Quantcast

Former Managers Allege Pervasive Inventory Fraud at Walmart. How Deep Does the Rot Go? | The Nation

  •  

Former Managers Allege Pervasive Inventory Fraud at Walmart. How Deep Does the Rot Go?

  • Share
  • Decrease text size Increase text size

(AP Photo/Damian Dovarganes)

In 2012, Erica Davidson, a Walmart veteran and store manager, took on the daunting task of turning around a struggling store on the outskirts of Greensboro, North Carolina. The store had run through its share of managers, Davidson said, and she viewed it as the sort of challenge that could make or break a person’s career.

Davidson said that one of her primary tasks was to reduce the troubled store’s high rate of “shrinkage”—defined as the value of goods that are stolen or otherwise lost—to levels deemed acceptable by the company’s senior managers for the region. As a result of fierce competition, profit margins in retail can be razor thin, making shrinkage a potent—sometimes critical—factor in profitability.

Prior to her arrival, Davidson said, the Greensboro store could see annual shrinkage losses as high as $2 million or more—a sizable hit to its bottom line. There had even been talk of closing the store altogether, she recalled.

For years, Walmart’s senior management in North Carolina had been waging a war on shrinkage, Davidson said; it had become a central priority of the company’s local leadership and a source of constant strain for store managers. Though the unrelenting pressure weighed on her, Davidson said she became an asset in Walmart’s battle against shrinkage—so much so that, in 2011, the North Carolina regional team named her a “subject matter expert” on reducing shrinkage and would send her to meetings in the Walmart regional office in Charlotte. There, she recalled, she would train district managers on her practices in the presence of the company’s most senior officers for the state.

The only problem, Davidson said, was that her superiors’ preferred methods for improving this vital metric were not always aboveboard; they included an array of improper techniques to conceal shrinkage losses and make the inventory numbers—and profit margins—look better on paper than they were in reality.

According to Davidson, inventory results that “should have raised red flags” were actually lauded by those significantly higher in Walmart’s regional chain of command. One recently departed senior vice president, for instance, would send her handwritten notes commending such numbers, she said.

“Those things were just like money in the bank to them,” Davidson told The Nation. “It was like, oh, great job. There was never any accountability or any investigation that went into why—not just in my store but in any store throughout the region.”

Then, in late summer of 2013, all of that came screeching to a halt, Davidson said.

During the last days of August, Davidson’s annual inventory audit showed a massive reduction in her new store’s shrinkage rate that surprised even her: down to less than $350,000 from roughly $2.1 million the previous year, she said. In the days that followed, however, none of the usual praise for delivering spectacular numbers came showering down from her superiors. Davidson knew then that something was amiss: “There was none of that ‘rah-rah, congratulations’ stuff that I got the previous years,” she recalled.

Soon Davidson would learn that company fraud investigators had arrived in the state to examine allegations of irregular inventory accounting. In response to detailed questions from The Nation, Walmart spokeswoman Brooke Buchanan acknowledged for the first time that the company is conducting a “thorough review” of “store level processes,” though she didn’t elaborate on the scope or details of the review.

As the investigation continued into 2014, a number of Davidson’s superiors departed from the company. Ronny Hayes, the head of Walmart’s North Carolina operations, retired; so did his superior, Henry Jordan, who led the company’s massive Eastern Seaboard Division. Walmart’s regional asset-protection manager for North Carolina, who was intimately involved with inventory tracking in the state, was fired in May, according to a number of sources. The reason for their departures is unknown, and Walmart did not respond to questions from The Nation regarding why they are no longer with the company.

Davidson was also fired in May, after nineteen years at the company, as was Victor Hernandez, one of her co-managers (or “shift managers”) at the Greensboro store. The reason for Davidson’s firing was listed as “Gross Misconduct–Integrity Issue,” according to an exit-interview form she shared with The Nation. Davidson, however, believes that she is among the casualties of an effort by Walmart to clean house and thereby limit its exposure to allegations of accounting fraud. She said that her superiors within the company’s Eastern Seaboard Division tolerated and even encouraged managers to falsify inventory accounting records to hide shrinkage losses.

