What is Phantom Inventory & How to Deal With It

Discover the top causes of phantom inventory, the biggest consequences, and the best ways to deal with ghost inventory through real-world examples.

When merchandise goes missing or gets damaged (without your knowledge), it can still appear as “in stock” within your system. These data discrepancies are referred to as phantom inventory — since the actual product has no on-shelf availability.

Phantom inventory makes it difficult to know your stock levels and to make purchasing decisions for your retail store. And it leads to data errors, lost revenue, and unsatisfied customers. But luckily, with a bit of detective work, you can find what’s causing phantom inventory and exorcize the problem.

What is phantom inventory?

Phantom inventory (also known as ghost inventory) refers to missing units when a store’s physical stock count does not match its digital records.

For example, a product might be damaged, stolen, or misreported but still shows as in stock in your records. However, this inventory is not actually available for sale, despite what the record shows. As such, phantom inventory misleads retailers about their stock levels, impacting product availability and long-term revenue.

There are many reasons for phantom inventory. But for ecommerce retailers, the most common cause is inventory not being tracked properly. Take damaged goods, for example. These products are unsellable, but until they’re found and properly reported, they are marked as in stock in your inventory management system.

What causes phantom inventory?

Ecommerce retailers can proactively prevent phantom inventory (before it causes long-term issues) by identifying the root problem. Here are the most common causes of lost stock.

Inventory replenishment errors

Manual processes for inventory replenishment run the risk of human error. For instance, if someone miscounts how many items were received and misrecords the shipment, that can cause phantom inventory.

These mistakes cause a chain reaction that throws off your stock levels until the data error is discovered. In the meantime, you run the inventory risk of phantom stockouts happening, which can lead to overselling a SKU and make meeting customer demand more difficult.

For instance, you might enter 78 units for a specific SKU when the actual count is 75. These 3 extra units (that don’t exist) become ghost inventory, leading to incorrect reorder points, potential stockouts, and unhappy customers.

Shrinkage caused by shoplifting, theft & fraud

The National Retail Security survey saw retail shrinkage hit an all-time high in 2020, accounting for 1.62% of brands’ bottom lines and costing retailers a whopping $61.7B.

When merchandise is stolen or goes missing, it disappears physically — but it’s still counted in your inventory management system. This inevitably throws off your stock levels and inventory optimization efforts (AKA, your endeavors to keep only the stock you need on hand).

While it’s less common, inventory shrinkage can also be caused by vendor fraud. Meaning, a supplier might send less than initially promised on your approved purchase orders (but still show the agreed-upon amount on the invoice). This can be intentional or unintentional (like if the PO’s order accuracy was off). Luckily, 3-way matching should quickly catch this phantom inventory either way.

Damaged merchandise

No matter how well your supplier packs and ships products, some items will still arrive damaged. Typically, these items should be discovered when the shipment arrives at your warehouse. However, if these items go undetected, you end up with unsellable items on your shelves. And you unknowingly have less inventory to meet demand.

Alternatively, items can also be damaged when they’re not stored properly. For instance, LuLaRich had a stinky legging scandal when some of their merchandise was held outside, exposed to the elements, and left to grow mold.

But its damaged inventory isn’t always in your brand’s control. Some products get shipped to customers up-to-par and returned in a below-standards condition. As a result, these items typically live in “inventory purgatory,” where they take up warehouse space but can’t be resold.

Inaccurate inventory audits

Inventory audits should keep inventory data reconciled and correct. But like anything with a human operator, there’s still room for error. These miscounts or misreports (like skipping over a damaged item) muddle inventory data and throw off your next replenishment.

That’s why you generally want a minimum of 2 people running each inventory audit. One to count and the other to check that count. While seemingly small, this extra step can massively improve the accuracy of your inventory records and prevent ghost inventory.

Inaccurate inventory sales records

When an order gets fulfilled but isn’t scanned properly or marked as sold, it still shows as “in stock” in the system. Frequently, a flawed process for recording sales or a faulty inventory management system is the root cause.

For example, let’s say you sell 2 of the same product in different colors. But you only ring up one SKU twice because they’re the same price and forgo scanning each separately. This will skew stock levels for both colors and create phantom inventory for the color you didn’t scan.

The impact phantom inventory has on your retail operations

When left unchecked, phantom inventory impacts your in-store availability, which wreaks havoc on your sales, revenue, and financial health. Here are the biggest consequences of poorly managed phantom inventory.

Delayed automated reordering

The biggest impact of phantom inventory is when they create discrepancies between your digital records and actual product availability. These mismatches can delay automated reordering and stunt inventory turnover (since your system says there’s more inventory than there is).

For instance, let’s say your reorder point (ROP) is set at 30 units, but 10 of those units are actually phantom inventory. This means your ROP won’t hit at the proper time, and you won’t have enough stock to meet forecasted demand (leading to stockouts and lost revenue).

Stockouts or overstocks

When you believe you have more inventory than what’s available, there’s less merchandise to meet demand. This leads to stockouts, whether they’re caused by delayed reorder points, inaccurate replenishment counts, or inventory breakage.

On the other hand, phantom inventory can also create overstocks from mismanaged returns. Because when returns aren’t properly entered into the inventory management system, you end up with SKUs you got back (but your system thinks they’re still with a customer).

