How to spot counterfeit parts
Caveat emptor, or buyer beware, is appropriate advice for buyers sourcing in China. Buyers need to watch out for counterfeit and poor quality parts.
By Jim Carbone -- Purchasing, 11/21/2002 2:00:00 AM
The electronics industry downturn has been very painful to most electronics OEMs, electronics manufacturing services (EMS) providers and suppliers and has put new emphasis on the need to reduce manufacturing cost.
It is one reason why many companies have flocked to China to manufacture and to source. China boasts the lowest labor costs in the world. Many companies that manufactured in Mexico because of cheap labor have transitioned production to China. As more manufacturing moves to China so does supply and sourcing.
While there are no hard quotas, the Chinese government wants companies manufacturing in China to use as many Chinese suppliers as possible. As a result, many indigenous Chinese suppliers are springing up in addition to the Japanese, Taiwanese, Korean and U.S. transplants that have set up operations.
By all accounts, the amount of electronics produced in China will grow by leaps and bounds over the next five years. China is already a major manufacturing locale for passives and interconnect products. Ron Bishop, president of connector researcher Bishop and Associates, estimates the Chinese connector market represented about 5% of the global connector market in 2000. By 2006, it will be about 12% of the worldwide market.
While semiconductor fabrication is limited, it is expected to grow dramatically over the next five years. The Chinese IC market is expected to grow from $9.5 billion in 2001 to $30.7 billion in 2006, according to market researcher IC Insights.
Most of the components manufactured in China are being consumed by indigenous companies or foreign multinational companies manufacturing there, says Joe Abelson, director business development for iSuppli. However, in the next five years, more components will be made in China, not just for manufacturing in China, but for export as well.
Opportunities abound
As China becomes an important player in the electronics supply chain, it poses both opportunities and challenges for buyers. It is said in China that no matter what you pay for a part, you can find the same part for less from some other source. Savings on components can range from 20-50% depending on the part, the volume and the source.
However, pursuing the lowest possible price can get buyers in trouble because even in a Communist country, not all suppliers are created equal. Quality varies dramatically, according to commodity managers, analysts and suppliers.
Some Chinese suppliers can produce the same quality as their Japanese transplant counterparts while others don't have a clue about quality systems.
Besides quality, there is the counterfeiting problem. Some buyers sourcing in China have been stuck with bogus parts. In some cases the parts are functional and carry the labels of well-known component manufacturers, but in fact have not been built by those companies. In other cases the parts are nonfunctional and are virtual shells.
Another challenge buyers will face is the information technology (IT) infrastructure. The infrastructure is improving, but most people doing business in China say it isn't where it needs too be. For instance electronic data interchange (EDI) is not common in China. Orders are sent via fax or email.
An underlying concern of many is political stability in China. Right now the political leadership is encouraging investment and business in China. But will that attitude continue if there is a change in leadership?
"China doesn't have a stable means of transferring power from one leader to the next," says Robin Gray, executive vice president of the National Electronic Distributors Association (NEDA). "China is notorious for letting westerners in and then kicking them out." However, others say the more China accepts investment and does business with the West, the more stable it will become because it will have too much to lose.
Exporting parts
For the foreseeable future it appears that China will grow as a source for electronics supply and manufacturing. While much of the components made in China will be used for end equipment manufactured there, more components will be exported, especially as more semiconductor production takes place in China.
In fact, in some cases that is already happening. Case in point: Motorola Personal Communications Sector (PCS).
"Motorola produces most of its cell phones in Asia," says John Miller, corporate vice president and director of global procurement for Motorola PCS. "In 2003, 70% of our cell phone production will be in Asia including China, Korea, Singapore. Motorola PCS also has factories in Germany, Mexico and Brazil.
"What we source in China is also for export to our other facilities," says Miller. "Typically we build the same phone in two places. With some of the parts, it is easier just to send the parts from China."
Motorola buys printed circuit boards, passives and connectors in China as well as metal stampings and plastic moldings. Miller says through September of this year, Motorola had spent about $688 million with 159 local suppliers.
"Since joining the World Trade Organization, China doesn't have local content quotas, but we are achieving 55% local content on our products," says Miller. "We are starting to use more state owned companies. We always had the notion of trying to source as much as we could locally. It is just good business," he says.
He adds that most of what Motorola sources in China is from foreign transplants, but "we are beginning to use state-owned suppliers."
Another company buying parts for production in China and for export is Canadian EMS provider Celestica.
"We buy magnetics, switches, printed circuit boards and cabling in China," says Perry Mulligan, vice president of commodity management for Celestica. "I am sourcing not only for my China facilities but for other Asian operations." Celestica also has facilities in Singapore, Thailand and Korea. Celestica makes a variety of equipment for OEM customers including video graphics cards, consumer electronics equipment, wireless base stations and motherboards for servers among others.
Lowest cost rules
He says while China is a low cost provider of many parts, there are other locations that may deliver a lower cost solution.
"In telecommunications and networking, there is frenzy right now to migrate to low cost," says Mulligan. "In that process, people are perhaps becoming tunnel visioned and just looking at China. If we rolled back the clock we would be talking about low cost as our footprints in Mexico, in Eastern Europe and Asia. It seems as the tension in supply chain increases, the focus is more on China," he says.
But in some cases China may not be the lowest total cost solution. Mulligan says Celestica has operations in Malaysia, Singapore and Thailand. Suppliers there can provide lower cost solutions in some cases than China.
"Our idea is to provide the lowest total cost for our customers. I am doing a box assembly in Thailand where I have infrastructure in terms of supply chain management and execution capabilities," says Mulligan. "I have chassis suppliers that can provide good solutions and who have short supply chains and are close to our facilities. They have cost and quality equal or better than what I am getting out of China," he says. The total cost may be lower even though the cost of labor may be a little higher.
