Cut it out

Corruption is becoming more widespread. And as procurement staff gain more strategic positions within companies, they must help to tackle the problem. In the first of a three-part series, Peter Sammons reports on the fight against the hidden costs of frau


Gordon Foxley, a Ministry of Defence procurement director, was sent to prison for four years in 1994 for taking $2.25 million in bribes to place orders with three companies. But the real cost was much more than that. Transparency International, an organisation dedicated to increasing government accountability and reducing global corruption, concluded that Foxley had, in fact, caused up to $200 million of financial damage. This included the cost of job losses at UK factories that had failed to win orders because of the bribery, lower values for privatisation exercises as a result of lost profits, and the loss of technical skills. And there have recently been well-publicised allegations of serious corruption at the highest levels of the European Union and the International Olympic Committee. Further east, the fall of communism has brought in its wake new opportunities for corruption in former Soviet-bloc nations. Procurement professionals are already alert to the dangers of fraud and bribery. But, let’s be honest, too many buyers are still too low in the chain of command to have a real influence, even if they suspect corruption may be going on. However, there are two reasons why professional procurement is set to find itself more involved in corruption management. First, procurement is - albeit slowly - achieving board-level status, a trend that is expected to continue. Second, the Organisation for Economic Co-operation and Development (OECD) has enforced tough new agreements aimed at curbing corruption of public officials. It is widely held that, in terms of international trade, it is the OECD and industrialised nations that hold the key to halting the tide of corruption. Having agreed what needs to be done, the OECD is looking to its member governments to enforce the new agreements. In his book Grand Corruption, George Moody-Stewart defines corruption as “the misuse of public power for private profit”. In the context of procurement, whether public or private sector, corruption is the misuse of a position of authority to favour one supplier in return for some benefit. Meaning is important, if only because people hold different views on the definition of corrupt behaviour. Child labour, for example, may be immoral, but it is probably not corrupt, depending on the laws of the country. Many purchasers will have first-hand experience of being offered bribes. Others will have been offered “grey” inducements, normally gifts or hospitality, designed to create a favourable atmosphere between buyer and seller. CIPS’s ethical code deals with these issues. But a new development, especially in high-level overseas procurement where there are often multi-party investors in complex technical projects, is that purchasing professionals will be operating alongside many other professionals working to different agendas. Why does corruption matter? Most business people would find paying bribes abhorrent. In the developing world, however, many officials who otherwise would not accept bribes do so out of a need to compensate for poor wages and a lack of job security. Their peers are probably involved in corruption, as - on a far wider scale - are their political masters. It is difficult to maintain a lone stand in these circumstances. So why the fuss about corruption? It’s as old as business. If you don’t do it, you will lose business. Besides, you might well see an inferior competitor secure what could legitimately be your business. There are a number of classic excuses for doing nothing about corruption, from “it’s everywhere, there’s nothing you can do about it”, to “cleaning society of corruption would take a wholesale change in attitudes - realistically, it won’t happen”. Corruption matters because important decisions are determined by ulterior motives, with no concern for the interests of the company or the wider community. It raises the cost of goods and services, increases the debt of poorer countries and carries with it recurring debt-servicing costs into the future. It leads to a drop in standards, as inferior goods are often supplied and inappropriate or unnecessary technology acquired. It also results in projects being chosen because of high capital value, regardless of whether investment in employees would be more useful for a particular country’s development. Dieter Frisch, former director-general of development at the European Commission, points out that when a country carries out projects that are not economically viable, the additional debt not only includes the price hike caused by the corruption but can often mean that the whole cost is wasted if the project itself is unnecessary. There are many costs associated with corruption that cause, in economic terms, “allocative inefficiency”. * If corruption takes the form of kickbacks, it diminishes the total budget available for legitimate purposes. * Corruption