Whether that item is sellable or not, it requires storage space and sucks up holding costs. And enough of these can lead to overstocks because you have more inventory than your records show.

In other words, this phantom inventory causes you to over-forecast what you need (assuming the returned merchandise still meets the brand’s standards and can be resold).

Bad customer experience

Let’s say an excited customer comes to your site to buy a product they’ve been eyeing for days. They add the item to their cart and go through the entire checkout process. But because there’s a mismatch in your records, they receive a refund and apology instead.

In this scenario, your brand not only misses out on the individual sale but also the long-term relationship. Why? Because 33% of customers will switch companies immediately after 1 bad experience.

Lost sales and revenue

Admittedly, a few units of phantom inventory might not seem concerning at first. But these units quickly add up, resulting in really bad data over time.

This unreliable data makes it nearly impossible to make smart inventory purchasing decisions for your brand. And when (note: not “if”) you end up ordering the wrong products at the wrong time, you’ll lose out on sales or eat away at your profit margins.

For instance, say you constantly have stockouts from ghost inventory. When that happens, you lose the opportunity to make a sale at that moment — but you also weaken your customer lifetime value (CTV) long-term. That’s because stockouts deter customers from returning again in the future.

🔥 Tip: Stocking out doesn’t have to mean missing out on one-off revenue. Instead, sell on backorder with Cogsy. Backorders convert at nearly the same rate as selling that same product in stock. Learn more.

Reduced forecasting accuracy

As you already know, if a SKU isn’t properly tracked when it’s sold, it still shows up as “in stock” in your real-time inventory records.

And when your records don’t match your physical inventory counts, it’s impossible to have inventory accuracy. This disrupts your forecasting efforts and makes it difficult to meet demand properly.

For instance, let’s say your inventory management system says 18 units, but your physical stock is actually 10. The upcoming forecast says you need 20 units to meet demand. But because of the bad data, you only order 2 units (instead of 10) and run into stockouts later.

How to deal with phantom inventory

Improving inventory visibility is the best way to detect and deal with ghost inventory. Here’s how brands can comb through their data and recount their stock as accurately as possible.

Conduct physical counts and cycle counts

The most common solution for phantom inventory is to physically count your stock and check it against your records. This way, you can catch when damaged goods, inventory shrinkage, and potential fraud — while ensuring inventory accuracy.

There are 2 approaches for inventory reconciliation:

1. Physical counts require brands to count every single item in inventory once or twice a year. It’s a cumbersome job that requires a lot of manual work, but it’s effective for reconciling records.
2. Cycle counts are when brands count small samples of inventory at a time, auditing their entire inventory over time. For instance, if a brand performs quarterly cycle counts, it’ll audit a quarter of its merchandise each cycle to ensure it counts all of its stock by the end of the year.

Ideally, brands combine these practices. They conduct perpetual inventory cycle counts throughout the year as spot checks. And they do a full physical count annually or semiannually to fully audit their inventories.

Why? Because generally, the more often you count, the more accurate your inventory records are, and the sooner you can address potential phantom inventory problems.

For example, say you catch 10 units of ghost inventory in your March cycle count. If you only ran an end-of-year physical count, you wouldn’t have discovered this issue until December. At that point, not only is there likely more phantom inventory, but you’ve likely invited bigger problems — like stockouts, lost revenue, and inaccurate forecasts.

Analyze POS data

Your point-of-sale (POS) system is the second-best resource to detect and prevent phantom inventory. Why? Because all you need is a quick scan to see where discrepancies arise.

Most POS systems track when you receive and sell inventory, as well as your returns and exchanges. This also includes how many units you have of each SKU and per storage location.

Ecommerce retailers can compare their sales and inventory data to spot any discrepancies that led to phantom inventory. For instance, say you ship 15 shirts from one warehouse to another, but only 13 show up. Sometime during that transfer, 2 units went missing, and the discrepancy started.

Unlike cycle counts and physical counts, analyzing your POS system allows you to identify when and how your ghost inventory came to be. But similarly, this initiative takes time and can be prone to human error.

Use inventory management and analytics software

Your best bet for spotting ghost stock? Using inventory management and analytics software that does the detective work for you (and notifies you right away of any problems).

Unlike manual data entry or counts, these solutions use artificial intelligence to constantly compare real-time inventory data against sales records and historical trends. Plus, with machine learning, they consider hundreds of other data points to spot potential phantom inventory. The ML models perform this all by working undisturbedly on the quality data they have been trained on.

🤿 Dive deeper: Compare the top 7 real-time inventory software.

How Cogsy helps DTC brands reduce phantom inventory

When brands leverage Cogsy to track their inventory management, they improve data accuracy to proactively prevent phantom inventory — here’s how:

• Cogsy monitors your inventory levels in real-time to ensure data accuracy
• More accurate data fuels better demand forecasts, which optimizes stock levels
• Low-stock alerts raise red flags for out-of-stock products and trigger investigation

Plus, with Cogsy’s multi-location support feature, you can accurately forecast demand and monitor inventory at individual warehousing locations (as well as holistically). This enables brands to track in-motion inventory — whether it’s an incoming shipment or inventory moving from one warehouse to another.

As a result, you always know where your units are located, ensuring better inventory visibility and decreasing phantom inventory. This next-level accuracy supports smarter decision-making and optimized stock levels for your brand.

Want to see how Cogsy can help you prevent phantom inventory?