Vendor Fraud Prevention for Dropshipping Businesses

According to BDO Malaysia, procurement fraud accounted for 25% of fraud incidents among surveyed organizations in the region in 2023¹. Yet, only about half (52%) of these businesses feel prepared to prevent and detect fraud1. 

These figures highlight a significant risk, as vendor fraud can disrupt supply chains, cause financial damage, and erode the trust that is foundational to B2B commerce and dropshipping. 

Therefore, it is crucial to adopt robust strategies to safeguard your business against supplier-related fraud and disruptions, especially amidst the rise of B2B e-commerce. This blog will guide you through common types of vendor fraud and provide actionable strategies to prevent them, empowering you to protect business continuity. 

What is vendor fraud?

Vendor fraud is a malpractice in which fraudsters scam a company's accounts payable department into making illegitimate payments. Unlike other financial crimes, vendor fraud exploits the trusted relationship you have with your supplier to deceive you. 

The impact of supplier fraud can be far-reaching, extending beyond just financial losses to cause significant operational disruptions. For instance, it can strain your relationships with legitimate suppliers who face payment delays, which in turn can disrupt your supply chain and halt production. 

Therefore, understanding and preventing vendor fraud is crucial to safeguard your finances and ensure the smooth flow of your logistics and supply chain management. 

Understanding the workings of vendor fraud

Vendor fraud can be perpetrated by a variety of actors: external scammer vendors, internal employees, or a collaboration between both. In some instances of vendor impersonation fraud, sophisticated hackers may also steal a supplier’s identity to divert payments. 

 These fraudsters are often motivated by the "fraud triangle":

• Financial pressure: Individuals facing debt or financial instability may see fraud as an easy solution.
• Opportunity: A lack of robust internal controls provides a chance to commit fraud without being caught.
• Rationalization: A belief that a company owes them more can cause individuals to justify the act of fraud.

These fraudsters actively seek and exploit common weaknesses in a business’s procurement, payment, and internal control systems. Examples of these vulnerabilities include:

• Lack of separation of duties: A single employee handles multiple procedures, such as approving invoices and processing payments.
• Manual processes: Reliance on paper-based or manual systems increases the risk of human error and makes auditing difficult.
• Insufficient vendor vetting: A failure to thoroughly verify new suppliers or regularly audit existing stockist and vendor data.

Types of vendor fraud (with examples)

Vendor fraud can occur in various forms. Here are some vendor fraud examples to help you understand the most common types of scams:

Supplier invoice fraud

Supplier invoice fraud occurs when a fraudster submits a counterfeit invoice that appears to be from a legitimate vendor. The invoice may not correspond to any goods or services rendered, but due to a lack of proper checks, the accounts payable team may pay it automatically. 

For example, a scammer might send a fake invoice for ‘consulting services’ that your company never requested, hoping it gets processed amidst the usual payment flow.

Fake vendor fraud

In this scheme, fraudsters create a fictitious company and submit invoices for payment. This often requires extensive research to ensure the company details, such as bank accounts, tax ID numbers, and addresses, appear legitimate. 

A classic example of this type of fraud is when scammers set up a shell company with a name similar to that of a real vendor, then bill you for goods that were never ordered or delivered.

Billing fraud

This type of vendor fraud usually involves a supplier or an employee attempting to steal money by manipulating invoices. This can take several forms:

• Submitting duplicate invoices for the same service.
• Inflating the price or quantity of goods.
• Charging for goods or services that were never received. 

For instance, a vendor might add an extra line item for ‘shipping and handling’ on an invoice, even though it was already included in the initial quote.

Check forgery

Even in a digital age, check forgery remains a common type of internal fraud. This occurs when an employee tampers with a paper check intended for a legitimate vendor, using forgery to alter the payee's name or the payment amount. 

Vendor Email Compromise (VEC)

Vendor Email Compromise is a sophisticated cybercrime and a prime example of vendor impersonation fraud. This type of supplier fraud happens without your vendor’s knowledge. 

A fraudster hacks into your supplier's email account and sends an email to your company, requesting a change in bank account details for future payments. When you oblige this request, future payments will be diverted to the scammer’s account. 

Bid-rigging

Bid-rigging is a scheme where a vendor offers monetary compensation to an employee with influence in the procurement process, so as to secure a contract over competitors. 

This type of supplier fraud compromises the fairness of the bidding process and results in your company awarding a contract to a vendor who may not be the most qualified or cost-effective option. This can lead to significant financial losses.

