DMSMS: Counterfeits and the Industrial Base

1. September 23, 2008 DMSMS: Counterfeits and the Industrial Base Brad Botwin Director, Industrial Base Studies Office of Technology Evaluation

2. 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.

3. 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

4. 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)

5. 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

6. 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

7. 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.

8. BIS Counterfeit Electronics Survey – Preliminary Data

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

10. Counterfeit Incidents by Product Resale Value:Overall (2007)

11. Counterfeit Incidents by Product Resale Value: Distributors (2007)

12. Counterfeit Incidents by Type (2007)

13. Percent of Counterfeit Incidents Involving In/Out of Production Products 2005 - 2008

14. How Companies Are Uncovering Counterfeits (2007)

15. How Companies Are Uncovering Counterfeits: OCMs (2007)

16. How Companies Are Uncovering Counterfeits: Distributors (2007)

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

18. Top Countries Suspected/Confirmed to be Sources of Counterfeits* * Each company was asked to provide their top five suspected countries

19. 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.”

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

21. 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.

22. Percent of Distributors Conducting Pre-Stock Testing

23. Percent of Board Assemblers Conducting Pre-Stock Testing

24. Percent of Companies Performing Inventory Audits for Counterfeits

25. 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.

26. Steps Taken After Notification of a Counterfeit Incident: OCMs

27. Steps Taken After Notification of a Counterfeit Incident: Distributors

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

29. Steps Taken After Possession of a Counterfeit Part

30. 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.

31. “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.

32. 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. Industry Best Practices – 500! Most common responses – Don’t buy from China – Be wary of Brokers

33. 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. Industry Best Practices (cont.)

34. 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

35. 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

36. 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

37. 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 #212