How to Protect Against Marketing Fraud

Marketing Expenditure is growing faster than ever before, fuelled by corporate growth objectives that seek to launch new products, reach new customers, penetrate new channels and expand into new geographies. Marketing is a $450 billion industry. Media advertising expenditures alone reached $250 billion in 2004 in the USA, equivalent to almost $1,000 per capita. Major marketers such as Ford and General Motors spent more than $3 billion each in 2004. Procter & Gamble spent almost $5 billion.

Many question whether marketing is effective and delivers value for money. Equally important is the threat of marketing fraud and whether marketing expenditures are properly and sufficiently audited. In a climate of tighter governance, with the Sarbanes Oxley Act requiring that the CEO and CFO sign off on the company accounts, it is essential that boards and top management have confidence in the integrity of marketing expenditures.

Accounting reporting standards have been improved in recent years to outlaw bad practices such as artificial booking of as yet unrealised revenues to achieve quarterly or fiscal-year sales targets. In addition, the top line of the income statement must now represent the value of sales net of discounts rather than gross sales, which some companies were inflating by offering products and services at high list prices that were simultaneously accompanied by substantial discounts.

These changes, however, have not stamped out fraud and malfeasance. In 2004, the Warner Lambert unit of Pfizer Inc settled charges of deceptive sales and marketing practices for $430 million including a $250 million fine. Saks was found to have improperly collected $20 million in markdown allowances from vendors whose merchandise did not sell at expected retail prices. In 2005, AOL Time Warner agreed with the Securities and Exchange Commission to $1.2 billion in settlements, fines and revenue restatements; AOL had over-claimed its number of subscribers and charged AOL advertisers more than they should have paid as a result. And several advertising agency executives have recently been convicted of fraudulently overstating billing hours to publicsector clients in order to meet their revenue goals.

WHY IS MARKETING FRAUD NOW MORE LIKELY?

Four factors make marketing fraud more likely than in the past.

First, the pressure to meet the quarterly sales forecast is greater than ever, resulting in a disappointing 'do whatever you have to do to make your numbers (but don't tell the boss)' ethic in many organisations.

Second, the trust and continuity between customers and suppliers that characterised, for example, agency-client relationships 20-plus years ago no longer exists; over $35 billion of US ad agency billings were opened up by clients to agency competition in 2003–2004, a greater proportion than ever before.

Third, the marketing landscape continues to become more complex; for example, there are today 1,600 broadcast and cable outlets in the US alone from which advertising time can be purchased.

Fourth, the emergence of internet advertising and product/brand placement arrangements for which measurement and audit systems have yet to be defined or standardised adds an extra element of uncertainty and risk of kickbacks. vFirms vary of course in the size and materiality of their marketing, sales and distribution costs. We believe that firms with 7.5% of revenues or more in marketing expenditures should pay special attention.

HOW TO PROTECT AGAINST MARKETING FRAUD

What should the boards of directors, charged with protecting the reputation of these firms, do to mitigate the risk of marketing fraud?

Elevate Marketing

Appoint a chief marketing officer who combines budget accountability with creative flair. Have the CMO present the annual marketing budget to the board. Require that significant changes in the level or allocation of marketing expenditures be explained. Require that the CMO sign off on the integrity of the marketing expenditures component of the annual accounts.

Add Specialist Audits

Accounting firms define their roles more narrowly than ever; spotting fraud and waste are not on their agendas. Companies must ensure that their internal audit teams include marketing expertise. Internal audit or specialised outside firms should conduct sample audits of purchases from marketing suppliers. Audits are especially needed when advertisers such as airlines barter their products and services in exchange for media time and space.

Tighten Contract Terms

When buying media time and space through third party agencies, reserve the right to audit the cash flow trail all the way to the media owner. It's important to check that the agencies are refunding savings achieved by combining your purchases with those of other clients.

Deploy Six Sigma Processes

Fraud and waste are less likely when procurement processes are well-designed and well-documented. Good processes are a deterrent as well as an aid to discovery. At one newspaper chain, implementing six sigma revealed that front-line advertising sales people were ordering free make-up ads for ads that allegedly ran with copy errors. In fact, they were selling without authority five ads for the price of four, delivering the fifth as a make-up.

Practice What You Preach

Demand the same high stands of your own procurement and marketing staff that you expect of others. Require annual employee sign-offs on corporate codes of conduct that explicitly prohibit sales and marketing practices such as excessive gift giving, corporate hospitality and unauthorised discounts. Establish a whistleblower hot line and pay restitution to customers promptly if you discover employee malfeasance.

If retailers with surveillance cameras lose three percent of their annual sales to theft, it's probable that a similar percentage of all media expenditures are lost to frauds and deceptive practices. For the more than 50 US public companies spending over $1 billion each year on marketing, that is at least $30 million apiece, enough to warrant closer board scrutiny.

This article featured in Market Leader, Winter 2005.