damages the administrative apparatus, eroding integrity and high standards of probity. * Corruption results in substantial loss in productive effort as time and energy are devoted to making arrangements to outdo the system, rather than strengthening technical and commercial proposals. * The most ubiquitous form of corruption in many countries - “speed money” or “grease payments” - causes decisions to be weighed in terms of money rather than need, and helps to sustain corruption higher up the chain of command. One, perhaps unexpected, outcome of systemic corruption, experienced in Italy and written about by Donatella Della Porta and Alberto Vannucci in their book Political Corruption, is that of “dynamic inefficiency”, where corruption leads to a progressive loss of efficiency for firms specialising in supplying the public sector. “The toll paid for this process by the public administration is a heavy one,” they say. “Legislation on public tendering tends to reward firms who can bid lower than their rivals for a contract… more efficient firms may be unsuccessful precisely because their competitors, having no prospect in the private sector, are willing to pay bribes and accept reduced profits in order to maintain a share of the public-sector market. As alternative sources of profit arise in the private sector, the most productive firms abandon the public sector to be replaced by the less efficient.” And companies that win public-sector contracts through corrupt means are unlikely to want to invest any more money than necessary, so areas such as technological research and development - essential for the long-term health of an economy - are likely to be left behind. A drop in standards Everyone working in procurement has a duty to their employer to obtain the best value for money within whatever constraints exist. In corrupt systems, the best that can be achieved is, in effect, damage limitation. Most professionals, however, would not be satisfied with this. The point has already been made that most buyers do not pay bribes: they are much more likely to be recipients of bribes which, in the UK, is illegal. But purchasers may increasingly find their organisations operating in markets tainted by corruption. Certainly, opposite numbers in sales and marketing could have some difficult choices to make. During the past 20 years, there has been a drop in the standards of global trade, with grand corruption - as opposed to petty corruption between low-level bureaucrats - now far more widespread. Some lay the responsibility for action at the feet of law makers and regulatory authorities. EU procurement legislation, nominally designed to secure the single market and obtain “best value” for taxpayers’ money, was seen as a tacit weapon to combat corruption but is not watertight. Whatever the case, it is clear that procurement will have to play a greater role in managing the problem. When a customer organisation is corrupt, it is not unknown for all bidding suppliers to be asked to include a percentage commission - not in return for winning the bid, but simply because they will not be considered without it. It is also likely, especially for long-term projects, that officials will demand further bribes at a later stage; most companies paying bribes will prudently hold back a proportion of the project budget to cover this possibility. Moody-Stewart suggests three criteria with which to measure the corruption’s appeal: size of bribe; mystification (the ability to conceal “extra” payments within a complex deal); and speed of payment. Using these criteria, he devised an order of preference for supply categories to governments and agencies. Defence leads the way, followed by industrial goods, civil works, ongoing supplies and consultancy. Earlier this month, a US Commerce Department report said that half of the corruption complaints it receives concern international defence procurement. The tendering trap Competitive tendering is seen by some as a panacea to corruption, but it can complicate things further, or be circumvented by several means: * ensuring the winning bid includes a “commission” rewarding the person who controls the project; * slanting the specification to favour one supplier; * pre-qualification: limiting the shortlist of suppliers to those most likely to provide “the right” bids is a way of reducing costs to the suppliers and customer. However, a pre-qualification application, possibly including false information, can easily be assembled by suppliers. The absence from the shortlist of companies, particularly well-qualified ones, would, in this case, be ignored by the customer. European companies in particular need to be careful they do not fall foul of the EU procurement rules; * incorporating unhelpful terms and conditions - some companies may be known to have difficulties with certain contractual clauses. Even where the “wrong” company is selected under a competitive tender, a corrupt official can still demand a pay-off as the price of future co-operation. If this is unsuccessful, it may be possible to find other reasons for re-opening the bid process. Unfortunately for the