5 Practical Tips to Help Prevent Inventory Fraud and Manipulation
Inventory fraud is a growing issue for merchants — especially for those that sell limited-edition items or highly valuable merchandise. This threat can often be overlooked, but it can be incredibly harmful to your business, impacting more than just your balance sheet and income statements. We’ll talk about the warning signs of inventory fraud and walk you through prevention tactics.
What is Inventory Fraud?
Inventory fraud involves the theft or manipulation of inventory items. And there are a number of ways that it can happen — both from employees and third party fraudsters. Inventory is a huge asset to your business, but it can be difficult to track and measure adequately — making this type of fraud tough to manage on your own.
Types of Inventory Fraud & Manipulation
So what threats are you up against? And how can you spot them? We’ll cover everything you need to know.
Falsified inventory records
Employees can commit inventory fraud by falsifying inventory records on your company's financial statements. For example, an employee may record artificially inflated inventory counts or put false entries into the general ledger. The goal is to steal goods from the business in a subtle way. However, there are ways to detect this scheme. You just need to know what to look for.
Warning signs
- Suspicious entries in the inventory system — such as entries that don’t fully explain a reduction in merchandise.
- A sudden increase in the cost of goods sold (COGS) percentage while sales remain the same.
- Shipments that don’t have a correlating sales invoice.
- Discrepancies in recorded inventory counts compared to physical inventory.
How this impacts you
Theft and dishonesty amongst your workforce can diminish the trust you have in your employees. And unfortunately, it’s difficult to build that trust back up. You also lose inventory that you likely won’t be able to recover.
Retail arbitrage
Retail arbitrage happens when someone purchases large quantities of items and resells them online for a higher price. Often, fraudsters will use bots — computer programs that can run automated tasks — to quickly snatch up as many items as possible.
Unfortunately, this practice can quickly undercut profits, drain inventory, and turn away legitimate customers. Plus, it can reflect poorly on your brand, hurting your opportunities for future sales.
Warning signs
- Unusual shopping patterns for certain items.
- An abnormal spike in website traffic.
- Sudden reduction in inventory for certain items.
How this impacts you
A single attack can cost you hundreds of thousands of dollars in lost inventory and revenue. Fraudsters typically use stolen cards to pay for these goods, so not only do you lose money to legitimate sales, you likely will pay chargebacks for these fraudulent transactions.
Inventory depletion
Inventory depletion occurs when a single buyer purchases a large quantity of inventory intended for many consumers, like concert tickets and electronic devices. Like retail arbitrage, buyers often use bots to quickly scoop up all merchandise.
Inventory depletion can cause a variety of issues. It can push customers to other vendors and damage their impression of your brand, costing sales and revenue. It can also put you in violation of promotional agreements with suppliers.
Warning signs
- An abnormal spike in website traffic.
- Selling out of inventory seconds after it is made available.
How this impacts you
When customers are continually turned away from your business because the items they want are always out of stock, they’ll go somewhere else. They likely won’t come back and may even tell others not to shop with you. Your brand reputation could suffer, and as a result, you may see diminished customer loyalty.
Denial of inventory
Denial of inventory is an attack that involves filling up many carts with hard-to-get items to reduce available inventory and prevent legitimate customers from buying the merchandise. Typically, fraudsters use bots to carry out these attacks as they can be done in a matter of seconds.
Once all the carts are full, fraudsters program the bots to execute coordinated cart abandonment attacks so they can purchase the freed inventory. This kind of attack creates a variety of logistical problems, frustrates your customers, and increases the shipping and delivery costs.
Warning signs
- An abnormal spike in website traffic.
- Sudden changes in inventory count for certain products.
- Complaints from customers unable to complete purchases.
- An increase in stock being added to carts but not moving forward to the payment step.
- Sudden spike in cart abandonment.
How this impacts you
Not only does the fraudster freeze inventory for legitimate customers, but the increased bot activity can also crash your website. So you lose sales and have to pay in labor to fix the website, improve security, and answer customer queries.
How to Prevent Inventory Fraud
Inventory fraud can be a heavy burden on your business. There’s a lot at stake, so it’s best to take a preventive approach.
1. Set up controls to prevent employee theft.
First and foremost, make sure that your inventory is secure and only authorized people have access to it. Make sure you have surveillance cameras in your warehouse, around dumpsters, and in parking lots.
Secondly, divide up duties amongst different team members for purchase authorizations, inventory management, and record-keeping. For example, you should have one employee in charge of purchasing orders, another for authorizing inventory purchases, and another for editing inventory records.
Lastly, add a checks and balances system to certain roles. For example, when an employee authorizes a purchase request, have another employee sign off on the order. Adding another person to important steps of the process can deter theft and manipulation.
2. Regularly review inventory records.
Fraud can happen without detection for months or more if you don’t pay attention. That’s why it’s important to regularly check your inventory and compare it to past records.
Yes, that’s right — perform physical inventory counts on at least an annual basis. Then compare the results to what is recorded in the general ledger. You may also consider performing surprise inventory counts periodically, even if it’s only on certain items.
Additionally, when you review your records, compare the current years’ activity to the activity recorded in prior years. Look at the amount of inventory recorded compared to the amount of cost of goods sold. Take note of any increases in inventory compared to increases in sales. If sales decline, inventory should fluctuate accordingly.
3. Improve your website security.
Stop large-scale attacks by boosting your web security. Make sure you have firewalls installed so that you can track and monitor your web traffic. If you see unusual spikes in web activity — an indication that bots may be attacking your site — you can block traffic from suspicious IP addresses.
Additionally, you can set up CAPTCHA challenges to block bot activity. For example, if a user tries to make a purchase using guest checkout, you could require the user to complete a puzzle or fill in a code to prove they are human.
4. Adjust the checkout process for high-risk inventory.
Some merchandise is more prone to fraud and manipulation than others. If you’re experiencing issues with your inventory availability, you may need to do some data analysis to figure out which items attract fraudsters the most.
Once you know what the high-risk items are, you can set up controls to mitigate fraud. For example, you can require that customers create an account to purchase the item. Or you can set limits on the quantity a single customer can purchase.
5. Use technology to detect and stop fraud at the source.
Fraud prevention software is your best bet against inventory fraud. It’s incredibly versatile, too, stopping multiple types of fraud all at once. Plus, the best software works in real time to stop threats as they emerge.
For example, if a fraudster is about to launch a denial of inventory attack with bots, the technology can detect and stop the attack before it hits your website. What’s more, it will collect data from every event that you can use to discover patterns and anomalies.
Want Help With Your Risk Management Strategy?
Fighting inventory fraud can be a daunting task. And we understand how that feels. The good news is that you don’t have to go through it alone.
Kount — a leader in digital fraud prevention software — could be the answer you’ve been looking for. We know fraud. We know the challenges you face. And we’re here to help.
We’ve been working with companies for decades, helping build unique risk management strategies tailored to each business. Reach out to us if you’re looking for a more effective way to mitigate risks.