Securing supply chains through data transparency and better market design.
The rise of counterfeiting in recent years has been astounding. The U.S. economy loses some $250 billion annually with some three--‐quarters of a million jobs lost every year to what the Wall Street Journal has labeled as “nothing Short of an economic crisis.” The Pain reaches in to all corners of the economy, and the high technology manufacturing is no exception. Counterfeit electronic components can be found in all corners of high tech chain, from basic light switches and games to advanced medical scanners and telecommunications infrastructure. As electronic components find their way into more and more parts of modern life, the risk of counterfeit will threaten economic growth and consumer safety the world over. For the industry to successfully protect against this risk, we must understand its causes and how finds its way into the legitimate supply chain.
Several trends have created this crisis. Some are deep themes of the globalizing economy, others are very specific to the how transactions occur in the electronic components secondary market. None of them are likely to change anytime soon.
Apart from a brief mention below, this paper will not examine the macro economic issues involved but will instead concentrate on the more immediate factors which drive illicit parts into the legitimate supply chain.
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General
China
Over the last 10 years, the growth of manufacturing in China has been staggering. With annual growth rates in excess of 10 percent (and possibly much more, according to some analysts), the Chinese economy has grown so ferociously in the last decade, it is deeply enmeshed in almost every global supply chain.
This move to becoming the “factory to the world” has included the wholesale relocation of manufacturing from high cost regions to China southeastern coast.
As they have shifted manufacturing know--‐how and methods to China, western manufacturers have learned a painful lesson about the notoriously weak protections for intellectual property in China.
Whereas a decade ago the counterfeiters used crude and shoddy techniques to create fakes, today they have access to the most modern tools and techniques and, in some cases, the original assembly lines themselves.
Lean
One of the most remarkable transformations of global manufacturing in the last few decades has been the proliferation of lean manufacturing. One of the core tenets of lean is the elimination of waste, to include unused inventory sitting in warehouses in the form of buffer stocks.
As supply chains have become more efficient, many firms have struggled to implement lean methodologies properly across their supply base, leaving themselves with practically no inventory in times of heightened demand.
Suppliers have worked hard to cut their own inventory risks so when a manufacturer finds an unexpected increase in demand, it can sometime take the primary market weeks if not months to react. The resulting shortages mean increased exposure to the secondary market and to the growing risk of counterfeit.
Global Growing Markets
A third macro trend in recent years has been the globalization of markets. Firms find themselves selling into new national and regional markets around the world, both as a consequence of expanding their targeted markets and of the rapid growth of the middle class in those developing economies.
These newly established and emerging markets have introduced yet another layer of volatility into a company’s forecasts and increased its exposure to shortages and the tide of fakes in the secondary market.
Electronics Everywhere
Magnifying the effect of growing markets has been the dramatic penetration of electronic components into entirely new products lines. A child’s toy truck was once just bent metal with some plastic tires, but one now would be hard pressed to find a toy that comes without a dazzling array of flashing lights and sound effects.
Automobiles will contain nearly twice the dollar value of electronic components in 2012 than they did a mere 5 years earlier. Newly electronic products mean even more volatility in the electronics supply chain.
Low Risk, High Return
Like smart businesspeople everywhere, criminals look to minimize risk and maximize their return on investment. In 2007, the U.S. Federal Bureau of Investigation estimated that the distribution of counterfeit product was 900 percent more profitable than the distribution of cocaine.
With narcotics smugglers facing mandatory sentences stretching into the decades, it comes as no surprise that criminal syndicates are attracted to selling counterfeit products, the penalty for which often amounts to just a few months behind bars.
Specific
Lack Of Transparency
Criminals thrive in the dark, and one would be hard pressed to find a market with less transparency then the electronics secondary market. Serviced by brokers and independent distributors who make their profits by exploiting the information asymmetries between buyers and sellers, the components secondary market is built on a foundation of no transparency whatsoever.
A broker would be foolish to identify his source to a buyer as they would be immediately cut out of any arrangement. With sometimes three or more brokers handling a component as it makes its way through the market, there is ample opportunity for a knowing or unknowing broker to include fake parts in an otherwise legitimate shipment of goods.
Existing Filters Ineffective
Most brokers and independent distributors are well meaning, driven not just by altruism but also a dependence on the goodwill of their customers for future business. Manufacturer buyers will concentrate their spending on a handful of brokers in order to ensure the broker has a great deal to lose should counterfeit parts make it to the manufacturer.
In years past, this reliance on brokers to weed out fakes has been an effective method for protecting the supply chain, but as the fakes themselves have become more sophisticated and advanced, the ability of the brokers to detect and remove them has fallen precipitously.
Even the most motivated broker employing best-practices often cannot identify which parts are legitimate and which are not. We have passed the point where traditional secondary market distributors are capable of protecting their customers from counterfeit electronic components.
Author John P. Brown is co-founder and VP of Marketing and Strategy at Verical, an emerging online electronic components marketplace. He brings a wide range of marketplace design and anti-counterfeiting. 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. Learn more about Verical at http://www.verical.com/, blog: http://blog.verical.com, Twitter: @Verical, and email John at jbrown@verical.com.