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Blockchain and Shrinkage: Building a Supply Chain with Reduced Risk

Inventory is constantly moving in the supply chain. From the time you order raw materials to final delivery, and even to the point of the warranty becoming null, the supply chain is reaching beyond the walls of your factory and warehouse. Many companies implement state-of-the-art systems to try to reduce shrink but fail in a keyway. Across the US, there are many companies still using paper or a spreadsheet to control, or lack control, over their inventory.

There’s a new buzzword in tech sitting next to machine learning and artificial intelligence. With a lot of the hype around blockchain, there are many misconceptions around it. This includes confusion with Bitcoin and only financial companies can use it. Blockchain has produced a secure and transparent way for the financial and insurance industries to record business transactions, but with the evolution of this new ledger technology, can the supply chain be revolutionized by Blockchain technology?

Supply Chain Traceability

Shrinkage costs businesses tens of billions of dollars each year. While internal and external theft is major components, loss of inventory due to administrative errors and unknown causes account for a large amount of shrink.

Administrative errors are among the leading causes of shrink in the supply chain. While many companies have moved to digital tracking, it still may not be error proof enough to track issues or trend previous issues to predict where, when, or why a problem may occur. These errors can be as small as leaving out commas, which is still a huge issue, to double orders of raw materials right up to failing to properly log a pallet of goods. Each of these, no matter how small an error, can have a huge impact on your COGS on your income statement at the end of the year.

Unknown causes for inventory issues accounts for approximately 6% of shrinkage according to the Corporate Finance Institute. This is when your numbers just don’t match and there’s no explanation. This could be error or theft.

These errors can be reduced greatly using blockchain. The nature of blockchain almost matches what is missing from proper supply chain management. Using blockchain for inventory control will give management or auditors the ability to look down the chain and see what error caused inventory shrinkage. Traceability gives accounting the best advantage to do quick and thorough audits of inventory during normal audit times or in the event of an issue.

There’s a case to use blockchain for each type of administrative error. By allowing each transaction to be traced easier than paper or other software, errors involving mistypes, such as forgotten commas and periods, can easily be caught and corrected. While each block is immutable in a public chain, in a private chain a new block will be created with a new hash to show the block was corrected. The private chain can be programmed to allow for error correction with safeguards being implemented for fraud detection with accounting and operations. This also holds the auditor and the original block creator accountable for the transactions.

Issues such as double orders can be caught with proactive monitoring by accounting or managers and stopped prior to being placed into stock. By limiting the creators of blocks, errors in double entry and other clerical errors can be avoided while maintaining transparency for viewing the blocks.

Image with various keywords for blockchain arraigned in a pattern

By giving your inventory unique blocks, this may help alleviate much of the unknown factors to inventory shrinkage. By giving managers and accounting a point to start an audit or investigation, the shrink can be corrected or allocated to the appropriate account for balance sheets and income statements.

Fraud and Compliance

Fraud can be a huge issue within the supply chain. The traditional supply chain is extremely complex and has many holes and areas where fraud can take place. Using paper and manual inspection of inventory through the supply chain leaves your stock open and vulnerable to records manipulation, theft, and other forms of fraud.

Record manipulation can be used to hide fraud and theft by changing key numbers in inventory records. Changing quantities of goods on hand, sold, ordered, or moved to a waste account can cover the theft of a product. This leaves unaccounted for loss in revenue due to accounts payable spending for a product that has vanished or never received. While a large-scale theft will eventually be caught, a large supply chain losing a few pieces a quarter can take years to track.

Immutable blocks can help to prevent and detect these types of fraud and theft earlier. First, changing a block changes the hash ID and breaks the chain. This allows for others with access to detect and investigate the break. This can have a huge effect on the mindset that manipulation of transactions won’t be detected. It also allows for quick auditing and physical security measures to correct and set up to prevent further attempts. Second, with a closed ledger, the amount of personnel that can access the chain is reduced. This can help to properly screen and monitor those with access.

Another issue with the supply chain comes with the FDA and the 2013 Drug Supply Chain Security Act. This requires an end to end electronic, interoperable system built to trace and identify certain prescription drugs from the manufacturer to the consumer.

Blockchain can be used for this as well. Audits and tracing by the FDA or investigators can be done in a fraction of the time using blockchain. The ease of tracing along with the transparent nature of blockchain can help alleviate many of the obstacles brought on by the time it takes to conduct audits and investigations. Also, as stated above, the immutable and closed ledger systems of blockchain can greatly reduce fraudulent transactions and potential regulatory violations.

Blockchain in the Food Supply Chain

Beyond Bitcoin, finance and keeping track of non-perishable inventory, blockchain has huge implementation in the food supply chain to reduce waste and keep with FDA compliance standards for tracing food up and down the supply chain. You not only save on your bottom line, but you can also keep current with safety standards and keep a socially responsible persona for your company.

Each year we see recalls for various food items due to contamination, foreign particles, foodborne illnesses, or other pathogens. The FDA passed the Food Safety Modernization Act in 2011 which requires each step in the food supply chain to have the “one back, one forward” approach to tracking the last and next point in the supply chain. While this helps to investigate the source of the contamination, it is a lengthy process to track each point one step at a time. A great example is the romaine lettuce recall from 2018 which took two months to track the source of the contamination but not before leaving infecting 210 people in 36 states according to the CDC.

Blockchain can help reduce the time it takes for agencies to narrow and pinpoint the point of contamination. The current approach to one back, one forward, can be expanded through the entire supply chain reducing the time it takes to investigate. Blockchains immutable time stamp can pinpoint points of interest in the investigation. This can reduce the spread and amount of people affected by an outbreak significantly. The source can be shut down and the appropriate actions can take place to stop and prevent a future outbreak or contamination. Blockchain can have a huge impact on saving lives and risk reduction.

Waste from product spoilage and miss-shipped inventory account for a large amount of shrinkage each year to US companies. Blockchain’s timestamps can help to keep better track of inventory. This allows for proper rotation, storage, and shipment of perishable goods allowing for more good product shipped and more revenue due to the reduction of shrink.

Using the standard bill of lading systems, inventory is counted and matched to the paperwork without knowledge from a receiving department of the initial order. The inventory may then be stored and wait to be shipped from the distribution facility or stocked. The time from original shipment to the identification of the error in the order creates the perfect environment for waste and will cost on COGS and re-order. Blockchain can allow for the original purchase to the point of sales to be recorded and readable. Receiving can then match the order block to the bill of lading and then the actual product. This reduces time stored and prevents loss from spoilage of perishable inventory. Having a transparent system from purchasing to receiving allows for the reduction in errors.

Conclusion

While blockchain is still a new technology and has a stigma of dark web criminals and Bitcoin, the truth is, blockchain can be used to secure and prevent fraud and shrink within your companies supply chain. The key features of blockchain make it a technology that you may want to research to see how it can help revenue and give a great ROI by saving time and money on shrinkage and auditing your supply chain.


To learn more about blockchain, email us at info@coveycs.com or call us today at 315-738-6016. We are a software company specializing in custom software and integrations, cloud technologies (AWS Certified), blockchain, and staff augmentation. We work with startups to global corporations in manufacturing, insurance, finance, defense, and cybersecurity. Contact us today for more information on how we can help start, grow, or make your business more efficient through our software solutions.