DMSMS: Counterfeits and the Industrial Base

Brad Botwin

Director, Industrial Base Studies

Office of Technology Evaluation

September 23, 2008

Bureau of Industry & Security (BIS)

MISSION: Advance U.S. national security, foreign policy and economic interests.

BIS develops export control policies, issues export licenses, prosecutes violators, as well as monitors the capabilities of the defense industrial base.

OTE Industry Assessments-Background

Under the Defense Production Act of 1950, ability to assess: Economic health and competitiveness Defense capabilities and readiness

Enable industry and government agencies to: Monitor trends and benchmark industry performance Raise awareness of diminishing manufacturing and

technological capabilities

More than 50 industry studies & 125+ surveys

Counterfeit Electronics Study-Goals

Assess the impact of counterfeit electronics on U.S. supply chain integrity, critical infrastructure, and industrial capabilities

Recommend best practices to mitigate risk to U.S. supply chain

Study sponsored by Naval Air Systems Command with support from Semiconductor Industry Association (SIA)

Counterfeit Electronics-Broad Definition

An electronic part that is not genuine because: An unauthorized copy Does not conform to original OCM design, model,

and/or performance standards Not produced by the OCM or is produced by

unauthorized contractors An off-specification, defective, or used OCM product

sold as "new" or working Has incorrect or false markings and/or documentation

Counterfeit Electronics Study-OTE surveys distributed

5 separate but related surveys targeting: Microchip & discrete electronic manufacturers – 106 Electronic board producers/assemblers – 37 Distributors and brokers of electronic parts – 144 Prime contractors and subcontractors – 147 DOD arsenals, depots, and DLA – 48

482 total survey participants

Counterfeit Electronics Study-Survey Objectives

Each survey contained approx. 80 questions Scale and scope Past problems and impact Internal procurement policies and protocols Testing, inspection, and inventory management Post-identification procedures Industry and government best practices

Tried to keep questions uniform across surveys.

Type of CompanyEncountered Counterfeits

No Counterfeit Incidents

Total

OCMs

Discrete Electronic

Components9 17 26

Microcircuits 13 15 28

Distributors

Authorized Distributors

6 19 25

Independent Distributors

25 8 33

Brokers 7 1 8

Board Assemblers 5 19 24

Total 65 79 144

BIS Counterfeit Electronics Survey – Preliminary Data

3397

5985

7383

5747

0

1000

2000

3000

4000

5000

6000

7000

8000

2005 2006 2007 2008 (est.)

Total Counterfeit Incidents:OCMs, Distributors, Board Assemblers 2005 - 2008

Counterfeit Incidents by Product Resale Value:Overall (2007)

Counterfeit Incidents by Product Resale Value:Distributors (2007)

Counterfeit Incidents by Type (2007)

64%56% 53% 54%

36%44% 47% 46%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 (est.)

In Production Out of Production

Percent of Counterfeit Incidents Involving In/Out of Production Products

2005 - 2008

How Companies Are Uncovering Counterfeits (2007)

How Companies Are Uncovering Counterfeits: OCMs (2007)

How Companies Are Uncovering Counterfeits: Distributors (2007)

Percent of Companies With Documented Cases of Counterfeits Sold by Specific Entities

* Each company was asked to provide their top five suspected countries

Top Countries Suspected/Confirmed to be Sources of Counterfeits*

Counterfeits Damaging a Company’s Reputation

OCM Comment: “With counterfeit goods in the market, purchasers are not sure if they received genuine or fake goods, so they tend to avoid the brand entirely.”

Distributor Comment: “When distributors or brokers trade in counterfeit parts the entire industry’s reputation is tarnished with a ‘guilty by association’ mentality.”

Percent of Companies Indicating Counterfeits Have Negatively Effected

Their Image or Reputation

Discrete Electronic Component Manufacturers

12%

Microcircuit Manufacturers

36%

Authorized Distributors

8%

Independent Distributors

45%

Brokers 63%

Top 10 Reasons Identified by All Companies for Counterfeits Entering the U.S. Supply Chain

ReasonNumber of Companies

Less Stringent Inventory Management by Parts Brokers 75

Greater Reliance on Gray Market Parts by Brokers 72

Greater Reliance on Gray Market Parts by Independent Distributors

62

Insufficient Chain of Accountability 58

Less Stringent Inventory Management by Independent Distributors

56

Inadequate Purchase Planning by OEMs 50

Insufficient Buying Procedures 49

Purchase of Excess Inventory on Open Market 48

Greater Reliance on Gray Market by Contract Manufacturers 44

Inadequate Production by OCMs 42

Pre-Stock Testing By Type of Supplier(Distributors and Board Assemblers Only)

Only 56% of Distributors and Board Assemblers test products they purchase before placing them in inventory.

Average Percent of Incoming Parts Tested

by Type of Supplier

OCMs 52%

OEMs 44%

Authorized Distributors

52%

Independent Distributors

58%

Brokers 62%

Internet-Exclusive Sources

38%

81%

59%

74%77%

13%

56%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

VisualInspection of

Packagesand

Paperwork

Confirm OCMPedigree

Paperwork

Inspection ofOCM

ShippingPackages

VisualInspection

ElectronicTesting

PhysicalEvaluation

Percent of Distributors Conducting Pre-Stock Testing

Percent of Board Assemblers Conducting Pre-Stock Testing

52%

17%13%

0%

15%

30%

45%

60%

75%

Distributors OCMs Board Assemblers

Percent of Companies Performing Inventory Audits for Counterfeits

Contractor Testing Problems

Four companies had problems with Non-U.S. contractors concerning improper management or theft of electronic scrap after testing.

