The Ugly Truth About Counterfeiting

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Nothing has polarized the supply chain like counterfeiting. It has pitted segments of the industry against one another (distributors versus brokers) and more recently divided the channel into two camps: Pro-DNA and anti-DNA. Both of these debates center around proposed solutions to the counterfeit problem in the channel and both have spurred action. But these debates continue to miss a point about counterfeiting that nobody in the electronics ecosystem wants to talk about: the role of OEMs and EMS providers.

First, a little background:  Excess inventory in the supply chain has created an open market by which inventory can be bought and sold by anyone that has the wherewithal to invest. Brand owners such as Intel, AMD, ADI, TE, Kemet, AVX and Murata – frankly, all electronics component makers  – limit their sales channels for a number of reasons. They authorize distributors to protect their brand; represent them in the market; pass on their product warrantees and exchange sales and end-market information.

Authorized distributors protect these brands for the same reasons suppliers do: they have skin in the game. Selling counterfeit components hurts both suppliers and distributors. Therefore, the supply chain has made a concerted effort to encourage commerce only though authorized channels.

One of the ways counterfeits enter the supply chain is the buying and selling that goes on outside of authorized channels. OEMs or EMS companies buy too much products that for one reason or another can’t be returned to the distributor or supplier. Rather than lose money on the inventory, OEMs can sell it in the open market. As this inventory changes hands, it is occasionally mixed with parts from other sources: parts pulled off of boards, remarked parts, parts advertised as mil-spec that aren’t, relabeled parts or defective goods.

Once parts can no longer be traced back to the brand owner or authorized distributor, they become suspect. Therefore, marking these parts to make them traceable has become a viable option. Applied DNA Sciences has come up with a plant DNA-based taggant that identifies where a device comes from, and sells the equipment necessary to read the tags. This practice has been adopted by the U.S. government’s Defense Logistics Agency (DLA) in an effort to curb the sale of counterfeit goods into mission-critical military, defense and aerospace equipment.

Both solutions have created an “us-versus-them” mentality in the channel. Authorized sources point to unauthorized sources as the origin of the problem. Unauthorized sources have taken steps to mitigate risk and flag suspect parts and separate themselves from less-scrupulous brokers. DNA marking has so far only been adopted by fragments of the industry – not all component makers use it – so an interim solution was developed to account for existing parts. Since that solution includes non-authorized channels (because the DLA sources from these vendors); authorized channels reject DNA marking as a solution. (See: DNA Marking Roils Anti-Counterfeiting Camp.)

The only constituency that’s not part of the debate is customers. Because demand is an inexact science, customers often overestimate the amount of components they’ll need. Since OEM and EMS companies buy huge volumes of parts, they end up owning a lot of product. Even in a just-in-time (JIT) or build-to-order (BTO) market, orders are padded, projects are delayed or cancelled — things just don’t work out. So there is always excess in the channel.

That excess has a dollar value attached to it, specifically, what the OEM/EMS paid for the parts. If products cannot be returned (they are too old; have become obsolete; they are slow-movers so the distributors/suppliers don’t want to store them) and OEMs are stuck with goods they are losing money on. The open market was created for such a reason: independents take excess – often, factory-sealed product – off of OEM/EMS hands and resell it to companies that need it. These independents differ from brokers: brokers, like commodities traders, hope to buy low and sell high. The veracity of the product is a secondary consideration.

The problem for the supply chain is that this taints the entire channel. Suppliers and distributors have made attempts over the years to discourage OEMs from selling into the open market, but in the current environment they are losing leverage. During times of shortages, the threat of cutting off supply to an OEM selling in the open market had significant consequences. In times of ample supply, there is very little a supplier or distributor can do. And vendors differ on just how far they’ll push customers: big enough customers probably don’t get reprimanded by their suppliers all that much.

So the channel – and by this I mean suppliers and distributors of all types – are battling over solutions that don’t address the real problem. There will always be excess in the channel because customers can’t forecast. Independents fill a need by buying and selling excess. Some players in the open market are better than others. Marking parts may help separate the good parts from the bad, but only if everybody buys in to the technology. Strictly from the technology level, DNA marking has a lot of advantages and is being used in other markets. But the battle over DNA isn’t really about DNA. It’s over keeping the channel pure. And that won’t happen until customers buy into the solution, whatever it may be.

At the recent ECIA conference, Avnet’s Ed Smith shared one city’s solution to counterfeit goods sold on its streets. (See: Distribution: Some Policies No Longer Work.) It was impossible to stop the counterfeiters, so police arrested buyers of bogus products and seized the goods. They took counterfeits out of the supply chain. That’s the same end-game the supply chain aspires to. But until customers become part of the debate, suppliers and distributors are charged with fixing the problem. And as long as the channel remains divided over possible solutions, nobody wins.