Hernandez, Davidson’s co-manager, supported these allegations in conversations with The Nation, as did a third manager who works at a different North Carolina store and wished to remain anonymous. All three stated that irregular inventory accounting practices pervaded Walmart’s operations in the state. They also said that based on what they had seen on an internal company database containing the inventory numbers for thousands of Walmart stores nationwide, peculiar inventory numbers do not appear to be confined to North Carolina alone.

The three managers’ comments buttress the account given to The Nation last year by Sylvester Johnson, a former Walmart district manager who was once Davidson’s boss. Johnson alleged that Walmart’s regional leaders in North and South Carolina often set inventory targets that were impossible to meet ethically, and that they commonly pressured managers into using misleading accounting tricks to conceal shrinkage losses in order to achieve such numbers. These reduced “shrink rates,” Johnson claimed, artificially inflated the profitability of stores on a large enough scale to boost the company’s bottom line.

Johnson was fired by Walmart in 2009, after which he filed an unsuccessful discrimination suit alleging that improper inventory accounting was pervasive at the company and that he had been singled out for termination because he is black. Walmart has previously denied these allegations.

It is unclear how far the inventory accounting practices described by Johnson, Davidson, Hernandez and the anonymous manager extend beyond North Carolina. However, conversations with several former managers who worked in states ranging from Georgia to Idaho suggest that the problem might reach deeper into the Walmart empire.

Most of the managers interviewed said that irregular accounting practices concealed shrinkage losses and were an effort—tolerated and even promoted by their superiors—to inflate the stated profitability of stores. Several, however, offered a different interpretation of events. One former assistant manager spoke of the irregular accounting that resulted simply from low staffing levels, causing overstretched employees to fabricate inventory numbers because they didn’t have time to perform a proper count of physical merchandise. And a former district asset-protection manager said he had never seen tolerance of inventory irregularities of any kind while working at Walmart.

Among the big questions raised by these allegations is whether irregular inventory accounting practices are widespread and systemic throughout the company, or the result of a few local rogue operations. And, if the practices are widespread—and not corrected for on the company’s financial statements—are they significant enough to inflate the company’s profitability and, in the process, its stock price?

When asked to respond to a list of questions regarding allegations of irregular inventory accounting, Walmart spokeswoman Brooke Buchanan responded with a brief statement:

Walmart takes allegations of improper conduct seriously and we have strong programs in place to prevent, detect and remediate issues that may arise.

We have initiated a thorough review of our store level processes to help ensure we have the right policies and controls in place.

The review is ongoing and it would be inappropriate to comment until its conclusion. Through the course of our review, appropriate action will be taken if it is determined that there are areas where we can strengthen our systems or if any associate violated our policies or procedures.

Walmart’s statement aligns closely with comments made by the North Carolina managers interviewed for this article, who said that the company appears to be taking measures to correct the problems. Yet much uncertainty remains. As the review continues, perhaps the most pressing question is how it will play out. Will it be an exercise in scapegoating, with a handful of lower-level managers taking the fall, or a real attempt to address any improper practices?

The Enemy of Profitability

In his 1992 memoir Made in America, Sam Walton, Walmart’s legendary founder, penned a brief indictment of shrinkage. “Shrinkage, or unaccounted-for inventory loss—theft, in other words—is one of the biggest enemies of profitability in the retail business,” he wrote with his trademark vinegar.

Walton was not wrong. The National Retail Security Survey has pegged shrinkage losses at roughly $35 billion a year in the retail industry, and even a 1 percent shrinkage rate at a company like Walmart can cost it billions a year. Yet Walton’s response was notable by the standards of the time: to combat the shrinkage threat, he instituted a “shrink incentive plan” in 1980, which consisted of setting rigorous company-wide shrinkage goals. If the workers at a given store beat these goals—by banding together to keep sticky fingers in check, both within their ranks and outside them—they were awarded bonuses of as much as $200.

“This is sort of competitive information,” Walton confided, “but I can tell you that our shrinkage percentage is about half the industry average.”

More than twenty years later, analysts believe that Walmart continues to have a below-average shrinkage rate. Although the retailer doesn’t publicly report its exact shrinkage numbers, in both 2009 and 2010 Walmart cited favorable shrinkage results as among the primary drivers of its increasing profit margin. At the same time, Sam Walton’s aggressive goal-setting approach remains a hallmark of the company, part of the model that has catapulted Walmart to its position as the world’s largest corporation and the United States’ largest private employer.

