Due to the remarkable growth of the middle class in many emerging markets, manufacturing companies must have a presence in those markets to remain competitive. The appeal of lower production costs, the benefits of regional centers of manufacturing expertise, and proximity to customers’ global supply chains leaves the industry with little choice but to expand. Unfortunately, such expansion has made the manufacturing sector the most vulnerable to fraud, as highlighted in this year’s Kroll Global Fraud and Risk Report survey, which showed that 91% of respondents from the sector had experienced fraud in the past 12 months, the highest incidence of all sectors surveyed.
A critical fraud risk in the sector is the loss of intellectual property. For example, in one of Kroll’s high-profile cases, a clothing manufacturer learned that authentic versions of its products, not counterfeit goods, were being sold through unauthorized supply channels at far below the market rate. The traditional methods of fraud identification and verification, such as factory walkthroughs and other assessments, proved inadequate to identify the source of these goods.
Kroll conducted an investigation, which found that the Asian vendor was mishandling factory overproduction and the production of lower-quality goods or “seconds.” Rather than being disposed of properly, excess supplies and seconds were diverted by managers and sold on the gray market.
In another case, the jerseys of a major sports league were being counterfeited in China. The quality of the counterfeit jerseys was indistinguishable from the actual product; the jerseys were even printed with barcodes corresponding to U.S. retailers. Therefore, the sports league was unable to determine if jerseys were excess production or counterfeit goods. Kroll’s investigation helped them identify and move towards shutting down the sellers, while the manufacturer deployed proprietary anti-fraud technology to help deter future counterfeiters.
Operations in far-flung markets challenge a manufacturer’s ability to ensure adequate integration into its global strategy and safeguards. Kroll’s investigations have uncovered numerous examples of local partners or management taking advantage of the distance to systematically siphon production, customers, and profits into parallel operations for their own benefit.
In two recent cases in a Latin American country, Kroll investigations found that the local management activities of a supplier to the automotive industry and a consumer goods packaging company were so shielded from global management oversight that they were working almost entirely for the benefit of their own networks, while creating significant material and reputational liabilities for the respective global companies. Only through a comprehensive understanding of how this occurred were the global companies able to recover control of their local operations and avoid continued losses and liabilities.
How can manufacturers take advantage of the opportunities in new markets while mitigating their exposure to fraud?
- Before establishing relationships with partners and third-party vendors in country, conduct due diligence on, among other things, their personal and business reputations, regulatory history, and business practices. These findings (and the relevant parties) should be monitored on an established schedule.
- When considering a manufacturing joint venture or acquisition, it is not enough to understand the partner or target: the strengths of (and threats to) its whole logistics chain and its relationships must also be understood. Mapping what is key to the business and what should be changed from the outset will help determine the success of the venture.
- When assessing or managing the risks in a manufacturer’s value chain, look beyond fraud and corruption to other compliance issues—for example, labor practices (child labor, modern slavery, substandard work conditions) and community and environmental issues. Also, examine the business’ own operations as well as those of its suppliers.
- After the deal is signed, ensure that global best practices and oversight structures are integrated into the newly acquired operation, and that the local partner or personnel understands the role that these practices and structures play in the global company’s strategy.
- Conduct robust and frequent audits of overseas operations to assess regulatory compliance. Areas of inquiry should include, but not be limited to, compliance with anti-corruption and anti-money laundering regulations, and any applicable sanctions.
- Identify vulnerabilities in the protection of intellectual property and introduce appropriate measures to secure assets before a loss is suffered.
These strategies will help maximize the opportunities for manufacturers in overseas markets and significantly mitigate fraud as an enterprise risk.