Category Archives: Finance

Some Examples of Supply Chain Fraud

Today’s guest post is courtesy of Norman Katz, Certified Fraud Examiner, of Katzscan, Inc. and maintainer of the Supply Chain Fraud website as well as the Supply Chain Sarbanes-Oxley website. Both of these supply chain sites are worth checking out. After all, you don’t want to join Fox in SOX!

In accepting the holistic view that the supply chain extends beyond the walls of the company, can encompass raw materials, finished goods, monies, and services, and can be in fact more internal than external, the types of supply chain frauds become more numerous and in some cases, more severe.

One of the most glaring examples of supply chain fraud is the tainted product scandals that have surfaced over the past year. However, not all of the problems were associated with lead-tainted paint; some product recalls of toys were due to small parts breaking loose that a child could put in their mouth and choke on. If the toy was not being designed overseas, but just manufactured overseas, than the toy designer should be faulted for a poor – if not dangerous – design. Was the overseas manufacturer given any guidelines in regards to stress tests to gauge whether a child could pull off a small piece?

In this example, the fraud itself would have started with a poor design and would have occurred early in product lifecycle management (PLM). Was there a quality assurance (QA) review during PLM to cover aspects such as this? Was there QA testing of prototypes and products after go-live production to ensure quality standards – if established in the beginning – were being adhered to?

Similarly, in terms of the tainted food products, what tests were performed by the product company to ensure the manufacturer was adhering to standards and not introducing unsafe ingredients? This is especially true in the pet food scandal, were an unsafe ingredient was added by the overseas raw material supplier and/or overseas manufacturer to (artificially) boost protein levels during product testing. Why was there no testing for foreign substances?

In the above examples, if the QA department’s ability to function as needed was reduced due to unnecessary or unwise cost cutting by executives, especially if the goal was to increase executive bonuses or inflate stock prices by reducing costs, the executives themselves can be considered the perpetrators of the fraud and may be civilly and/or criminally liable for the results.

In another case that was caught before the supply chain fraud occurred, a military contractor was prevented from outsourcing the manufacturing of night vision goggles to a company in China. The US military is quite particular about who can manufacture their technologically advanced equipment, and rightfully so! The reason the company executives stated they were looking to outsource the production was greed, pure and simple: they wanted to lower costs to gain more profits, and were willing to do so at the real risk of giving away US military secrets to a country known for producing pirated software, videos, music, and merchandise imitations!

Internal thefts of raw materials and finished goods are an obvious supply chain fraud. How about when machinery and equipment are not maintained according to schedule, even though the maintenance supervisor swears they are? Abuse of equipment is most certainly a type of fraud, but when the abused equipment produces less-than-first-quality finished goods, the fraud has now become more widespread. Further, if the less-than-first-quality finished goods can cause injury or death, then the impact of the fraud just became much more serious.

Internal thefts can also include monies when fraud happens in the account department. Also, a person with the right authority may be able to set up a fraudulent services-only vendor for the purposes of stealing money via the submission of fake invoices paid to a fictional vendor who is really the fraud perpetrator themselves.

Thanks, Norman!

For more examples of where fraud can occur in the supply chain, check out the new Supply Chain Fraud wiki-paper over on the e-Sourcing Wiki.

Does Trouble-Free Mean Fraud-Free?

In a recent post on e-Sourcing Forum, I alerted you to a recent press release from Kroll that summarized the results of their “Global Fraud Report” which found that in some sectors, fraud in the supply chain has increased five-fold in the last six years – and that’s something to be worried about because, if you think you’re trouble free, there’s a good chance you’re not!

In my last post, I described some of the red-flags that indicate your supply chain could be at risk, which included:

  • Abnormal Vendor Selection
  • Payments Outside the Normal Accounting System
  • Unusual Payment Patterns
  • Rates Out of Line with Your Company’s Standing in the Market
  • Unexplained Lifestyle Improvement
  • Complaints or Tips

But the following can also indicate fraud:

  • automatic order triggers in a VMI system
    a vendor can manipulate stock levels to indicate a re-order prematurely to increase their revenue
  • more purchase orders than usual
    although it looks like your team is doing a good job by getting more purchases through the system, this could represent collusion between your buyer and a seller to inflate either the sales person commission or the buyer’s bonus by submitting false orders that will just be cancelled or returned at a later date
  • an unusual number of returns
    your buyer could be colluding with an individual at a shipper’s facility to create orders for unwanted goods which will be filled incorrectly; the buyer will then demand a refund and the goods will get lost during the return process
  • more defective returns than usual
    your quality assurance personnel might be accepting inferior products for bribes

The reality is that the supply chain is ripe with opportunities for fraud. These include:

