Electronics supply chain, heal thyself: How industry leaders inadvertently enable the counterfeit parts market

By John P Brown, Verical -- Electronic Business, 10/20/2009

Though they bear the brunt of the pain of counterfeit electronic components in the supply chain, industry leaders regularly engage in activity that not only exposes them to the risk of getting stung, but enables the counterfeiters to thrive. Some of these activities are central to their business strategy, but many are not. Companies throughout the electronics supply chain need to be aware of how their actions affect the flow of counterfeit parts and decide if the risk is worth it.

Despite their very best efforts, secondary market players themselves face the daunting challenge of increasingly sophisticated fakes. While most independents and brokers strive to protect their customers, the bad apples amongst them exploit the lack of transparency in the grey market and insert fake parts into the supply chain.

The players in the primary market and their powerful suite of software tools create a secure flow of components that is transparent, traceable and marked by accountability. It is when companies deviate from these direct connections that they get into trouble. Below is just a partial list of how companies create the conditions that criminals exploit.

Component manufacturers

As owners of the IP (intellectual property) and brands targeted by counterfeiters, component manufacturers would seem to be the ones most sensitive to the risk of fake parts, but some of their actions directly and indirectly contribute to the counterfeit market.

Scrapping without oversight: Quality rejects destined for the scrap heap are a prime target for counterfeiters. After all, they are legitimate parts in almost every way, besides the fact they do not work properly. Companies should supervise the entire scrap process to ensure no rejects go unaccounted for and somehow make it into the grey market.

Selling excess or slow moving inventory into the open market may help meet quarterly targets, but, perhaps counter intuitively, dilute the concentration of the fake parts in the grey market, thereby sustaining the channel through which fake parts are sold.

Going fabless: Companies should not be surprised to hear that sometimes unused capacity at fabs goes to produce extra batches (of unknown quality) that stay off the books and are sold straight into the grey market.

Franchised distributors

Like their upstream counterparts, franchised distributors sell inventory into the grey market. Other activities that may inadvertently contribute to the flow of fakes include:

Accepting unscreened returns: When companies get stung by fakes, some unethical ones go so far as to purchase the legit versions from authorized distributors and “return” the fake ones. Components distributors are getting much better about filtering returns and segregating them from the common inventory, but it has been one of the vulnerabilities in the franchised supply chain.

Not carrying stock: Central to the distributor business model, low inventory levels can create long lead times for buyers, which force shortage buyers to turn to the open market.

OEMs and contract manufacturers

OEMs suffer most when fakes enter their products, but the contract manufacturers that built those parts know the pain of damaged brand and reputation, too. Some things these companies do that create opportunities for counterfeiters include:

Keep inventory too low: Essential for efficient operations, low inventory levels may be too low, thereby exposing the company to shortage and counterfeit risk. Not many companies track the full cost of shortages such as returns, warranty, and brand damage, much less incorporate them into inventory planning.

Intermingle primary and secondary market inventory in common bins: A standard practice, using bins might become too costly as companies bear the rising cost of fakes that can hit $2500 per component once warranty, rework, and replacement costs are factored in.

The rapidly evolving electronics supply chain is one of the most complex systems on the planet. Counterfeiting is one of the fastest growing risks in the industry. Managers should not only be aware how their actions inadvertently provide cover for counterfeiters, but reexamine their procedures to limit the opportunity for criminals to penetrate the supply chain.

About the author
John P Brown is co-founder and VP of marketing and strategy at Verical, an emerging online electronic component marketplace. He brings a wide range of experience in operations, supply chain, marketplace design, and anticounterfeiting. A term member of the Council on Foreign Relations, John focused on information management and infrastructure protection at the Department of Homeland Security and holds a BA, MPA, and an MBA from Harvard.