If you have not yet tackled the question of ethics in Procurement, now is a great time to start. It does not matter whether you are a procurement professional, internal customer, external customer, senior executive, or supplier. Directly or indirectly, you are affected.

Procurement is what sets entire supply chains and their organisations in motion. How procurement handles itself and its activities set the tone for all the events that follow, right up to the final delivery of goods and services to the end-customer.

Ethical Procurement: Some Scenarios to Consider

The ground rules for good ethics in procurement are simple enough. Practice integrity, avoid conflicts of interest and personal enrichment, treat suppliers equally and fairly, and comply with legal and other obligations.

To make it even simpler, the overriding principle is “do the right things.” However, simple is not the same as easy. One of the challenges of ethical procurement is to know how to make it into a practical reality that people can apply in a consistent way.

For example, how would you deal with the following situations in procurement?

• You are responsible for the procurement of janitorial supplies for your mid-sized company. A potential supplier sends you its catalogue together with a gift of an expensive-looking ballpoint pen with the supplier’s logo on it.
• You have agreed to a two-year supply contract with a small, foreign supplier, but a drop in demand for your own company’s products is seriously depressing its profitability. Another supplier guarantees lower supply prices that would re-establish the margins your company needs to meet its objectives. This would mean breaking the contract with the first supplier without just cause. Legal action by that supplier would be unlikely, because of its small size.
• Your Italian company is negotiating the supply of aerospace products to a government in Asia. Your contacts in that government insist that your company also buys goods or services from another supplier in the country of that government.
• Your American company is competing with the Italian company above for the same contract. The government client insists on the same conditions. Will the procurement policy of your American company differ compared with your Italian competitor, and if so, how?

Read on for more about these examples in the text that follows. If any of them have left you bemused, you can take comfort in the fact that you are certainly not the first and probably not the last to wonder about the right thing to do.

Procurement Ethics: Shocks, Horrors, Scandals and More

It may seem strange that procurement, often viewed as an unexciting part of an enterprise, can find itself embroiled in events and situations that make world headlines. Ethics—or lack of them—is often at the heart of the discussion. From the deaths of garment factory workers earning pittances to corruption and kickbacks in defense contracts, procurement can be a hotbed of horror stories and scandals.

Immoral or illegal practices can include:

Bribery: Payments in cash or in kind made to individuals or their friends, family, or partners to buy their support for a supplier or a contract negotiation. Bribes can occur before, during, or after (kickbacks) award of a contract.

Coercion: Threats made against or pressure put on individuals with the same objective as bribery – to gain support for a supplier or contract negotiation. The difference is that whereas bribery aims to motivate individuals with what they can gain, coercion aims to motivate through the fear of what they might suffer or lose.

Extortion: Asking for a bribe or similar illicit payment. This may or may not be accompanied by a menace.

Favouritism: Also known as nepotism, in which individuals give undue preference or negotiating advantage to a supplier who is a friend or part of the same family.

Illegal sourcing: Suppliers offer goods or services misrepresented or produced illegally or immorally, whether because of materials used (such as the substitution of horsemeat for beef) or the labour conditions in which production takes place (notably in the garment industry). Stolen and black-market supplies are further examples.

Traffic of influence: The exchange of an award of contract (or support for the award) for a favour or preferential treatment by the other party of another individual or organisation.

Bribery in Procurement: What Happened at Smith & Wesson?

As bribery is one of the more common forms of unethical or even fraudulent procurement practices, it is worth examining a case study to understand how it typically takes place, but more importantly, how the consequences of what to some may simply be seen as ‘greasing the wheels of business’ are increasing in seriousness.

Between 2007 and 2010, during attempts to win firearms supply contracts with law enforcement and military agencies in Indonesia, Turkey, Pakistan, Bangladesh, Nepal, and Turkey, gun maker Smith & Wesson’s sales employees allegedly embarked upon a spate of unethical transactions, via third-party representatives, with foreign officials.

The Smith & Wesson employees authorised, offered, and paid financial rewards and gifts to government officials in the aforementioned countries, to the value of some $11,000. The officials, in turn, tried to influence the procurement decisions of the various agencies in order to secure the contracts for Smith & Wesson.

What’s Interesting About this Case?

In an earlier time (although not so very far back in the past), it would have been unheard of for a company to be taken to task in its home country for greasing palms overseas. The Smith & Wesson case served as a wakeup call to enterprises in the United States, highlighting the change in government attitudes toward ethical business practices.

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What’s also interesting is that apart from the Pakistan deal, which went through and netted just over $100,00 for Smith & Wesson, none of the other contract deals was successful.