Yet the company’s famously hard-driving management goals have also come at a cost. Labor groups have long complained that the company issues meager payroll targets that force managers to underpay hourly employees while simultaneously trimming their hours. More recently, The New York Times uncovered a bribery scandal in Walmart’s Mexico operations that allegedly stemmed, in part, from the company’s overambitious efforts to dominate the Mexican market. In its article exposing the scandal, the Times quoted a whistleblower saying that “very aggressive growth goals” pressed managers to do “whatever was necessary” to obtain permits to build new stores. Walmart is now under criminal investigation by the Justice Department for possible violations of the Foreign Corrupt Practices Act.

Former managers told The Nation that Walmart has employed a series of incentives, both negative (such as firing) and positive (such as promotion and the aforementioned bonuses), to compel managers to meet or exceed their shrinkage targets. Indeed, Erica Davidson alleged that producing favorable shrinkage numbers could make a significant difference in a manager’s yearly pay, and that a high shrinkage rate could jeopardize a store manager’s bonus.

“If your store ‘shrinks out’ [reports unacceptably high shrinkage], then you don’t hit your target; then you don’t hit your P&L [profit-and-loss statement] for the year,” Davidson said. “Shrink is a huge part of it.”

One obvious way to reduce shrinkage is by preventing theft, and Walmart stores have “asset protection” personnel on staff to keep too many goods from walking out of stores. However, the managers interviewed for this article said that they also have access to a number of inventory tricks that can help conceal shrinkage.

One of these, according to Davidson, involves simply declaring that missing items are not in fact missing. “You could go to the hardware counter and count screwdrivers,” Davidson explained, “and if the on-hand count was off—as in, you were supposed to have five but you only had two—you could say, ‘Well, we used those missing three in the store, for store operations.’ They were probably actually stolen, but you’re telling the system that you have possession of them and that you’re using them in the building. That way, you take them out of your financial inventory and you’re accounting for them so that, on inventory day, you’re not going to shrink on those items that are missing.”

Another basic way to pad an inventory count to hide losses—and a method that several former managers spoke of—involves manipulating changes in the price of merchandise, especially during Walmart’s famous “markdowns.” In its most stripped-down form, this approach involves managers going into their stores’ computerized inventory system during a markdown on a batch of items and then reducing the computer value of that merchandise by an excessive amount. What’s critical is that the managers slash the value of the merchandise in the inventory system more than they slash the actual price that consumers pay for those goods at the register. The result is that the value of that batch of real, on-hand merchandise can be more than the value listed for that batch in a store’s financial books.

“It’s not like it was a secret or it’s hard to do,” said Davidson. “Any salaried manager has access to that [inventory] screen.”

Such tricks, according to former managers like Davidson, often caused certain departments in a store to see inventory “overages.” An overage occurs when a batch of inventory expands—on paper, at least—to become larger than was ever supposedly shipped to the store in the first place. This unaccounted-for growth of goods is generally a sign of counting errors or the manipulation of inventory numbers.

“Significant overages, or overages at all on any consistent basis, don’t quite make sense,” explained Michael Stevenson, former treasurer and vice president of finance at the apparel retailer Abercrombie & Fitch. “If you’re over one or two items or a hundred bucks in one department just one time, that’s not a red flag. But if there are overages consistently, count after count, whether it’s a hundred bucks or a thousand bucks, that would be harder to chalk up to human error; that would raise [the need for] an investigation.”

Several managers told The Nation that overages were commonly seen in the stores’ most seasonal product categories, such as apparel or lawn and garden, which were subject to frequent price changes and thus offered more opportunities for manipulation. Such overages, they said, were essentially used to offset departments that had higher shrinkage in order to reduce a store’s overall shrinkage rate. Stevenson, who is now a partner and forensic accountant at Clarus Partners in Columbus, Ohio, confirmed that consistent overages could have the effect of reducing the overall shrinkage rate at a given store and could even affect its reported profit. (It is worth noting that managers interviewed for this article said that inventory numbers are tabulated by third-party auditors, like RGIS, whose job is simply to take the count, not to scrutinize the integrity of the results, they said.)

