If buyers didn’t have an unfulfilled need, the gray market wouldn’t exist.

A wise contract manufacturer (CM) once said that to be successful, his company had to focus on three things: quality, quality, and quality.

When an OEM searches for a contract manufacturer (CM), the company knows that its baby (brand) may be at risk if cost and availability issues lead to the CM sourcing components from a variety of places. Prices can be negotiated, quality most certainly cannot. 

According to Chuck Delph, senior vice president of sales for Avnet Electronics Marketing, Americas, CMs need a robust quality management system in which they can show how they are managing their quality end-to-end.

“Quality management systems are critical today when our customers are choosing which contract manufacturers to partner with,” says Delph. “We only buy directly from the suppliers. In return, we sell directly to the CM. It’s complete traceability through the supply chain. Our preference is that they are going to buy from franchised distribution or directly from the manufacturer to ensure that they have supplier traceability. But in today’s environment, it’s easier said than done.”

OEMs place a lot of faith and trust in the CM; and in their legal department’s ability to draft contracts they believe offer protection.

“OEMs need to take a more proactive approach,” says Robin Gray, executive vice president of the National Electronic Distributors Association (NEDA). “The CMs profit margins are so razor thin, you can’t blame them for looking for parts that are less expensive to make a little more money than the contract called for.”

In order to pad the bottom line, product swapping and procurement through the unauthorized supply chain has become an issue in the market. Pricing is no longer the greatest pressure point for CMs. The electronics industry has become an increasingly product-constrained environment with deliveries at the mercy of the supplier community.

According to Gray, without rigorous inventory control, the product procured from both authorized and unauthorized suppliers can get mixed on the factory floor. Even if a CM unveils a counterfeit, it has a hard time sorting it from the genuine product.

If CMs are going to buy from multiple sources, Gray says they need to segregate the products from unauthorized sources. If a problem does arise, they know where to find the source of the problem.

“[Swapping] is a slippery slope that’s a lot more of an issue in a market when components become so hard to find,” says Michael Knight, vice president of corporate product management and supplier marketing, TTI. “There is probably a lot more swapping going on than anybody really realizes.”

Traditionally, OEMs required CMs to follow a specific process in order to make a swap on a bill of material. There was, and is, a lot of hard talk from OEMs that if the process isn’t followed, they would find another partner. According to Knight, it seemed like a credible threat.

“Frankly, the CMs are buying a part number. In [TTI's] interaction with CMs, they are not open to any suggestion of a swap,” Knight says. “There are loads of legitimate easy swaps, but in this day and age buyers and engineers haven’t been in product sets for years. They’re just buying the part number. Buyers and engineers don’t have enough knowledge or understanding about what they’re working with to make those kinds of judgment calls.”

Has the Internet made it so easy that if one company doesn’t have the part, you Google the part number and find someone who does?

“The swapping is happening in the gray market, but I have too much to lose,” adds Knight. “If my suppliers catch me swapping, I lose the franchise. If we start leaking counterfeit product to the customer base through the authorized channel, it shoots the whole reason for using an authorized distributor in the head.”

Most importantly, when CMs shop the gray market to manage their supply chains, the companies must have transparency to the OEM. 

“There are times when we will go out and buy from non-franchised suppliers at the request of our customers, in which case we have an agreement with them to go and do so,” says Delph. “Have a process in place to show the customer how you procured the product.”

It’s not a matter of whether a company will ever have counterfeit product in their supply chain. When buying from the gray market, it’s only a matter of time.

“You hope you’re able to catch [swapping] before it ever reaches the end customer, but heaven forbid if any of this stuff is in a medical or military device … many of these things are impacting people’s lives,” says Delph. “It’s not about an iPod that doesn’t work; these are devices that must work to the specifications.”

The tremendous pressure to meet immediate requirements flows all the way through the supply chain and forces some CMs to look at alternative solutions. It lends itself to a problem with counterfeits. According to Delph, counterfeiting is exponentially worse today than it was 10 years ago.

“We can almost pinpoint it to one particular region, Shenzhen, China, where a fair amount of this product has been traced back to,” he says. “You have two dynamics: the shortage of supply, and absorbing the price increases inherent with a supply shortage.”

However, there is a reason that the gray market exists, beyond the particular province in question. If buyers didn’t have an unfulfilled need, there wouldn’t be a gray market.

“It’s hard to argue with that,” says Knight. “The biggest source for the gray market is franchise distributors who use it as an outlet for excess and obsolete inventory. If all of us stopped, it would be next to impossible for the gray market to acquire parts.”