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

Given all these threats, how can a supply chain manager protect his company and his customers from the risk of counterfeit components? Using most of these approaches, it is impossible, but companies still have to try. Here is a high-level list of some of the different classes of defenses.

Buffer Stock

The easiest but most expensive way to avoid shortages is to maintain higher inventory levels, but the large measurable costs of maintaining high component inventory levels across the board far outstrip the likely cost of a shortage in one particular component.

Managers have made huge strides in recent years in transforming their supply chains to a lean environment, and perhaps the costs of shortages can be used to justify the maintenance of a larger buffer stock, but given both the uncertain and imprecise costs of shortage and the very large and easily measureable cost of maintaining excess, most organizations would have a difficult time in building support for such a measure.

Buy From Franchise

As franchised distributors will rightly observe at every opportunity, the best way to protect against counterfeit parts is to purchase direct from authorized channels.

Unfortunately, if a manufacturer can find parts from their primary market suppliers, it does not have a shortage, by definition. Companies with shortages have presumably exhausted their authorized channels and must turn to the grey market for supply.

The franchised distributors are correct that avoiding the uncontrolled grey market will protect companies from counterfeit, but urging buyers to ‘buy from franchise’ will not protect them.

Visual Inspections

One of the key services brokers and independents play is to protect their end buyers by filtering out bad or unreliable parts. In recent years, their effectiveness as a filter has been called into question as counterfeiters have improved their technique markedly.

With manufacturing relocating to China and other low-cost manufacturing regions with weak intellectual property protections, counterfeiters have gained access to the same technologies and equipment that legitimate manufacturers use themselves.

As noted above, fake parts increasingly look like the genuine article, and secondary market intermediaries are proving incapable of detecting and, therefore, filtering out these fakes.

Component Testing

As counterfeiters have gained access to better technologies, not only do their wares look like the genuine article but they perform as well as the real product…for awhile. Fakes nowadays will often pass initially quality tests, but because they lack the durability to hold up in ‘real world’ conditions, will fail later on, after it has passed quality checks.

Just like any quality defect, the costs of counterfeit parts increase exponentially as the item advances further along the manufacturing process. Furthermore, the quality team faces a tough question: which parts to test? Criminals are smart enough to spread their fake parts out along a reel or to scatter them throughout a tray or pallet.

Even if a part passes a test, there is no assurance that the items to its left and right are legitimate.

Trackability/Traceability

The primary market has a high level of accountability, visibility and control. When an item moves through the primary supply chain, it is possible to identify where that part has come from and where it is going.

No such ability exists in the secondary market, where brokers and independent distributors are able to make money precisely because there is no information available to buyers or sellers that tells them how to connect. Creating trackability and traceability is simply not feasible with the grey market business model.

Enhanced Supplier Screening

Some purchasing departments place great faith in their abilities to evaluate grey market suppliers for their trustworthiness. Procurement managers insist on certifications, facility inspections, audits and strict internal processes from brokers who wish to earn a spot on their approved vendor list.

Due to the very nature of the grey market, where some 80 percent or more of orders are brokered between two or more middlemen, the truth is a buyer really has no visibility into where companies on the AVL purchased the components. There is little point vetting your immediate supplier without visibility into who their suppliers are.

Policing Of Secondary Market

Many component manufacturers will hire investigators to police the secondary market to find counterfeit parts and report the vendors to local authorities. Even the most robust efforts are a mere drop in the ocean and are intended strictly as deterrence to the next group considering knocking off a manufacturer’s brand.

Other component makers install elaborate authentication technologies in their product, but such tools require expensive infrastructure and training to use. While employing these brand protection measures may be desirable from the upstream component maker’s perspective, they do not measurable change the counterfeit risk profile for the downstream manufacturer who faces potential shortages across their entire bill of materials, not just one or two parts.

Government Regulation

Governments have becomes very active in drafting anti-counterfeiting laws and regulations, but because supply chains are so uncontrolled, these measures do not materially change the risk profile for a would-be counterfeiter.

Governmental action is important, but, like governmental efforts to stamp out the drug trade, its effectiveness is uncertain, at best.

Inspections & Police Action

Like other corporate and government efforts to crack down on counterfeiters, raids and inspections are severely limited in their ability to protect the supply chain.

They may act as a deterrent to some weak-willed criminals, but most criminals will simply chalk the occasional seizure as the cost of doing business.

The FBI estimated that distributing counterfeit product was nine times more profitable than distributing cocaine with such extraordinary profit margins, it is highly unlikely that counterfeiting gangs will abandon their efforts easily.

Supply Chain Pedigree

As Verical sees it, the only way to truly protect the supply chain from the risks of counterfeit components is to redesign the marketplace serving shortage buyers. Instead of permitting excess inventory to slide into the grey market, where it loses its traceability, Verical maintains inventory in an ‘extended primary market’, where manufacturers enjoy similar levels of visibility and control that they do elsewhere in the primary market.

By enabling firms with excess components to market them directly to buyers in the secure and controlled environment, Verical ensures a safe and reliable stock of inventory and gives buyers the confidence they need to make good decisions sooner.

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.