When asked about these overages by Sylvester Johnson’s lawyers during a 2012 deposition, a divisional asset-protection director named Art Binder conceded that there were apparel overages at Walmart. “As a company, we have experienced some overages in apparel departments in most stores,” Binder said, “and the company cannot understand why those overages are there. So there’s a case of an unexplainable overage.”

Beyond North Carolina

Cody Champagne told The Nation that during his six months working as an assistant manager at a Walmart in Fort Worth, Texas, he saw unusual accounting practices. They bore a distinct resemblance to those described by the managers who worked more than a thousand miles away in North Carolina.

Champagne referred to these practices as “the madness” and said fellow managers at his store tolerated and even encouraged unethical inventory accounting. These practices, he asserted, contributed to his leaving Walmart in 2012. Champagne said he suspected that the odd inventory accounting was not only misrepresenting his store’s profit margin but—worse for his day-to-day work life—was constantly thwarting his team’s efforts to maintain a proper count of the merchandise and keep the shelves stocked. “I’m someone who believes that rules exist for a reason,” Champagne said. “And when you’re not being honest about your inventory, you’re lying to a lot of people.”

Champagne said that the store’s unusual accounting practices led him to access the company’s central system of inventory records. He said he was astonished by the consistency of suspicious numbers across stores—specifically, the regularly occurring overages in “soft line” categories such as apparel. “That was the straw that broke the camel’s back,” he said. “It put everything in perspective for me. I didn’t even dig much deeper because, at that point, I knew I was going to leave the company.”

Please support our journalism. Get a digital subscription for just $9.50!

Champagne believes that, although occasional overages can be explained by one-off accounting errors, there is no excuse for consistent overages. “How in the hell you grow inventory like that?” he asked rhetorically. “You can’t. Inventory doesn’t do that—or at least it shouldn’t—but it was happening across the board.”

The people that he worked alongside would sometimes even directly indicate that they were concealing losses, Champagne added: “If we were missing a high-ticket item, like a thousand-dollar TV, they’d say, ‘Oh, don’t worry about it—we’ll make it up at the end of the year with clothing.’”

According to Champagne, he perceived his store’s irregular accounting practices to be the result of the unintended effects of understaffing as well as deliberate efforts to falsify the inventory records. To Champagne, much of the corner-cutting he described came down to employees’ and managers’ seeking to look good on Walmart’s detailed employee performance evaluation reports, called “scorecards.” He is unsure whether the accounting tricks were part of a concerted effort by the company.

“It’s a chicken-and-egg question,” Champagne said. “Did the company passively sign off on these practices by not correcting them, or did they actively promote them? I don’t have the answer to that.”

Vikki K. Gill said that misleading inventory accounting was a common practice throughout the five states in which she managed Walmart stores. She said that her superiors induced the practice by forcing stores to meet unrealistically low shrinkage targets, which were impossible to achieve without manipulation.

“To ‘shrink out’ was a career-ending decision,” said Gill, who left Walmart in 2009 and now works for the United Food and Commercial Workers’ campaign to press Walmart for higher wages and better conditions for its hourly workers.

Gill said that her superiors pushed improper inventory accounting through an almost daily series of winks and forceful nudges. “When there was no one around,” she recalled, “they would tell you: ‘You know what you need to do. Now go do it. And if you have a problem with it, find another job—you’re paid well for this.’” Achieving targets not only protected managers from firing or demotion, Gill said, but also contributed significantly to the tens of thousands of dollars that the managers could receive in bonuses.

Gill said that, in her experience, it was common practice for managers to use price changes to create inventory overages in seasonal categories to bring down a store’s overall shrinkage rate. “Cosmetics, electronics and sometimes sporting goods were high-shrink,” she explained. “The departments that you could create overages in were the seasonal categories, where it was easier because they weren’t followed or watched as much—you never got in trouble for an overage.” Gill said the dynamic was similar during her time managing stores in Idaho, Illinois, Mississippi, Oklahoma and Missouri.

