Vendor fraud is rampant, with nearly half of companies reporting incidents in the past two years according to PwC.1 As a business relying on external suppliers and partners, you are highly vulnerable. Vendor fraud can range from falsified invoices to sophisticated cybercrime schemes, resulting in massive financial damage and ruined trust.
This comprehensive guide will equip you to detect and prevent the seven most common types of vendor fraud. We‘ll analyze insider tricks, collusion schemes, cyber threats, and more. You‘ll also learn proven fraud prevention best practices relating to vendor oversight, employee controls, and security systems.
Let‘s dive in to the most frequent and damaging varieties of vendor fraud impacting businesses today.
The 7 Sneakiest Types of Vendor Fraud
Vendor fraud causes an estimated $7 trillion in annual losses globally.2 Here are seven common schemes to watch out for:
|Price Fixing||Multiple vendors conspire to set higher than normal prices|
|Bid Rigging||Vendors collude to unfairly direct a contract to a single vendor|
|Billing Fraud||Vendors submit inflated or completely false invoices|
|Overbilling||Vendors exaggerate quantities or prices on legitimate invoices|
|Check Forgery||Employees forge company checks to pay personal accounts|
|Bribery||Vendors bribe staff with gifts/cash in exchange for business|
|Cyber Fraud||External theft through hacking vendor systems|
While vendors perpetrate some schemes solo, often fraud requires complicity from employees or third parties. Let‘s explore examples and warning signs for each fraud variety.
Price Fixing Between Vendors
With price fixing, multiple vendors agree to uniformly raise prices above normal market rates, forcing the buyer company to overpay.
For example, several maintenance and repair vendors servicing your locations could agree to hike hourly rates by 30%. Without competitive market pricing, you end up paying artificially inflated service fees across contractors.
Price fixing is usually subtle and hard to detect, but warning signs include:
- Sudden concurrent price increases across vendors
- Identical pricing between vendors
- Refusal to negotiate lower pricing
This practice is illegal in the U.S. and many jurisdictions, but still occurs, especially in B2B contexts.3
Bid Rigging Between Vendors and Staff
With bid rigging, vendors actively collude with your employees to unfairly steer contracts or orders to a single vendor. This denies you the benefits of a competitive bidding process.
For example, a procurement officer could provide one vendor special insights that help them craft a winning bid. In exchange, they receive a cash kickback. Or vendors could agree to alternate "winning" bids over time.
- Same vendor winning despite higher pricing
- Employees resisting bid process changes
- Rotation of winning vendors by project
Bid rigging, sometimes called collusive tendering, violates fair bidding laws. Still it occurs frequently, with an estimated 13% of public procurement manipulated by bid rigging.4
Tricky Billing Fraud Schemes
With billing fraud, vendors submit inflated invoices or invoice for goods/services not provided.
A common scheme involves shell companies: Employees set up fake vendors and place orders with them. They verify receipt of goods to "legitimize" the shell company, then receive invoices and process payments funneling money to themselves.
Alternatively, vendors may take legitimate projects and tack on extra hours or expenses that didn‘t occur. Without diligent invoice review, overstated charges get paid.
Be wary of vendors:
- Charging significantly above market rates
- Lacking detailed invoices or overusing generic descriptions
- Billing for suspicious expenses like vague consulting fees
The Association of Certified Fraud Examiners found that billing schemes accounted for 21% of vendor fraud cases, making it one of the top varieties.5
Overbilling on Top of Real Transactions
While billing fraud involves completely fake purchases, overbilling relies on legitimate transactions with inflated quantities or prices.
For example, a parts supplier actually ships 100 units but bills you for 120 units at $10 each. Or they charge $15 per unit when the agreed price is $12.
Overbilling is harder to catch than fake billing, since the underlying transactions are real. Watch for:
- Prices exceeding agreed rates
- Quantities exceeding what was ordered
- Invoices that don‘t match purchase orders
Careful invoice auditing is key to detecting overbilling. This variety of fraud tends to flourish among high-volume vendors who can more easily hide bogus amounts within large transaction flows.
Employees can forge company checks to funnel money to their own accounts or accomplices. They make the check out to a real vendor, then deposit or cash it themselves.
For example, an accounts payable clerk could create a $2,000 check to ABC Construction, then deposit it into a personal account. Forged endorsements disguise the diversion.
- Vendors claiming non-payment on issued checks
- Checks showing unusual endorsements
- Employees resisting electronic payments
While not inherent vendor fraud, check forgery relies on leveraging vendor payment systems for personal gain.
Bribery and Corruption
Bribery represents an illicit quid pro quo between vendors and employees. Vendors provide kickbacks, gifts, or other benefits in exchange for contracts, higher prices, or favored treatment.
For example, an employee awards shipping contracts to a logistics vendor that gives them cash, vacations, or other rewards. They might ensure the vendor gets excessive pricing in return.