procurement profession, especially in the public sector, the tendering process is still often seen by politicians and others outside the industry as being the best procurement method. If procurement professionals fail to tackle corruption, there is a danger that other professions will take greater control of the procurement process and limit purchasing professionals’ involvement. Corporate colleagues in the legal profession, for example, could seek to control the procurement process by imposing stricter rules. And those in finance could seek to develop the auditing skills necessary to detect corruption, both at pre- and post-project phases. New opportunities On a positive note, there may be opportunities for the procurement profession to make a notable contribution to the fight against grand corruption. Organisations such as Transparency International, the World Bank and the OECD emphasise the need for more effective regulation, especially in public-sector procurements. Others, however, are taking a much more pragmatic approach. Among the better suggestions to have emerged in recent years are: * to promote genuine competition; * to establish a new balance between regulations and professional discretion; * to improve oversight mechanisms - auditing, inspecting and investigating; * to introduce top-quality recruitment for senior procurement roles; * to change the reward/penalty structure for bidders: incentive contracts could reward ethical behaviour by linking payment or future contracts to cost and quality. It would also help to make the penalties tougher and “name and shame” guilty companies. Peter Sammons is director of Buy Research Shamed: Jonathon Aitken Why? The former defence procurement minister’s “simple sword of truth and trusty shield of British fair play” that he said would exonerate him backfired when he finally admitted he lied about who paid the $2,500 Paris Ritz bill. In June this year he admitted perjury and perverting the course of justice and was sent to prison for 18 months. All over a hotel room? The rules say that ministers should not accept gifts, but this was a minor point in more damaging allegations made by The Guardian and World in Action. Which were? He was there for talks with his former Saudi business partner, Said Ayas, and Prince Mohammed, a son of the Saudi king, working on a plan for British arms firms to pay millions of dollars in commissions to a Swiss bank account in return for securing arms contracts worth hundreds of millions of dollars. Shamed: Edith Cresson Why? The former European Union commissioner’s dentist achieved infamy when it was discovered he had been appointed as a consultant to the European Commission. Attacks on Cresson were one of the main factors that led to the resignation of EC president Jacques Santer and all 20 commissioners in March. There must have been more to it than a dentist… The mass resignation followed a damning report on fraud and nepotism. Tender specifications for printing contracts were often changed to benefit one firm and there were fraudulent invoices. Shamed: The IOC Why? Juan Antonio Samaranch (left), president of the International Olympic Committee, did nothing wrong, but he has still had a tough time persuading the world that the Olympic spirit holds good after four IOC members resigned, six were expelled and 10 censured following corruption allegations. What for? The Olympic six - Congo’s Jean-Claude Ganga; Ecuador’s Agustin Arroyo; Sudan’s Zein El Abdin A Gadir; Mali’s Lamine Keita; Chile’s Sergio Santander Fantini; and Samoa’s Paul Wallwork - were all accused of receiving money or favours from the Salt Lake City bidding committee that was awarded the 2002 winter games. Anything else? Gifts from countries bidding to host the games are acceptable, but only up to a value of $200. Salt Lake City was revealed to have spent $1.2 million. In June, Atlanta admitted exceeding the limits on gifts in its successful bid to win the 1996 summer games. A case study A local development company secured permission to develop a build, operate and transfer project and had signed a procurement contract with a major plant supplier. Following this, potential investors were invited to fund the project as equity stakeholders. There was little doubt that the project had been “bought” at some considerable cost to the equipment supply firm whose price, even allowing for certain technical difficulties, was 20 per cent over the market norm. In a $360 million project, this needed to be reigned in. Potential investors were acutely aware that clear parameters had been established between the project developer and the equipment supplier, even though they were now effectively on different sides. Several times during critical meetings, both parties would leave the other key investors and have a private meeting in the corridor. Since all parties were desperate for a win, the irregularity was ignored and the price to the ultimate consumer was certainly higher than necessary. Over a 25-year payback period, this represented a considerable and unnecessary burden for consumers.
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