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Fraud in Outsourcing

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A great deal of emphasis has been placed in recent years on outsourcing. Often this has been done without adequate consideration of the risks of fraud and corruption.

Outsourcing often gives rise to many opportunities for fraud and corruption, most of which are difficult to detect. 


Collusive Tendering 

Perhaps the most obvious risks are those of collusion; either between the tenderers as a group or between a tenderer and an employee. 

The inquiries in New South Wales and Victoria into the building industry have shown widespread collusive practices between groups of tenderers. These practices have supposedly ended; but allegations of collusion in other industries continue to surface periodically. 

Collusive practices take a number of forms, including: 

* sharing a market between tenderers, so that they pretend to compete against each other without ever in fact really competing; 

* paying tenderers to stay away; 

* paying other tenderers to put in "fictitious" tenders; 

* having related companies tender to make the process seem more competitive and help establish a benchmark price; 

* paying each unsuccessful tenderer a fee by loading the tender price; 

The payments to collusive tenderers are not always in the form of cash, but can also take the form of subcontracts, returning the favour in kind, etc.  

Detecting collusion between tenderers and staff is notoriously difficult.  

Allegations of this arise far too frequently for anyone in charge of outsourcing to assume that it could not happen in his or her organisation. 

As one person responsible for outsourcing commented: "The temptation is great and the risks are low. It is difficult to expect that people will not succumb." 



Another dishonest practice is capturing information and technology, sometimes also referred to as "data-raiding".  

In this situation tenderers bid low in order to get the contract because they intend capturing information, technology or techniques from the organisation.  

These are often then packaged and on-sold to other organisations, including competitors of the organisation from which the information, technology or techniques were taken. 

Sometimes they are not packaged for on-selling, but are integrated into the tenderer's standard services or products.  

On other occasions they are grafted on to other products or services that the tenderer is developing for selling. 

Organisations outsourcing activities often naively believe that their information, techniques and technologies are adequately protected from tenderers.  

Unfortunately the protection they have is fairly limited, especially when they do not take special measures to protect their interests. 


Foot in the Door Price and Variation Killing 

Other deceptive and often dishonest practices include "foot in the door pricing" and "variation killings". 

These involve submitting a low tender with the intention of initially making a loss but thereafter making excess profits to more than compensate. 

Variations refer to work that the contractor does that is different to the work described in the contract. It is usually charged for at far higher  prices than the contract work. 

It is said that in contracting you get the milk from the contract and the cream from the variations.  

Tenderers are often able to find areas in the tender documents that will allow other interpretations, lower quality goods and services to be delivered, etc.  

Contracts can sometimes be relatively easily manipulated to produce extremely lucrative variations for the tenderer. 

When organisations outsourcing their functions are hit with these activities they often find that they are worse off than they would have been if they had retained the services in-house. 

Trying to contain variations in contracts has been likened to trying to hit a target that not only keeps moving, but also keeps changing shape. 


Conflicts of Interest 

Tenderers may be able to obtain unfair advantages through being involved in conflicts of interest. 

An example is where an accounting firm providing audit services is called in to decide: 

(a) should the internal audit branch of an organisation be outsourced;  

(b) if it should be outsourced, what factors should be considered in deciding who to award the audit activities to; and 

(c) what audit work should be done by the contractor, how should it be done, and so on? 

Any fair observer would have to say that the accounting firm could easily manipulate the process so that the audit of the organisation is given to the accounting firm. 

There are many other conflict of interest situations, many of them involving fraud, that can arise in outsourcing. 


Other Risks 

In this article we have considered a few of the risks of fraud and corruption in outsourcing. 

It is an area that should be considered to be high risk and subject to the most intense scrutiny.


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For more tips, advice and practical pointers see Fraudproof Your Business Manual.