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In the end, this unethical sales initiative turned out to be an $11,000 gamble that cost the jobs of the entire Smith & Wesson international sales team and lost the company $2 million in fines levied by US federal regulators—not to mention doing untold damage to Smith & Wesson’s reputation. The company neither admitted nor denied any wrongdoing—probably a moot point, as it paid the fines and has seen its name tarnished by association with the incident.

What Can We Learn from Smith & Wesson’s Misfortune?

Sadly, this story centres on how a company was harmed by unethical sales (as opposed to procurement) practices, primarily because it’s not known what became of the people on the other side of the negotiating table. What is known though is that corrupt officials received bribes, and that those who paid them received no benefits.

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Aside from the Pakistan deal, Smith & Wesson won none of the contracts concerned, and the perpetrators (if that’s what they were) lost their jobs and their professional credibility.

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Given that in Indonesia, for example, business bribery is commonplace (despite the efforts of a governmental anti-corruption agency), one must wonder if Smith & Wesson’s salespeople were the corrupters or the corrupted.

In spite of being a sales-focused story, the moral is totally relevant to procurement, since it highlights how tolerance for unethical business practices has diminished in recent years, even when a national economy (in this case, the United States) stands to gain from international supply contracts. Imagine the ramifications in a reversal of the Smith & Wesson situation, if a company is found to procure products or services unethically from overseas, at the expense of local suppliers.

The Impact of Poor Procurement Ethics

The immediate reaction to the idea of unsatisfactory procurement ethics is that it will be damaging for public relations if those ethics become known. This is true. In this information-rich and communication-enabled age, bad press can spread rapidly—as confirmed by the Smith & Wesson case study.

Consumers and other members of society wield considerable power in the form of associations, forums and networks, whether online or offline. They know how to use that power to punish enterprises and organisations they consider offenders. Sanctions can include boycotting purchases of a company’s products or services, or voting governments out of power.

However, this is only part of the picture. Even if an organisation is able to hide unethical procurement activities, it lays itself open to other problems. The first being one of management.

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For example:

• If senior management does not know about the lack of ethics, or if it takes no action, then it is essentially inept
• If senior management condones or actively supports unethical behaviour, it is corrupt.

The second is the efficiency of the procurement process and the effect on overall organisational performance. If procurement is driven by personal gain rather than value to the organisation, profitability suffers.

A third problem is rogue procurement. Having seen the example set by others, non-procurement staff may initiate their own procurement efforts, which are in turn likely to suffer from inefficiency, reduced value to the organisation, unethical behaviour, or any combination of these.

Who Judges Whether Procurement is Ethical or Unethical?

Some organisations rise to the challenge and produce a procurement ethics manual. These documents can vary in length. Some are succinct web pages. Others are detailed handbooks that explain not only the principles to be observed, but also give examples of how and how not to conduct procurement in order to remain ethical.

The guide made available online by the United Nations is a case in point, and interesting background reading for anyone who wants to dig deeper into the subject. Yet as the United Nations Procurement Practitioner’s Guide also points out…

“No matter how hard policy-makers try, they will never specify in law, code, regulation, rule, or other written requirement everything that a procurement officer needs to know regarding what is allowed or appropriate and what is prohibited or shunned.  It is necessary for procurement officers to understand what the law or rule is intended to accomplish.”

Depending on countries, cultures, customs, and even industries, definitions of what is ethical or unethical in procurement may vary. Practices defined as corrupt by some parties may be taken for granted by others and considered a normal part of doing business. The aerospace and defense sector is an example. Some public sector buyers ask foreign suppliers to in turn award contracts (“offset contracts”) to local or national companies.

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One consequence of offset contracts, often desired by the buyers, is to improve the balance of payments between the two countries concerned.

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The recent procurement scandal involving the sale of helicopters to India by the Italian company Agusta-Westland included such offset contracts. Italy currently has no public law about this. On the other hand, the United States opposes mandatory offsets as breaking free market rules and hence, as being unethical.

As it turned out, offset contracts were only part of the problem. Other factors fuelling the scandal included the alleged millions of dollars paid by intermediaries as bribes and the possible alteration of procurement specifications to help sway the contract award decision.

Role Models Start at the Top

Procurement ethics, like many other aspects of management, are top-down. The example set by senior management, its attitude, and its behaviour, strongly influence employees at other levels. Senior managers have to demonstrate fairness and transparency to encourage the visibility of the same qualities in procurement executives and teams. Procurement ethics have to be on display.

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If ethical standards are applied, but hidden, suspicious among stakeholders (internal customers and suppliers, for example) can still arise if decisions do not match their hopes or expectations.

