The suit filed against EMS Flextronics International by chip maker Xilinx Inc. is a classic example of a common practice in the supply chain that the industry has been fighting against for decades: the resale of excess component inventory by OEMs and EMS companies and the consequences of such an action.
The outlines of the suit are sparse, but the situation is common. Flextronics, a customer of likely all major component suppliers, acquired Xilinx parts for its own use or at the behest of a customer. Flextronics presumably found itself with excess Xilinx components, and resold those devices to another company, Checkpoint Systems Inc. This raised a red flag when the parts cost less than Checkpoint was paying Xilinx. (See: Xilinx Sues Flextronics for Alleged Fraudulent Chip Resale).
The most common channel for component resales is the independent distribution or broker market, also called the gray market. OEMs or EMS companies that find themselves with excess inventory lose money on these parts because they have already paid for them. They sell the parts into the independent channel -- sometimes at a discount. Independent distributors may already have a customer looking for those parts or be able to easily find a buyer. It’s up to the distributor how much they charge. If a broker buys the parts, they could wait until there was sudden demand or a shortage of these devices and resell them at a premium. This particular practice – called arbitrage -- enrages the authorized channel because it gouges buyers or undercuts supplier pricing.
The supply chain has tried everything from best practices, policies, threats, technology and more recently DNA marking so that the buying and selling of parts can be traced. All of these efforts are well and good but don’t really address the problem, as was pointed out at the ECIA’s Executive Conference in November. Until companies such as Flextronics – and any or all other OEMs and EMS providers – stop selling excess components, some argue, there will always be some sort of price discrepancy in the market. Additionally, the practice of buying and selling into the open market opens the door for counterfeiting.
The rather surprising remedy to this, some suggest, would be taking action against buyers of components through unauthorized channels. Currently, component brand owners and authorized distributors have little recourse against resellers that buy and sell excess. In addition to affecting the price of components, the unauthorized channel is the biggest source of counterfeits in electronics. Bogus parts are often mixed with authentic parts and returned to authorized distributors that take back inventory based on contractual obligations. Sometimes, counterfeits are reintroduced into the supply chain through authorized channels. Most of the time they pass through various channels until they are flagged -- often, by an OEM.
The Xilinx situation is particularly perplexing because Xilinx’s products are usually programmed on behalf of a specific customer. This makes reselling these devices difficult because unlike commodity components, Xilinx parts are not easily interchangeable.
Without assessing blame one way or another, the Xilinx-Flextronics suit could unveil a lot of things the supply chain would rather remain hidden. It appears that Flextronics sold parts directly to Checkpoint. Why, if Checkpoint was a direct customer of Xilinx, did Checkpoint buy parts elsewhere? Did the devices pass through Xilinx’s authorized channel at all? (A lot of FPGA programming is done in the distribution channel.) And what were the conditions of the original sale? In most cases, custom devices are non-cancellable/non-returnable because they cannot be resold to another customer. This makes the Xilinx situation particularly perplexing -- and possibly explosive.