Vendor fraud can cost companies millions in lost revenue every year. But what exactly is vendor fraud, and what are the most common types businesses need to watch out for?
In this comprehensive guide, we’ll break down the top 7 vendor fraud schemes to be aware of, along with key strategies to detect and prevent this threat in your organization.
What is Vendor Fraud?
Vendor fraud refers to any scheme by a vendor, supplier, or third-party service provider to illicitly obtain money or benefits from a buying company. It often involves complicity with employees on the inside.
Some estimates suggest that companies lose 5% of their annual revenues to vendor fraud on average.1 That can translate into staggering losses – over $7 million for a company with $150 million in revenue.
And the risk is rising. A PwC survey found that 49% of companies experienced fraud in the past 24 months, with suppliers and vendors as one of the leading external culprits.2
So who is most vulnerable? Any business that relies on vendors and suppliers in its operations – which nowadays is practically every company. Small and mid-sized businesses can be especially at risk due to less stringent controls compared to large enterprises.
Below we reveal the 7 most prevalent types of vendor fraud that businesses encounter:
7 Most Common Types of Vendor Fraud
1. Vendor Collusion
Collusion refers to secret cooperation between vendors, or between vendors and employees, for illicit gain. Two common forms are:
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Bid rigging: When vendors conspire to circumvent the bidding process by fixing prices or having one vendor submit an intentionally losing bid. This defrauds the buyer of competitive market pricing.
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Price fixing: When vendors agree to set higher prices than normal market rates for goods and services sold to the buyer. This forces the buyer to pay more than needed.
A 2018 bid rigging scheme involving IT contracts in New York resulted in over $100 million in losses.3
2. Billing and Payment Fraud
These schemes aim to falsely bill a company or manipulate payments for services not rendered. Tactics include:
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Fictitious vendors: Employees set up fake vendor accounts and regularly direct payments to them.
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Duplicate payments: Employees make double payments to real vendors, directing the second to their own accounts.
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Overbilling: Vendors invoice for non-existent or inflated goods and services. This can be hard to catch for high volume purchases.
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Check fraud: Employees counterfeit or alter checks to redirect payments meant for actual vendors.
A vendorinvoicing scheme at Anheuser-Busch cost the company over $550,000 in losses before being uncovered.4
3. Bribery and Kickbacks
Vendors may bribe or offer kickbacks to employees in exchange for contracts and other preferential treatment. Secret commissions are paid to the employee, often a percentage of the contract value.
In 2020, Amazon sued two former employees for accepting over $100,000 in bribes from multiple vendors.5
4. Cyber Fraud
With increased use of digital payments, cyber fraud is an emerging risk. Hackers gain access to vendor accounts to manipulate invoices and payments.
In 2019, Cabell County Schools in West Virginia lost $550,000 when a hacker posing as a vendor altered invoice banking details.6
5. Money Laundering
Vendors may use their transactions with a company to launder illegally obtained funds and make them appear legitimate. This can facilitate terrorism, drug trafficking, and other crimes unbeknownst to the company.
In one case, criminals used a metals trading company to launder over $370 million.7
6. Embezzlement
Vendor employees may abuse access privileges to misappropriate company assets, data, or intellectual property. This differs from external theft.
A group of vendor employees embezzled over $3 million from popular clothing retailer Guess.8
7. Tax Evasion
Vendors may intentionally under-report income or avoid taxes, increasing profits earned from the buying company. Governments lose substantial tax revenue from such evasion annually.
The Canada Revenue Agency reports over $500 million in losses each year from GST/HST tax evasion.9
How to Detect and Prevent Vendor Fraud
With numerous vendors and daily transactions, fraud can be difficult to recognize before significant loss. But the following strategies can aid in early detection and prevention.
Vendor Management
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Screen vendors thoroughly during onboarding, including background checks, verifying identities, and financial viability assessments.
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Review vendor master data regularly – any missing or outdated documents could be a red flag of fraud risk from inactive or non-existent vendors.
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Perform invoice matching by requiring 3- or 4-way checks between invoices, purchase orders, receipts and other documents to catch discrepancies.
Internal Controls
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Segregate duties for vendor setup, ordering, receiving, payment approval, and reconciliation. No single person should have end-to-end control.
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Require mandatory vacation periods to disrupt any ongoing fraud schemes by employees.
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Conduct surprise audits on vendor transactions to identify abnormalities.
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Maintain an anonymous hotline for employees to safely report suspicious vendor or coworker activity.
Technology Solutions
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Implement AI-powered fraud detection to analyze 100% of transactions and identify outliers and suspicious patterns that humans would likely miss.
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Adopt accounts payable automation to reduce reliance on manual processes prone to manipulation and human error.
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Use vendor management software for centralized visibility and control over the vendor lifecycle.
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Automate identity verification when onboarding new vendors using digital KYC solutions.
The Bottom Line
Left unchecked, vendor fraud can slowly drain companies of millions in revenue, resources, and reputation. But following the tips in this guide will help protect your organization against the latest fraud schemes.
By combining vigilant vendor screening, tight internal controls, separation of duties, and AI-powered fraud detection, you can keep this threat at bay. Stop fraudsters from taking advantage of vendor relationships and maximize confidence in your supply chain.