Price-fixing

In price-fixing, two or more vendors conspire to fix the cost of a contract at a price that is artificially higher than the normal market rate. This collusion eliminates fair competition and leaves your business with no choice but to accept a bloated budget for a project or supply contract. 

Vendor fraud detection: Identifying the red flags of supplier fraud

Meticulously analyzing payment data, vendor records, and transaction histories for discrepancies can go a long way in detecting vendor fraud. By scrutinizing these records, you can uncover suspicious patterns and identify red flags:

• Unusual invoices: Be vigilant for invoices with identical numbers or strange formatting that don't match your usual stockist invoicing.
• Vague descriptions: Watch out for invoices that use broad, non-specific descriptions, such as ‘consulting fees’ or ‘miscellaneous charges’, that make it difficult to verify services.
• Sudden change in banking details: A sudden request to change a long-term supplier's bank account details is a major red flag for vendor impersonation fraud.
• Lack of proper documentation: Be cautious if a vendor cannot provide sufficient supporting documentation, such as a purchase order or delivery receipt, to justify an invoice.
• P.O. box addresses: A vendor's address listed as a P.O. box rather than a physical address could indicate a fictitious company.

Beyond these technical checks, cultivating a company culture where employees feel safe reporting suspicious activities without fear of reprisal is essential to encourage internal whistleblowing. This encourages your team to report red flags, making your internal controls more effective.

5 tips for vendor fraud prevention

1. Effective vendor management

Combating supplier fraud starts with a robust vendor management system. By establishing clear and consistent procedures, you can significantly reduce the chances of your dropship business falling victim to a scammer.

• Vetting and onboarding: Conduct thorough background checks and verify all banking details before onboarding any new supplier. This due diligence significantly lowers the chances of a scammer vendor infiltrating your system.
• Information management: Centralize vendor information in a secure, digital system. This ensures data accuracy, prevents unauthorized modifications, and helps maintain a clear audit trail.
• Regular reviews: Periodically review vendor contracts, performance, and financial details to ensure the ongoing legitimacy of your partners. This can also uncover any irregularities over time.

2. Audit your vendors regularly

Regular auditing is a powerful tool for vendor fraud prevention. They help you proactively identify inconsistencies, such as duplicate payments, inflated prices, or charges for services never received. 

You should implement audits in two ways:

• Scheduled audits: Conduct routine, periodic audits of vendor invoices, statements, and supporting documentation to ensure consistent compliance and identify ongoing irregularities in your financial records.
• Unannounced checks: Perform surprise audits on your vendor files and payment processes. These checks are highly effective at detecting fraudulent activities that might be deliberately hidden during a scheduled review.

3. Employ a multi-level payment approval process

A multi-level payment approval process is a crucial vendor fraud prevention strategy where different individuals are responsible for vendor approval, invoice processing, and payment authorization. For example, a tiered approval system could be implemented where higher-value payments require multiple levels of authorization. 

This segregation of duties makes it significantly harder for collusion to occur and for a single bad actor to commit fraud. 

Furthermore, financial software can help in enforcing these multi-level approvals, enhancing the effectiveness of your fraud detection measures. 

4. Use the invoice matching technique

The invoice matching technique involves a three-way comparison between purchase orders, goods receipt notes, and supplier invoices. This robust control point is designed to detect discrepancies before any payment is authorized. 

Additionally, technology can automate and significantly enhance this process. For example, an Enterprise Resource Planning (ERP) system can automatically scan and match documents, flagging any inconsistencies for review. 

By rigorously comparing these three documents, you create a strong defense against fraudulent payments and ensure that you only pay for goods and services your dropship business has actually received. 

5. Rotate employees

Another vendor fraud prevention strategy is to periodically rotate duties among employees involved in procurement and accounts payable. 

Fraudulent schemes, particularly those with internal accomplices, often rely on an extended period of control over a specific process. Therefore, by regularly changing roles, you disrupt the opportunity for such long-term schemes to take root. 

Moreover, this practice can bring a fresh perspective to various procurement processes, enabling your company to potentially identify irregularities or patterns that may have been previously overlooked. 

Strengthening your defenses against vendor fraud

A proactive approach to vendor fraud prevention and detection is crucial for you to strengthen your organisation’s financial security and operational resilience. Moreover, these practices do not only protect your bottom line.

They also help you build a more secure and resilient foundation for future success – a secure vendor ecosystem fosters trust and allows you to focus on your core business growth without the constant threat of scammer vendors. 

So, start implementing the above prevention strategies to significantly bolster your risk management framework today.