Image: iStock.com/themotioncloud

Manufacturers and distributors face a persistent and evolving threat from fraud. From procurement schemes and inventory theft to falsified financial reporting and cyber-enabled payment fraud, these risks are systemic, costly, and often difficult to detect until damage has already occurred.

Fraud in this sector rarely takes the form of a single bad actor or isolated incident. Instead, it often emerges from gaps in oversight, pressure-filled environments, and complex operational structures that create opportunities for misconduct. Effective fraud risk management requires discipline, structure, and sustained cross-functional accountability.

Organizations that manage fraud risk effectively begin with a clear understanding that fraud cannot be eliminated entirely. It can only be reduced, detected earlier, and managed more effectively. When leadership assumes fraud is unlikely, controls tend to weaken over time, oversight becomes inconsistent, and warning signs are rationalized or ignored. In contrast, companies that acknowledge fraud as a realistic operational risk are more likely to invest in preventative measures and respond decisively when issues arise.

This mindset must be reinforced from the top. Leaders set the tone through their expectations, their willingness to question anomalies, and their response to bad news.

Conduct a Targeted Fraud Risk Assessment

A formal fraud risk assessment serves as the foundation of any effective fraud risk management program. This exercise should go beyond generic checklists and instead focus on how fraud could realistically occur within the organization’s supply chain, production processes and financial workflows. Manufacturing and distribution environments are particularly vulnerable due to decentralized operations, high transaction volumes, reliance on third parties and complex inventory movement across multiple locations.

A meaningful assessment evaluates where fraud could occur, who might have the opportunity and incentive to commit or conceal it, and what the potential operational, financial and reputational impact would be. Importantly, the assessment should involve stakeholders from operations, finance, procurement, IT and internal audit.

Once risks are identified, they should be prioritized based on likelihood and severity. This allows organizations to focus limited resources on the areas that pose the greatest threat rather than spreading controls thinly across lower-risk activities.

Strengthen Internal Controls Where Risk Is Highest

Well-designed internal controls remain one of the most effective deterrents to fraud, but only when they are consistently applied and periodically tested. Segregation of duties is a common challenge in lean manufacturing and distribution environments, where efficiency pressures often lead to overlapping responsibilities. However, allowing a single individual to initiate, approve and reconcile transactions significantly increases fraud risk.

When full segregation is not feasible, compensating controls become critical. Enhanced supervisory review, targeted exception reporting, and periodic independent audits can help mitigate risk.

Automation and data analytics have become increasingly valuable tools in fraud detection. Advanced systems can identify anomalies such as duplicate payments, unusual vendor activity, or inventory discrepancies across plants and warehouses. These tools are particularly useful in high-volume environments where manual review is impractical.

However, technology alone is not a solution. Systems must be configured thoughtfully, access rights reviewed regularly, and alerts monitored by individuals with both the authority and the training to investigate them.

Manage Vendor and Third-Party Fraud Exposure

Manufacturers and distributors depend on extensive networks of suppliers, logistics providers, and service partners, creating multiple entry points for fraud. Third-party fraud risk can arise through inflated pricing, kickback schemes, falsified invoices or unauthorized changes to payment instructions.

Vendor risk management should extend well beyond onboarding. Periodic validation of pricing and contract terms, monitoring of transaction patterns, and independent verification of banking changes are essential safeguards. Simple procedural discipline, such as confirming payment changes using known contact information rather than email requests alone, can prevent significant losses.

Policies and controls are far less effective in environments where employees feel pressure to meet unrealistic targets or fear retaliation for raising concerns. An ethical culture is a powerful fraud deterrent, particularly in operational settings where employees are closest to the activity and most likely to notice irregularities.

Clear codes of conduct, regular training grounded in real-world scenarios, and visible support from leadership reinforce expectations. Anonymous reporting mechanisms further strengthen this culture by providing employees with a safe avenue to voice concerns before issues escalate into larger problems.

Prepare for Incidents Before They Occur

Even the strongest prevention efforts cannot guarantee that fraud will never occur. Knowing how to respond when red flags emerge is therefore just as important as prevention. A documented fraud response plan should outline roles, communication protocols, investigation procedures, and escalation paths.

Preparation reduces confusion during high-stress situations and helps ensure incidents are handled consistently, legally, and with minimal operational disruption.

Fraud risk management should also never be viewed as a one-time initiative. Business models evolve, personnel change, and fraud schemes become increasingly sophisticated. Regular reassessment of risks, periodic testing of controls, and continuous improvement based on lessons learned are essential to staying ahead.

In an industry where margins can be thin and disruptions costly, the impact of fraud extends far beyond direct financial loss. It undermines operational integrity, damages relationships, and diverts leadership attention from strategic priorities. Organizations that approach fraud risk management as an element of operational excellence, rather than a compliance exercise, are better positioned to protect assets and sustain long-term performance.

*Tammy Gamble is a partner and chief risk officer for *The Bonadio Group

*John McCurdy is a partner and industry leader, M&D, for *The Bonadio Group