Procurement Ethics Need to Be Updated for a New Age
Procurement fraud is something we don’t talk about enough.
Core to the six types is conflict of interest. Procurement staff have a duty of loyalty to their organization. But, in an age of cost cutting and layoffs, in a time of conspicuous personal consumption, it can feel as if the organization’s loyalty to the individual is diluted. In that light, some people fall prey to the Faustian compact and prioritize their personal needs over their company’s requirements. They use corporate resources in ways that have negative consequences for the buyer over time.
“SAS research shows that almost 31 percent of businesses in the UK have fallen victims to contract bid rigging, and over 43 percent have been given fraudulent invoices. Besides, the PwC has ranked procurement fraud as the second most prevalent economic crime since 2014.” That quote comes from this CIOReview article entitled, “How to Avoid Procurement Fraud?”
The Gordian knot of rules and procedures that buyers employ hasn’t prevented procurement fraud. If anything, one might argue that these processes and their attendant complexity and opacity have enabled procurement fraud.
My sense is that most organizations may feel lulled into a sense of complacency that the putative rigor of procurement is a protection against malfeasance.
According to this framework from James R.S. Gayton in his MBA thesis at the Naval Postgraduate School, there are six classes of procurement fraud.
1. “Defective Product/Product Substitution”: Supplier promises a good that meets the buyer’s requirements but delivers something inferior and cheaper-to-deliver, pocketing the difference in cost as pure profit.
2. “Defective Testing”: Supplier doesn’t perform the required tests to the standard agreed upon in the contract.
3. “Bid-Rigging”: The buyer pays a higher price because either the buyer, the supplier, or the two of them set up a bid scenario that artificially limits competition.
4. “Bribery and Corruption”: This involves a supplier paying someone with influence or control over a purchase to sway the decision in their favor, potentially at a higher price than a truly competitive dynamic would produce.
5. “Defective Pricing”: When suppliers certify a price during the bidding for a contract, only to raise those prices in the delivery phase (citing ostensibly unanticipated cost shocks), this constitutes misrepresentation.
6. “False Invoices”: Either submitting an invoice for goods or services not delivered or submitting a full invoice when delivery has been incomplete is outright theft.
It’s easy to imagine the bribery and corruption cases. Here are a couple of great examples from Supply Chain Dive.
“A manager showing everyone the keys to a condo in Florida he borrowed from one of his suppliers, bragging about the family trip he had planned during school vacation. But he was upset that he couldn’t find anyone to pay for the airfare … and meals.”
“The buyer who yelled at the supplier for bringing a case of liquor to the buyer’s desk at holiday time, and for not putting the bottles in the buyer’s unlocked car trunk as directed. It seems as if the trunk was already filled with some new golf clubs and there wasn’t room.”
Our belief is that bid-rigging and defective pricing are likely the two most common types of fraud.
Some of the experienced procurement hands reading this article will read some of these classes of fraud and recall specific instances where they have seen this.
For example, imagine an IT services contract where the dominant criterion is price. It might be to supply three Java developers for three months to bolster the in-house development team on a new website. One supplier strategy might be to lowball the price below any reasonable price, undercutting all the competitors, subsequently raising the price to levels that exceed the total cost of delivery that the reasonable competitors would have ended up charging. This is not an unusual scenario. It is fraud. Do people identify it as such? Or, is it so commonplace in the context of the archaic RFP business process that people fail to recognize it as such?
How angry and frustrated does it make suppliers who submit ironclad bids to get undercut on price by a competitor they know will raise the price exorbitantly once they have won the contract?
And what happens to the people get caught doing these things? Are they prosecuted? More likely, they move on to the next buyer … and nobody knows. They pull the same defective pricing “act” with an unsuspecting newbie.
Whenever we tell laypeople that we want to adapt the RFP business process for the 21st century, we get the same earful.
“Oh, it’ll never work. The whole thing is political. It’s about the supplier who gets to write the RFP.”
That’s exactly the problem! What these laypeople are describing is bid rigging. This is what they think of procurement.
Imagine that you are an honest supplier and you see this kind of activity. I can guarantee you that it keeps suppliers at bay. Why invest all the time and money in developing a proposal if you think that the fix is in and the buyer has picked the winning vendor already, executing the RFP as a pro forma gesture for the compliance Gods?
When you start to think of instances like this, it’s no wonder that PwC characterizes procurement fraud as “the second most prevalent economic crime since 2014.”
In the case of “wired” RFPs that have been “shaped” by a supplier salesperson (as they are trained to do), this sort of kinder, gentler bid-rigging is a result of the fact that buyers don’t have the time or the money to conduct diligent, independent market research. Suppliers get to write the RFP for the buyer because buyers just ask salespeople to educate them about the marketplace, in the absence of any quick, inexpensive ways to acquire this knowledge.
One possible solution to the problem of fraud is to use data to try to identify unusual relationships or red flags. CIOReview sums it up well, “The analytics approach leverage [sic] machine learning to balance the behavioral anomaly detection.”
Things are compounded even more as procurement becomes decentralized.
Again from Supply Chain Dive,
“Where it all breaks down is in the decentralization of the procurement process. “Do it yourself purchasing” is becoming the procurement strategy at many organizations now and likely others in the future. As a result of enterprise level supply management software, and an effort to control staffing, procurement gives up significant control of buying to engineers, lab managers, facilities staffs and assorted requisitioners across the company, each with their favored suppliers.
“While there may be established contracts and approved supplier lists, maverick spend outside of those constraints continues to be an issue, leading to the potential of bad behavior for buyers and sellers. “Some sellers look to the unsophisticated buyer as an opportunity to infiltrate a company, bypassing the purchasing department and gaining direct access to the customers. The new “buyer” may just assume gifts (or more) are considered business as usual, given the traditional reputation of the purchasing agent.
“There are also those in the supply chain management function with increasingly unsupervised supplier communication, including planners, expediters, transportation managers, warehouse managers and anyone with direct supplier communication as a result of changes in the supply management process. They have direct and unmonitored access to suppliers, for better or for worse. Increased supplier interaction by those with limited ethics training, or even malintent, provide an opportunity ripe for unethical behavior by customer and supplier alike. This can undermine ethics related compliance and put a company in legal jeopardy.”
So, an ideal solution would combine analytics for behavioral anomaly detection, an audit trail even in a decentralized context that permits people from across the organization to access procurement directly, and tools that made the six types of corruption less likely to happen.
EdgeworthBox attacks these three problems head-on. Analytics are impossible without quality data in a structured format. We enable companies to organize all of their procurement data in a private repository for live RFPs, historical RFPs (and the attendant responses), and historical contracts using a structure promulgated by the Open Contracting Data Standard that was developed to fight corruption in emerging markets public procurement. We also give buyers and suppliers access to similar data in a public repository, typically related to government purchasing. Buyers can also use or social networking tools to connect to other buyers for market intelligence. Our business model charges organizations a license and then offers an unlimited number of seat licenses within the organization. This brings in different functions such as Finance, Operations, Sales, and Product to the sourcing conversation, making it truly strategic. It also reflects the entropy towards decentralized procurement, bringing with it an audit trail. Give us a shout at email@example.com. We’d love to talk to you about what we’ve learned.