17 companies, 41% of those employing testing contractors, had problems with U.S.-based firems concerning faulty or forged testing. The parts were cleared by the testing house, but were later

found to be counterfeit by the customer.

This is an area that deserves further analysis.

Steps Taken After Notification of a Counterfeit Incident: OCMs

Notify Internal Company Authorities 74%

Trace Supply Chain 70%

Inform Authorized Distributors 41%

Locate Select Inventory 39%

Pull Back Inventory 31%

Perform Random Testing 20%

Notify Industry Associations 19%

Notify Federal Authorities 19%

Other 17%

Wait for Additional Complaints 17%

No Steps Are Taken 6%

Steps Taken After Notification of a Counterfeit Incident: Distributors

Pull Back Inventory 61%

Notify Internal Company Authorities 56%

Notify Industry Associations 52%

Locate Select Inventory 50%

Trace Supply Chain 48%

Perform Random Testing 35%

Inform Authorized Distributors 30%

Inform OCMs 30%

Notify Federal Authorities 11%

No Steps Are Taken 9%

Other 8%

Wait for Additional Complaints 5%

Steps Taken After Notification of a Counterfeit Incident: Circuit Board Assemblers

Pull Back Inventory 63%

Notify Internal Company Authorities 58%

Locate Select Inventory 58%

Inform Authorized Distributors 54%

Inform OCMs 50%

Trace Supply Chain 46%

Perform Random Testing 29%

Notify Industry Associations 8%

Notify Federal Authorities 8%

Other 8%

Wait for Additional Complaints 8%

No Steps Are Taken 8%

Steps Taken After Possession of a Counterfeit Part

Action Taken OCMs DistributorsCircuit Board Assemblers

Enter into USG or Industry Database 11% 41% 4%

Retain Samples for Reference 63% 33% 13%

Test Part 56% 50% 46%

Enter into Company Database 50% 59% 42%

Quarantine Parts 26% 33% 21%

Leave Disposal to Party Filing Complaint

26% 9% 8%

Random Inventory Testing 19% 38% 42%

Disposal of Parts Immediately 17% 36% 13%

Issue Credit 15% 64% 58%

Turn Over to Law Enforcement Authorities for Analysis

15% 7% 29%

Check USG or Industry Database 11% 47% 13%

Other 11% 14% 8%

Turn Over to Law Enforcement Authorities After Analysis

11% 6% 17%

Return to OCM or Distributor 11% 33% 25%

Who Ya Gonna Call?

56% of OCMs,

65% of Distributors, and

75% of Board Assemblers DO NOT KNOW what authorities to contact when they encounter counterfeits.

71% of distributors tell customers to contact their firm if they encounter a counterfeit product.

Top Authorities Contacted(As a Percent of Total Companies)

None at all 35%

GIDEP 10%

FBI 8%

Customs and Border Protection

6%

ERAI 6%

IDEA 6%

DLA 6%

State/Local Authorities

6%

“Fun” Facts Only 38% of surveyed companies maintain a

database to keep track of counterfeit incidents. 63% of these companies are distributors.

67% of Circuit Board Assemblers co-mingle identical parts from multiple suppliers in the same bin. Only 14% of distributors do the same.

40% of companies stated that they find it difficult to identify counterfeits. However, 61% of companies find it easier to identify

counterfeits today than they did five years ago.

Industry Best Practices – 500!

From OCMs: Ensure proper disposal of

all scrap – crush all defective/unused products to prevent re-circulation.

Train all employees on how to identify and handle counterfeit parts.

Tighten contractual obligations with contract manufacturers regarding disposal of unused product.

From Circuit Board Assemblers: Audit OCMs/OEMs to ensure

that the purchased part is made within their facility and not contracted out.

Perform destructive testing if a part cannot be verified by other means.

Establish qualifications for supplier purchases.

Most common responses – Don’t buy from China – Be wary of Brokers

Industry Best Practices (cont.)

From Authorized Distributors: Ask for Certificates of

Compliance for all products purchased.

Educate your sales team regarding the risk of parts brokers.

Create a central database for identifying counterfeit suppliers.

Do not approve returns in greater quantities than the original purchase.

From Independent Distributors/Brokers:

Always purchase parts via escrow payments – Suppliers that believe in their product will not mind waiting for their money.

Audit all inventory purchased before anti-counterfeiting measures were put in place.

Follow IDEA 1010 for incoming inspections.

Use www.icphotos.org for visual verification of parts.

Company Comments “It is encouraging that the U.S. government has finally

recognized the scope of the problem and seems to be taking meaningful steps to counteract the counterfeiting plague.” - Independent distributor

“Our participation in this Assessment has heightened our level of attention and understanding concerning the importance of being proactive in combating counterfeit products … We appreciate the information that was presented within this Assessment and plan to implement appropriate internal/external actions necessary to mitigate the potential for a counterfeit incident to occur within our operation.” - Authorized distributor

Depot/DLA Unique Questions

Parts acquisition criteria Government/industry, low bid/best value, foreign sourcing Direct shipping to field

Commercial supplier criteria Platforms/subsystems affected by counterfeits

(2005-2008) Parts acquisition training Impact of DFAR Quality assurance and testing Record keeping

Next Steps

Continue compliance on the 5 surveys Verify and begin analysis of data Draft report and release public document in early

2009 Work with industry and government to

develop and implement best practices

BIS/OTE Contacts

Brad Botwin Director, Industrial Studies Office of Technology Evaluation 202-482-4060 bbotwin@bis.doc.gov

Teresa Telesco Industry Analyst 202-482-4959 ttelesco@bis.doc.gov

www.bis.doc.gov Come see us in Booth

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