Signs of potential bribery:
- Unexplained preference for certain vendors
- Vendors with close employee relationships
- Sudden lifestyle changes in employees
Vendor bribery can be hard to detect but undermines procurement integrity. According to PwC, 28% of fraud cases involved corruption like bribery.1
Cyber Fraud and Hacking
With cyber vendor fraud, external parties gain system access to manipulate payments or steal data.
For instance, a hacker could break into a vendor‘s network, create false invoices, and reroute payments to their own accounts. Or they could simply steal proprietary data to sell.
Cyber fraud indicators:
- Vendors reporting payment disruptions or data theft
- Inability to access vendor data
- Sudden, unexplained payments
Cybercrime is growing exponentially, with vendors‘ vulnerable systems providing a lucrative target. One study found that 57% of vendors had experienced cyber fraud.6
How Much Could Vendor Fraud Cost You?
Vendor fraud‘s financial impact on businesses is staggering. According to data, potential losses include:
- 5-10% of revenue lost annually to vendor overbilling alone7
- Median loss of $125,000 per corporate fraud scheme1
- Average loss of $1.5 million per billing/payment scheme5
Beyond direct financial harm, vendor fraud erodes trust in business relationships. A proactive prevention approach is essential.
Fraud Prevention Best Practices
Fighting vendor fraud requires vigilance across three domains:
Vendor Oversight, Employee Controls, and Fraud Prevention Systems.
Step Up Vendor Oversight
Carefully screening and monitoring vendors is crucial for reducing third-party fraud risks.
- Conduct thorough due diligence when onboarding new vendors, including background checks, document verification, credit checks, and evaluating past controversies.
- Re-verify vendor details like addresses and bank accounts periodically to detect fraud. Watch for mismatches.
- Match invoices to purchase orders to check for overbilling. Confirm goods/services were truly received.
- Watch for unusual payments, like new vendors suddenly receiving large sums or spikes from established vendors. These could indicate fraud.
- Leverage analytics to detect high-risk vendors, like those with frequent price changes or billing adjustments.
Robust vendor oversight measures deter fraud and quickly uncover warning signs.
Implement Employee Controls
Since employees often enable or perpetrate fraud, internal controls are imperative.
- Institute mandatory job rotations in procurement and payments departments so the same employees don‘t hold unchecked power.
- Segregate sourcing and approval duties across roles. This prevents single employees from steering deals to complicit vendors.
- Conduct background checks on new hires to uncover relationships or past fraud.
- Provide frequent anti-fraud training to employees so they can recognize and report suspicious activities.
- Maintain anonymous fraud reporting channels that give employees a safe way to report legitimate concerns.
Procedural controls and separation of duties disrupt the complicity enabling most fraud schemes.
Deploy AI-Driven Fraud Detection Systems
Modern fraud prevention software uses artificial intelligence and machine learning to quickly identify anomalous transactions indicative of fraud.
For example, forensic accounting AI can pinpoint duplicate invoices, flag unusual payments, detect fake vendors, and more. It far surpasses limited human auditing capacity.
Other vital fraud prevention systems include:
- Vendor management platforms that centralize vendor lifecycle oversight
- AP automation to streamline invoice processing with built-in validations
- Procurement software that enforces separation of duties
- EDI networks that secure supplier data exchange
Combined, advanced systems provide end-to-end protection across the vendor lifecycle. AI and ML dramatically strengthen fraud detection.
The Outlook for Vendor Fraud in 2023
Vendor fraud is already widespread today. Unfortunately, emerging trends suggest fraud schemes will only increase and grow in sophistication in 2023:
- Work-from-home policies with less oversight mean more employee fraud opportunities.
- Rising digital payments exponential increase targets for cybercrime.
- Supply chain disruptions motivate more companies to cut corners or falsify data.
- Sophisticated hacking tools permit elaborate vendor payment diversion tactics.
Businesses must prepare now with robust vendor controls, system safeguards, and trained eagle-eyed staff.
Are You Protected Against Vendor Fraud?
Left unchecked, vendor fraud in its many forms can quickly spiral out of control. But businesses willing to take proactive prevention measures can develop a strong fraud-resistant posture.
The combination of vigilant vendor selection, internal employee controls, and AI-powered fraud detection provides compelling protection.
Guarding against vendor fraud requires constant learning about emerging schemes, training staff, and being willing to ask tough questions. But the payoff is preserving your revenue, data, and vendor relationships against potential catastrophe.
Commit to a zero-tolerance policy on vendor fraud. Don‘t become the next victim.
1. “PwC’s Global Economic Crime and Fraud Survey 2022.” PwC, https://www.pwc.com/gx/en/services/forensics/economic-crime-survey.html. Accessed 19 November 2022. ↩
3. "Price Fixing, Bid Rigging, and Market Allocation Schemes." FBI, https://www.fbi.gov/investigate/white-collar-crime/price-fixing-bid-rigging-antitrust. Accessed 15 January 2023. ↩
4. "Bid Rigging Impacts 13% of Public Procurement." OECD, https://www.oecd.org/competition/bid-rigging-impacts-13-percent-of-public-procurement.htm. Accessed 15 January 2023. ↩