Known shrink is loss that has already been identified, recorded and processed, while unknown shrink is the loss that only emerges when a physical stock-take is reconciled against the company's book stock 1. The causes of unknown shrink cannot be identified, which is where the name comes from 1.
How each type is identified
Known shrink can be broken into sub-categories such as known theft that has been processed 1. Unknown shrink is discovered through the reconciliation between a counted stock figure and the recorded book stock figure, so the retailer sees the gap without seeing the cause 1. A related distinction appears in Strategies for Reducing Retail Shrink During Challenging Times, which treats shrink as inventory loss that is unaccounted for and damages as inventory loss that can be explained 2.
How retailers treat the distinction when measuring
Most companies regard shrinkage as consisting of both known and unknown losses, though the practice is not universal 1. Some companies exclude known loss from their shrinkage calculation, effectively defining shrinkage as those losses that cannot be attributed to a known cause 1. In the survey reported in Measuring Retail Shrink, every responding company included unknown loss in its shrinkage calculation, and Ninety percent of respondents also included known loss 1.
Why the definition matters
Different companies define shrinkage differently, measure it at different points in the supply chain and report it using different methods, so comparisons need care 1. The recommended practice is to measure both known and unknown shrinkage, and to record it by individual stock keeping unit and by individual store, distribution centre or transport route 1.