shrink reporting: ‒ SKU based information ‒ Tracking unit variance history vs. dollars ‒ Tracking unit history over larger periods ‒ Track and monitor inventory movement ‒ Track all product leaving the building POS, Backroom, trash compactor ‒ Monitor accuracy of price file

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 14 ACCOUNTING PROCESSES SYSTEMS PHYSICAL Inventory Shrink Roadmap Executive Presentations  Framing the issue  What gets better  Fundamentals  Strategic roadmaps Implementation roadmap  Activities  Milestones  Timelines  Resources  Cost  Impact on the bottom line Executive Presentations  Framing the issue  What gets better  Fundamentals  Strategic roadmaps Implementation roadmap  Activities  Milestones  Timelines  Resources  Cost  Impact on the bottom line Issue Identification Data Analysis Process& system reviews Root cause identification Quantify Identified Issues Observations & Recommendations Steering committee Working committee & project resources Shrink workshop  Review current findings  Identify Organizational Timeline  Review key process, system & accounting changes Outputs  High Level Systems Overview  High Level Data Flow  Map PI Process Flow  Develop preliminary list root causes  Develop high level project plan Steering committee Working committee & project resources Shrink workshop  Review current findings  Identify Organizational Timeline  Review key process, system & accounting changes Outputs  High Level Systems Overview  High Level Data Flow  Map PI Process Flow  Develop preliminary list root causes  Develop high level project plan DiscoveryRemediationRoot Cause Analysis

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15 Discovery Steering committee ‒ Working committee & project resources Shrink workshop ‒ Review current findings ‒ Identify Organizational Timelines ‒ Review key process, system & accounting changes Outputs ‒ High Level Systems Overview ‒ High Level Data Flow ‒ Map PI Process Flow ‒ Develop preliminary list root causes ‒ Develop high level project plan

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 16 Discovery Review and document key processes, systems, accounting and reporting to assist with the identification of gaps and to provide observations and recommendations ‒ Set up cross functional meetings to discuss key business processes ‒ Document current state process flows, systems, accounting ‒ Review procure to pay processes, systems, and accounting ‒ Root cause analysis

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 17 Process, System and Accounting Maps

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 18 Example Deliverables – Detailed Process Mapping

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 19 Discovery Review the accuracy of the current retail or cost method of accounting ‒ Assess the retail or cost method of accounting ‒ Test cost compliment calculation or definition of cost ‒ Provide a summary of recommendations related to key themes (Definition of cost, inventory adjustments, cycle counting, master data management, etc)

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 20 Discovery Complete a reporting impact analysis ‒ Document key current operational and financial reporting related to margin, shrink and inventory adjustments ‒ Importance of establishing one source of truth for reporting ‒ Assess master data clean-up and maintenance ‒ Assess shrink and waste calculations ‒ Assess inventory adjustments, cost adjustments, and other top level adjustments impacting margin, shrink and inventory adjustments

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 21 $95 Million Trend (200x) Unexplained Shrink  Resets  Theft  Drop Ships at Stores  Vendor Contracts  Over Production  Auto-distro’s  R-claims  Markdowns  Etc Issues Validate and Categorize Quantify Systematically research, identify, and resolve Inventory Variances and Shrink Bucket 1 Bucket 2 Bucket 3 Bucket 4 Component 1 Component 2 Component 3 Component 4 Bucket 5

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 22 Categorize Based on our analysis the top ten contributors to shrink in 200X are: ‒ Reported Shrink (Thrown Away) - $26.9 Million ‒ Shoplifting – $19.3 Million ‒ Under Reported Thrown Away - $15.1 Million ‒ Cost Compliment Variance - $ 9.2 Million ‒ Unknown – $4.9 Million ‒ Under Reporting (Thrown Away Weight Estimate Error) – $4.9 Million ‒ DC Pick Errors – $4.6 Million ‒ Cost Changes - $3.4 Million ‒ Retail Price Changes - $2.6 Million ‒ R-Claim – $2.3 Million

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 23 Categorize  Misaligned business rules across operations and general ledger processes  Markouts without receipt adjustments  Receipt adjustments after AP match  Lack of controls with global accounting process relative to changes to purchase orders and receipt  Systems deficiencies with PO and ASN information  POM not updating GSS quantities  Duplication of ASN quantities  Flexible receiving policies  Ability to receive shipments against any purchase order  Ability to change purchase orders once they have transacted with accounting  Assumed receipt information posting to the general ledger without verification at the cross docks  Inaccurate information provided by third party  K&N providing inaccurate ASN information $86M $24M $56M Preliminary Inventory Shrink Results incl. known loss Reclassified (balance sheet items) as Inventory Inaccuracy at the Cross Docks Reserve- Inventory Shrink plus known loss Period covering May 1, 20xx – April 28, 20xx $6M Final Inventory Adjustments Final 20xx-xx Inventory Shrink ($62M) $45M $11M -Known Loss -Shrink Reserve

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 24 Remediation Selling shrink projects to your executive suite Developing Executive presentations – Frame the Issue – Setting the Priorities – Business Case Development

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 25 Frame the Issue - Example Focus Areas Business Value Difficulty Estimated Savings/Benefit 1) Improve reported shrink tracking and management reports HighMed$29-$36 Million 2) Distribution operational and financial reporting changes HighLow$8-$11 Million 3) Improve the preciseness of inventory valuation High $10-$14 Million 4) Master data clean-up and maintance High Low$3-$5 Million 5) Store Detail receive all DSD shipments Med Low$1-$2 Million 6) Theft Reduction MedLow$2-$4 Million

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 26 Setting The Priorities Realizing sustainable shrink improvement hinges upon setting clear priorities which consider business value and level of difficulty. Focus Areas Difficult but Rewarding Gems Quick Wins Back Burner LowHigh Low High Business Value Difficulty )Improve Shrink Tracking 2)Distribution Operations 3)Inventory Valuation 4)Master Data 5)Detail Receiving 6)Theft Reduction

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved – Improve Reported Shrink Tracking Observations Shrink reporting should be standardized using cost or retail and should include all product removed from the store using a single process. Shrink allowances & R-claim should be systematically tracked by vendor and included in management reports. Stores should be rewarded for accuracy of shrink reporting and improvement, not based on a rate. Recommended Actions  Assign a cross functional team with representatives from stores, distribution, buyers and finance to standardize, simplify and develop the business requirements including:  Enable the stores using the handheld's to track the root cause and amount of reported shrink including: – Damaged, code dates, resets, production, force outs, and excess inventory – Scan all items removed from the store (ensure all item have UPC/PLU’s) – Track items used for production and include in cost of goods sold rather than shrink  The RMS system should direct the stores related to disposition of the product and record the shrink into the correct bucket automatically  Use bar codes on each r-claim box for improved reconciliation  Establish guidelines for tracking other key information to assist in developing new reporting related to on-going diagnostic and trend information including: – Late cost changes, Production tracking, RMS flag accuracy, R-claim variance reporting  Assign IT resources to scope, develop detailed design and cost estimates to support business requirements Business Value  Reduce current reported shrink from $49 Million to $13-$20 Million  Measure and understand the root causes of reported shrink  Monitor the appropriateness of shrink allowances  Improved R-Claim Reporting Business Value H M Timescale M M Costs M Resources Difficulty

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 28 Contact Information Al Voels Retail Practice Leader KPMG Canada Telephone: (206)

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.