Karen Youstin said that during nearly two years as a Walmart district manager in Georgia, she was mystified by the unrealistic inventory targets that the company set for her stores. She felt the goals couldn’t be met through ethical practices. “What they wrote on paper and what my boss told me I needed to achieve were completely different,” Youstin said. “I would ask my boss how on earth I would do this with this number of people. She just said: ‘Muscle through it.’ I still don’t know what she meant by that.” Despite this, Youstin said she never witnessed inventory fraud at Walmart.

Chaos Theory

Last year, Bloomberg News reported that Walmart’s inventory management was in shambles, with too few employees to carry products from the stores’ back rooms to the sale-floor shelves. Interviews conducted for this article indicate that this may be only part of the picture, and that employee shortages might be contributing to the stores’ inventory accounting woes as well. Several managers interviewed for this article repeated the point that Walmart’s high-tech inventory tracking system is only as good as the numbers it receives.

One former assistant manager, who worked at Walmart stores in Georgia and South Carolina and wished to remain anonymous, said that, as with Cody Champagne, dishonest inventory accounting helped drive him from the company. Yet he was unsure whether the irregular accounting that he described had any effect on his stores’ profitability, and he never saw inappropriate markdowns or deliberate “padding” of inventory. Rather, he said, understaffing created a situation in which employees simply had no time to take an accurate count of inventory. These physical counts of goods—often required each time a line of merchandise changed in price—would be fabricated in order to save time, he said. Often, the person conducting the inventory count would simply take the number of items that the computerized system had listed for the sales floor and then manually enter that number as the up-to-date physical count, he said.

“When you punch in those wrong numbers, the system no longer knows what you really have,” this former assistant manager pointed out. Like Champagne, he also observed that inaccurate information entered into the company’s inventory system caused almost daily operational headaches, including problems with properly stocking shelves. “There are times when you audit a bin and [the system] tells you there’s nothing in there, and [the bin] is stacked with items. Calling it chaos is an understatement.”

One of the interesting paradoxes raised by these staffing cuts is that, as Walmart has trimmed its workforce, including the greeters and other workers who keep an eye on merchandise, one would expect to see theft—and therefore shrinkage—rise. And in fact, John Marshall, a financial analyst at the United Food and Commercial Workers’ Capital Stewardship Program, told The Nation that “over the past few months, hundreds of associates from all over the country have reported to us that shrink is a significant problem in their stores—in areas including electronics, grocery, apparel and pharmacy, among others—and that it has been getting worse due to staffing cuts.” Yet Walmart hasn’t cited shrinkage as a problem in recent years, raising the question, once again, of how the company has managed to keep theft losses in check.

For J. David Fuller, a former Walmart district manager of asset protection, inventory manipulation had nothing to do with it. In an interview with The Nation, Fuller stated emphatically that he never saw any tolerance for inventory padding or even consistent overages. “In my many years with the company, up until I left in 2009, I never saw any such thing at Walmart,” he said.

Fuller, whose job as an asset-protection manager required him to keep a keen eye on the stores’ inventories and anti-theft protocols, worked in Nebraska, New Mexico, Texas and even Brazil during his tenure with the company. Fuller said that he was intimately involved with the mechanisms by which such fraud would have to take place, and that there were simply too many people within the company aware of the inventory numbers for such widespread manipulation to be plausible. “There can be isolated incidents of this,” Fuller said, “but it is not an endemic issue.”

Fuller said that in his seventeen years with Walmart, he had firsthand knowledge of only one manager’s cooking his books in the manner described by Davidson and others—and that manager was swiftly fired. At the time he left, Fuller added, the company expected its store managers to keep their shrinkage under 0.8 percent of sales. Fuller called this a “stretch” for some stores, but stipulated that it was not impossible to achieve through ethical means.

Fuller said that he never saw consistent overages in the product departments at Walmart, but he agreed with the basic premise that overages are either the result of error or intentional manipulation. He said that at Walmart persistent inventory overages would likely be investigated.

A Brief History of Manipulation

Walmart is not the only retail company that has been accused of distorting shrinkage numbers through mechanisms like inappropriate price changes.

According to Thomas Yake, a retail and financial consultant based in Kennebunk, Maine, who has served as an expert witness on inventory accounting issues for the Securities and Exchange Commission and the IRS, shrinkage figures are an especially easy way for companies to falsely boost their bottom lines. Yake said there is precedent for other retailers massaging these numbers.

