A PwC survey found that nearly half of companies had experienced fraud in the past two years, with vendors/suppliers being one of the top external perpetrators.1
Vendor fraud can be caused by one or more vendors, employees, or a collaboration between vendors and employees. In addition, third parties who can access the data of a vendor can use this data for fraud purposes.
So who should be concerned about vendor fraud? All businesses are vulnerable to vendor fraud as long as they rely on third parties for their operations and it is almost impossible to find a business that doesn’t rely on vendors. small and medium-sized businesses can be more prone to this risk as they are less likely to have control and checkpoints in comparison to large businesses.
In this article, we will:
- Identify 7 types of vendor fraud
- Explore how to detect and prevent it
7 Most Common Types of Vendor Fraud
- Price fixing occurs when two or more vendors agree to fix the price of goods or services to a higher amount than the normal market value. This way, they force the company to buy the products at a higher price.
- Bid rigging can happen between more than one vendor, or between an employee and a vendor, to secure a contract and payment in favor of a vendor. This is considered fraud because it is unethical and unprofessional, and happening beyond the company’s control.
Billing / payment fraud
- Billing fraud can happen in two ways:
- through a fictitious vendor, where an employee creates a fake vendor account and regularly makes transactions to it;
- through duplicate payments, where an employee uses an actual vendor’s information to manipulate the payment records by making double payments to the vendor and then directing the second payment to their personal account.
- Overbilling is observed when a vendor raises an invoice by adding nonexistent supplies or overpricing the delivered ones. It can be most common in vendor groups that supply in large quantities as it is easier to weave fraudulent payments in a pile of large transactions.
- Check Forgery is a technique generally used by employees to direct a company’s check payments to their accounts. They can manipulate check payments by making new checks, or by counterfeiting and altering a vendor check to divert money to their personal accounts. Although this is not a fraudulent activity directly caused by vendors, as employees use vendor information, this also must be checked in vendor transactions. However, a check forgery complicit between employees and vendors can also be a potential risk.
Other types of fraud
- Bribing is a complicity between employees and vendors, in which an employee receives personal payments from a vendor in exchange for extra business benefits.
- Cyber Fraud can be one of the most difficult fraudulent activities to detect because a third party unknown to both the business and the vendor manipulates an actual vendor’s account and electronically diverts transactions to their accounts. A common example can be online shopping via credit cards, where secured payment is highly important to avoid cyber fraud.
10 Ways to Detect & Prevent Vendor Fraud
Detecting fraudulent vendor activity can take a long time, especially if it is facilitated by an internal party like an employee. Some simple yet protective measures you can implement as part of your regular business can help to detect the risk before it’s too late. Here are 3 focus areas:
- Regular vendor information verification: If there are any missing documents (e.g. if their bank account related information is outdated), get in touch with your vendor to investigate why such documents are missing. According to the reasons given by your vendor, consider taking further steps.
- KYS due diligence during the onboarding process is crucial to minimize fraud. Control whether your vendor has a verifiable taxpayer identification number, whether it has a relationship with one of your employees, and whether its name was ever mentioned in past fraudulent activity. Also, check the financial stability of your potential vendors.
- Invoice matching: There are two-way, three-way, and four-way matching methods according to which types of documents are involved in the invoice matching process. In these, the invoice is checked against the purchase order number, the goods receipt, and the inspection slip. You can benefit from invoice automation methods to implement these matching methods.
Feel free to check our article on how to improve supply chain collaboration to encourage data sharing and minimize fraud.
- Separation of responsibilities and regular rotations: As doing business with vendors requires both the entrance of the purchase information into the system and the approval of the transaction, carefully segregating these duties among different employees can minimize employee misconduct. If you are a smaller company, you can also rotate employee duties in vendor management and purchase department to stand in the way of a planned fraud scheme.
- Background checks: Control whether they have been in any disgraceful offense in their professional life. Similar to vendor control, investigate whether a potential employee has any personal relations with any of your vendors.
- Anti-fraud training: If they learn how to be aware of fraud, they are better at detecting and preventing it beforehand.
- An anonymous tip line to encourage your employees to report suspicious activity of their colleagues can strengthen internal controls. Employees can be willing to report such activity but can refrain from doing so because they can be afraid of the consequences. Making this anonymous will make it easier.
- Anti fraud detection: Using AI/ML models, companies can identify fraud effectively and and efficiently compared to manual controls.
- Effectiveness: With their high computational capacity, AI/ML models can assess large datasets of vendor transactions and find out abnormal ones that humans may have missed.
- Efficiency: By reducing reliance on manual labor, these systems can reduce labor costs focused on fraud detection and enable employees to focus on higher-value-added activities.
- For more check our article on the use of AI in fraud detection.
- Vendor management software: Having centralized and efficient vendor management software is necessary to monitor vendor and employee activities. By being able to sort out who is in charge of which operation and what operation is related to which vendor, determining who is responsible for potentially fraudulent activity is easier.
- AP automation software: AP automation software can automate most of transactions from invoice to payment and highlight transactions that needed human intervention.
- Touchless transactions are safer than manual ones since they prevent employee related component of vendor fraud.
- Reducing number of manual transactions will reduce the work needed to check for fraud in manual transactions.
If you have other questions about vendor fraud, we can help:
Cem has been the principal analyst at AIMultiple since 2017. AIMultiple informs hundreds of thousands of businesses (as per similarWeb) including 60% of Fortune 500 every month.
Cem's work has been cited by leading global publications including Business Insider, Forbes, Washington Post, global firms like Deloitte, HPE, NGOs like World Economic Forum and supranational organizations like European Commission. You can see more reputable companies and media that referenced AIMultiple.
Throughout his career, Cem served as a tech consultant, tech buyer and tech entrepreneur. He advised businesses on their enterprise software, automation, cloud, AI / ML and other technology related decisions at McKinsey & Company and Altman Solon for more than a decade. He also published a McKinsey report on digitalization.
He led technology strategy and procurement of a telco while reporting to the CEO. He has also led commercial growth of deep tech company Hypatos that reached a 7 digit annual recurring revenue and a 9 digit valuation from 0 within 2 years. Cem's work in Hypatos was covered by leading technology publications like TechCrunch and Business Insider.
Cem regularly speaks at international technology conferences. He graduated from Bogazici University as a computer engineer and holds an MBA from Columbia Business School.
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