  • Fixed Asset Fraud
    Fixed assets might be used for purposes other than what they are designated for, or used more than they are supposed to be. This misuse can damage the asset or reduce its useful life-cycle.
  • Inventory Fraud
    Your employees help themselves to your inventory and falsify records so that you don’t notice the loss until weeks or months later. They might even falsify good receipts to indicate less was received than actually was.
  • Manufacturing Fraud
    Your supplier might send you a high quality product (from another supplier) during the evaluation process for testing, but then send you inferior products made from inferior materials after the contract is signed that look the exact same – and you don’t notice the problem until you get an extraordinary number of returns due to defects or inferior quality.
  • Picking and Return Frauds
    Your order pickers in your warehouse might be picking extra items during shipment preparation and pocketing them for private off-the-books sales.
  • Distribution Fraud
    One or more boxes of your shipment will not be loaded by the shipper who will falsify records and blame the third party carrier for the loss.

And this is just the tip of the iceberg. So, in a follow-up post later this week or early next week, I’ll address what you can do about it. Stay tuned!

Hackett Hacks Away at Recession Declines

Hackett recently published a research piece on how “G&A Spending Cuts Can Offset 21% to 45% of the Anticipated Decline in Pre-Tax Profit During Recession” as part of their Enterprise Strategy Series which noted that their 2008 benchmark data reveals a savings of 184 – 400 Million for a typical global 1000 company that’s worth a re-read. Unlike most of their pieces, this was available to the public (registration required), and, if it’s still available, you should definitely download it – as it is jam-packed with more information than a single blog post can cover.

The piece starts off that by noting that while mandated G&A cuts are the norm in times of recession, arbitrarily cutting costs across the board can lead to serious deterioration in service-delivery capacity. It’s critical that cuts are made in ways that minimize impact on business value delivery, but this requires an understanding of the strategic alternatives, current cost structures (as compared to those of world-class organizations), and clear-eyed risk assessments. Furthermore, Hackett found that average companies can reduce G&A cost between 15% and 41% simply by optimizing process cost. Furthermore, reduced technology spend can take out another 6% to 7%.

The research brief also points out that you should not determine a savings target before understanding what a “normal” spend level is in a world class organization. For example, a typical Global 1000 company (with 23.4B in revenue and 56,100 employees) spends 3.6% of its revenues on four core principle G&A functions (Finance, HR, IT, & Procurement), but world-class companies execute significantly better by combining process excellence with technology leverage. They perform at lower cost levels (22%+) and enable the business to succeed by producing improved financial results and cash-flow; by recruiting, training, and retaining talent; by driving costs out of the supply chain; and by making superior use of technology.

The research brief also identified 10 targets for G&A reduction across the four core functions that, when combined, should allow for a cost reduction of at least $158M in a typical Fortune 1000 company in process costs alone (labor and outsourcing) that can be achieved by way of best practices, simplification, and standardization. Specifically, the 10 functions, and potential cost savings were:

  • Infrastructure Management : 25.1
  • Revenue Cycle : 22.7
  • Application Maintenance : 21.6
  • General Accounting : 17.9
  • Application Development & Implementation : 15.8
  • Compliance Management : 13.4
  • End-User Support : 12.7
  • Transactional HR : 11.7
  • General Disbursement : 10.6
  • Purchase Order Processing : 6.4

The research brief identified a cost difference of 55.6 Million in technology spend between average and world-class organizations.

Hackett also identified another 74.9 Million in cost savings that may be available through globalization (and outsourcing).

So how do you start identifying these cost savings? You start by reading the research brief and focussing on the specifics in the identified areas. You also apply the expertise the doctor and his fellow bloggers have imparted to you over the years while noting that most of the savings opportunities are in technology (75.2), finance (51.2), and procurement (19.8). If you have been paying attention, this should screen one acronym to you: SaaS. If you’re currently using bloated behind-the-firewall software, switching to SaaS will simultaneously reduce your infrastructure (the largest), application maintenance (the third largest), application implementation (the fifth largest), and end-user support (the seventh largest) costs. Plus, if it’s e-Sourcing or e-Procurement, you’ll also reduce your revenue cycle (the second largest), compliance management (sixth largest), general disbursement (ninth largest), and purchase order processing (tenth largest) costs. That’s eight cost reductions with one decision! How can you go wrong?

The Financial Reporting Supply Chain

The financial reporting supply chain refers to the peopleand processes involved in the preparation, approval, audit, analysis and use of financial reports. The cycle both starts and ends with the investors and other stakeholders, who want to make informed economic decisions about a company and, therefore, require financial information to do so. The chain includes management, the board of directors, auditors, and regulators – and each have their part to play.