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This does not relieve procurement staff of its responsibility to “do the right thing”. Nor does it guarantee that the right thing to do will be obvious. The example scenario at the beginning of this article about breaking a contract with a supplier came from a real-life case.

Instructed by a senior executive, the procurement executive terminated the contract with the first supplier. The financial prejudice to that supplier was probably serious, possibly fatal. Termination of the contract however meant important financial breathing space for the buying company. Sometimes there is no easy answer, even from the top.

The Supplier’s Point of View

There is an assumption sometimes that villains in a procurement scandal must include the supplier. After all, if people involved in procurement have been corrupted, there must be a corruptor and suppliers can make good scapegoats.

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Yet many suppliers have their own written rules for employees about how to conduct sales activities and contract negotiation and management with public sector clients in particular.

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Procurement teams would also do well to remember that suppliers that have behaved ethically and won business honestly also need to be paid in a timely way. Otherwise, not only can motivation dwindle for upholding ethical standards, but also there may be fewer surviving ethical suppliers to do business with anyway.

Detecting Potential Procurement Ethics Problems

Identifying and understanding the problem are important parts to putting solutions in place. Telltale signs that something is amiss often fall into the following categories:

• Excessive secrecy: This can range from missing files and records to resistance to audits and reluctance to delegate or run competitive tenders.
• Suspect procedures: Normal procedures are ignored, or appropriate checks and balances are missing – for example, the same person approves an order and payment for that order, or only one person approves contracts.
• Inappropriate life or work styles: Buyers’ lifestyles may be out of keeping with their level in an organisation, they may have an unusually high number of meetings with a supplier, be entertained to an excessive level by that supplier, or a combination of any of these.

Correcting and Avoiding Procurement Ethics Problems

A written procurement ethics policy remains the starting point for raising and maintaining standards in an organisation. Employees at all levels that are involved in procurement need to know what is expected of them, and a written policy helps to resolve any arguments. There are also further conditions if such a policy is to be effective:

• The policy must be as clear and as concise as possible, while still offering sufficient guidance. That means covering general principles and stating specific rules as appropriate. Employees need clear instructions that will let them determine immediately for instance if a gift of a ballpoint pen can be accepted because it is below a defined value (perhaps $5), or if it should be returned to the supplier because it exceeds a defined limit and could be construed as an attempt to unduly influence procurement.
• Senior management must endorse the policy and act according to it.
• The policy must be published where employees and others can see them. A dedicated webpage on the organisation’s website is one outlet. Systematic inclusion in the annual report is another.
• Regular reviews and improvement of the policy is necessary. New laws and new public opinions will continue to impinge on an organisation’s ethics in procurement.
• Training in applying the policy should be provided, with refresher training at suitable intervals.

Auditing an organisation’s ethics then shows how well that organisation is performing both generally and in specific contract negotiations and awards. Audits also help to deter unethical procurement behaviour in the future.

Finally, a clear and effective reporting procedure must exist for employees to report actual and suspected cases of unethical procedure, or to obtain guidance about dealing with particular situations involving procurement ethics.

The Chain of Ethical Responsibility

Since this article was first published in 2015, supply chains and markets have globalised to such a degree that even some of the smallest businesses have supply chains spanning one or more international borders.

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This presents a greater range of ethical risks, and includes practices that may be far less flagrant than most of those discussed in this article thus far, and may take place somewhere far up the supply chain.

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While these practices may take place a long way away, the business may not be aware of them, and if they become known, may not draw the attention of any enforcement agency, the buying public has a surprisingly long reach. A connected society has become adept at rooting out unethical practices and their links to businesses at home—however tenuous or distant those links might be.

The practices in question can be anything from the use of animal products derived from endangered species, to child labour. It no longer matters that a business is an unwitting victim, or that the perpetrators are a supplier of a supplier of a supplier. There is an ethical chain of responsibility, and to be considered ethical and socially responsible, businesses must find ways to ensure they are squeaky clean and that no tier in the supply chain can be associated with such practices.

Conclusion

Enterprises and organisations can never assume that doing the right thing in terms of procurement ethics is automatic. Ignorance, doubt, temptation, and fear must be dispersed and replaced by a clear ethical model for all to follow. The advantages will be greater efficiency and value from procurement activities, a better brand image for the organisation concerned, and increased loyalty from end-customers and appreciation from the public in general.

Editor’s Note: This post was originally published in September 2015. It has since been revamped and updated with information that is more comprehensive. The most recent updates were made in October 2018.

Best Regards,
Rob O’Byrne
Email: [email protected]
Phone: +61 417 417 307