The discount retailer called Zayre, which was sold to Ames in 1988, is a prime example. Yake worked at Zayre from 1964 to 1973 and said he saw the inventory manipulation happening firsthand. “In later years at Zayre, this system, which centered on manipulation of ‘the shrink figure,’ became more refined and better orchestrated,” Yake wrote in a newsletter he published roughly two decades ago. “To a great extent,” he continued several paragraphs later, “the store managers’ job performance was evaluated according to their ability to manipulate the shrink figure. Some were so successful that stores actually showed large overages in merchandise—a ‘positive shrink’—at year end!”

Yake said that, as a consultant in the 1990s, he worked on a case involving F.W. Woolworth Company, which he said was distorting its inventory figures to prop up its faltering bottom line. Woolworth stores commonly saw total-store overages while the manipulation was occurring, Yake recalled. However, a major problem with obscuring shrinkage numbers is that it doesn’t help a company over the long term and can even cause shrinkage to run rampant, because management remains in the dark about much the company is actually losing.

According to Charles Mulford, the director of the Georgia Tech Financial Reporting and Analysis Lab, if such overages do exist at a large retailer, the business should—and likely would—correct for such errors on its annual financial statements, which are inspected by third-party auditors. “When it comes to the annual financial statements, that physical count is so important,” Mulford said. “The auditors are going to spend a lot of time making sure that’s a good number.”

Even so, a number of other publicly traded companies have been charged with misreporting inventory figures and profits. In 2002, the Securities and Exchange Commission cited the pharmacy chain Rite Aid for distorting its inventory accounting and misreporting its shrinkage figure by failing to disclose roughly $13.8 million in losses. It was part of an elaborate stew of schemes that the company’s top executives had conceived to understate the chain’s expenses while overstating its income. Rite Aid settled with the SEC, and several executives pleaded guilty to a host of criminal charges brought in a related Justice Department case.

Fall Guys?

When The Nation spoke with Victor Hernandez, one of Erica Davidson’s co-managers at the Greensboro store, he was still reeling from losing his job over a practice that, he said, did not start with him.

“I was following direction from above and then I got fired for following that direction,” Hernandez said. “This is how we were doing it for the nineteen years I was with the company. Those inventory numbers are visible within the company—everyone knew what we were doing.”

Hernandez felt that because top regional managers were aware of the irregular accounting, it seemed useless to question the ethics of the arrangement. “[They] knew—so where do I go? Who was I going to ask?” he said.

Hernandez also said that before the company abruptly decided to root out the accounting irregularities, he was never given a chance to correct his inventory practices. “They could have come down and said, ‘Look, stop what you’re doing or we’ll fire you,’” Hernandez said. “But no one ever told us to stop. Throughout my whole time at the company, as long as you had an overage [in some] departments, you were good.”

Davidson recalled that there was just one moment in her time with Walmart—in 2009, shortly after the company had fired Sylvester Johnson—when she was told to use restraint in applying markdowns. The order came, she said, from Art Binder, the asset-protection director who had testified against Johnson. Davidson said she complied with Binder’s directive and, in short order, her store’s shrinkage rate rose to a higher level.

Within a year, however, Binder was promoted to director of asset protection for the Eastern Seaboard Division and, with the arrival of North Carolina’s new management team, Davidson said, she was told to ignore Binder’s warning and was again under heavy pressure to conceal inventory losses. She said she felt that refusing to comply with this new directive could imperil her job.

But the tide may be shifting in Walmart’s North Carolina operations, if not beyond; according to Davidson, the company appears to be determined to show that it used aggressive measures in dealing with improper inventory accounting.

“I think they’re trying to avoid issues with the SEC or whoever else may get involved with issues of inventory inaccuracies,” Davidson said. “So they’re doing whatever they can to show that they held people accountable, even if it wasn’t for just cause. They’re putting forth the effort—or at least making it appear that they did.”

Spencer Woodman is a freelance writer based in New York. You can reach him at Contactspencerwoodman@gmail.com or follow him on Twitter via @spencerwoodman.

 

Read Next: Why Eric Cantor’s defeat is bad news for the Voting Rights Act

  • Share
  • Decrease text size Increase text size