In recent years, there have been numerous efforts, particularly in the USA, to change and improve financial reporting. But to what end? Have the reporting processes become better or worse? Have financial reports become more or less relevant, reliable, and understandable? What needs to be done? These are questions that the International Federation of Accountants (IFAC) attempted to answer in a recent survey (administered in June and July of last year) that was summarized in a “Current Perspectives and Directions” piece released in March of this year.

The reported summarized results on the issues of corporate governance, the financial reporting process, the audit of financial reports, and the usefulness of financial reports. The results included positives, areas of concern, and improvements that are needed. But per haps the most important result of the study is that while corporate governance, the process of preparing financial reports, and the audit of such reports has clearly improved in the last five years, the financial reports themselves have not become more useful.

Considering the huge financial burden placed on companies to prepare these reports, especially since the introduction of Sarbanes-Oxley, this is troublesome. The reports should be useful to the target user groups, they should address the relevant concerns that shareholders have with respect to corporate governance and auditability, and they should enable the supply chain, not detract from it.

So what can be done? The “areas of concern” identified in the report give some clues:

  • Reduced usefulness due to complexity
    In other words, the reporting requirements need to be simplified.
  • Focus on compliance instead of on the essence of the business
    You comply with laws in the execution of your business, you do not execute your business just to comply with laws.
  • Regulatory Disclosure Overload
    Too much information is required.
  • Use of Fair Value
    What exactly is fair value?
  • Difficult and often changing financial reporting standards.
    Financial reporting standards need to be steady.
  • Lack of forward looking information.
    Companies need to move forward as well as looking back.

However, regulatory changes take significant amounts of time, and in the interim, you need to continue to produce complex reports to meet an ever increasing dizzying area of regulation. So what can you do? the doctor recommends that you:

Automate. Centralize (a copy of) all of the relevant financial data in a central database / data warehouse and acquire applications that automate the production of as many regulatory reports as possible.

Simplify. Use whatever leeway you have in report preparation to design reports that are as clear and easy to read as possible. Consider producing different summaries for different groups to simplify message communication. Extrapolate forward based on past and current performance and paint a full, realistic, picture for the stakeholders.

It won’t solve all of your problems, but it’s a start.

Freight Audits Alone Aren’t Enough

SupplyChainBrain recently published a good article by Jeremy Dotson of APEX Analytix that noted that industry estimates show inaccurate freight bills add an average of 0.2% to a typical company’s annual freight costs (which is significant on a 100M spend, as this equates to 200K). However, vendors who fail to comply with established routing guidelines can have twice the impact – an average of 0.4%, or a 400K drain to the bottom line. Maybe 0.4% is not that significant in the grand scheme of things, but it’s just the tip of the iceberg! If you identify, and stop, five leakages in the 0.4% range, you’ve saved 2% – or 2M. And you can’t tell me that’s not significant!

The article described seven common sources of errors that, collectively, will drain percentage points of potential savings from the best network design. Thus, it’s important to be familiar with these errors and institute procedures and methods to stop them from occurring.

  • Failure to Combine Shipments
    The article points out that sometimes vendors overlook instructions to ship merchandise to the same destination on the same trailer and ship on multiple trailers at LTL rates, costing you significantly more than you need to be paying. However, even more important, is that in companies where different buyers handle different categories, it happens all the time! They’ll each schedule pulls from a central warehouses on different days when all pulls can be on the same day and freight consolidated.
  • Failure to Create a Single Bill of Lading
    Even if all shipments are consolidated onto a single trailer, if the shipments aren’t combined into a single bill of lading, you lose out on volume discounts. More importantly, if individual shipments consolidated onto the same trailer have a volume less than the minimum volume, you’ll be paying the difference for each individual shipment on the trailer!
  • Selecting the Wrong Carrier or Shipment Method
    Shipping by air when by sea is okay can cost hundreds of thousands of dollars extra!
  • Sending pre-paid shipments via freight collect
    Another case of the left hand not knowing what the right hand is doing. Adopt a standard policy for shipments and stick to it!
  • Failure to Automate Records
    Unless you do this, it will be virtually impossible to dig through mountains of paper to find the problems.
  • Failure to Make Your Routing Guide Web-accessible
    This allows vendors to enter information on each shipment and receive the specific routing instructions they are to use.
  • Failure to Review and Update the Routing Guide Regularly
    Your supply chain isn’t static. Therefore, your distribution network is not static either. As fuel costs rise, cost-effective breakpoints and shipping methods change. As demand changes, so does appropriate inventory levels and locations. As volume shifts between suppliers, your network needs to adapt.