However, the Chinese supply base is developing both in terms of the number of suppliers and their capabilities. As China improves its infrastructure it likely will improve its total cost.
Mulligan says the growing number of suppliers poses challenges for buyers looking to find low cost suppliers because their capabilities vary drastically.
He says there are three types of suppliers in China: transplants, indigenous and startups. Transplants are the Japanese, Korea, and U.S. suppliers which include semiconductors, passives and interconnect products. "They have a good global presence and order fulfillment capabilities," he says.
Indigenous suppliers are regional and include some passive suppliers, power supplies, magnetics and metal stamping and enclosure suppliers. Startups are similar, but are newer.
IT needed
One problem facing most suppliers in China is the lack of IT tools. "Things like EDI," says Mulligan. "In some cases the Chinese supply base is more traditional. It is purchase order centric. You ask for product, you pay for it, you get product as opposed to continuous flow repetitive manufacturing with EDI and forecasting to manage demand," he says. "But there are companies that have adopted western approaches and are as sophisticated as U.S. based chip companies."
However, generally the IT infrastructure in China needs work, according to Abelson of iSuppli. There is a lack of communication between manufacturing systems, especially among indigenous companies. "They are not running SAP or I2 or Oracle. They are running a couple of PCs shared by 30 people," says Abelson. Production information and shipping schedules are sent by fax or email.
"China lacks the IT infrastructure that is necessary to keep track of orders to make sure everything is shipping on time," says Abelson. "That is important if you are depending on one supplier as your primary source for a production line," he says " You have to know where your parts are and when they are going to come in. That is still not up to global standards," he says.
Quality is also an issue. "Very few Chinese component suppliers had been qualified up to generally accepted standard compared to western competitors," he says. Many lack sophisticated quality systems, don't use statistical process control or have ISO certification.
Buyer beware
Besides quality and infrastructure concerns, buyers sourcing in China need to look out for counterfeit parts.
"One practice that is emerging is theft of intellectual property," says Gray of NEDA . "You may have someone who works in or manages U.S. or other foreign national EMS companies who decides to steal the intellectual property concerning a part. He may then form his own company and start making an identical product," says Gray. "It may be a generic knockoff or it may be labeled as if it were brand name."
"The parts would be functional, but the quality control may not be good. You just don't know. The protection of the intellectual property is not a priority with the government there," according to Gray.
He adds that electronics distributors have to make sure they are doing business with reputable companies because there is large increase in the number of Chinese manufacturers of component parts looking for distributors in the U.S.
"The majority of counterfeit product is coming out of China," says Andrea Klein chief executive officer of independent distributor Rand Technology. She says counterfeit products circulate through Asia into the U.S. and Europe, but "is all made in China."
"If you have a passive device and it is the size of a peppercorn, all you have is a label to identify the part," says Klein. She says, "third rate, third party houses" build poor product and put a label from a reputable manufacturer such as Kemet or AVX. The parts are then sold through distributors and brokerage houses and are purchased by OEMs and contract manufacturers.
"Solectron is over there [in China], Flex is over there, Dell and Compaq are over there. Everybody is building over there and typically they buy from local channels because the price is better," says Klein.
"There are a lot of OEMs selling counterfeit excess and they don't know it," says Klein. "They bought it during the last allocation. I have seen people shipping Altera parts, but the parts have been completely remarked. I have customers call and say I received a Xilinx part which we couldn't figure out why it blew up the board and we opened it up and it wasn't a Xilinx part but a totally different component," she says.
Klein says a major customer in Florida bought about 400,000 capacitors that were all counterfeit and they came directly from a reputable capacitor manufacturer. Apparently another capacitor customer had excess inventory, canceled an order and shipped parts back to the capacitor manufacturer.
The parts were labeled with the manufacturer's name, but had not been made by the manufacturer, but from a supplier in China.
"Counterfeiting is a problem, but the Chinese government has recognized that," says Abelson. "Part of the agreement when China joined the World Trade Organization (WTO) included China's commitment to exercise greater control of counterfeiting of products and protection of intellectual property."
He says the central government is taking increasing responsibility for helping to limit the extent of the counterfeiting. "There is reason to believe it will get better than it is today. On the other hand, it has been going on for so long in small pockets of towns, garages and factories it probably isn't likely disappear overnight," says Abelson.
Security is the thing
Miller of Motorola agrees the government is cracking down on counterfeiting, which is good news because Motorola has had trouble with counterfeit rechargeable batteries for cell phones. However, Miller says the real issue is security.
"In some cases printed circuit boards have been stolen because the thieves will take the board and build their own phone around it," says Miller. Motorola has also had trucks filled with finished cell phones hijacked. "With 60,000 phones per truck, at $50 a pop, there is big money there."
Given the quality, counterfeiting, security, IT infrastructure challenges, buyers need to do due diligence before choosing suppliers in China.
"Identifying reliable sources is a challenge," says Abelson. "There are hundreds of indigenous Chinese component suppliers that have been supplying materials to primarily Chinese manufacturers for decades. Many of them can produce a part for less than suppliers in other countries can, but their capabilities in quality and delivery may not meet global standards.
You need an agent
But how can buyers find reliable suppliers and avoid getting stuck with counterfeit or poor quality parts?
"You need to find somebody on the ground in China who can sort things out for you and make the first cut for you," says Gene Richter, form chief procurement officer for IBM and a purchasing consultant. "You can hire an agent out of Hong Kong to make the first pass for you." The agent can weed out the counterfeiters and suppliers of questionable quality.
Richter also suggests getting the advice of suppliers you already do business with. "If you have a good supplier in China you may have picked the supplier because of its presence in the United States. Use that supplier to find other good suppliers of other commodities," says Richter.
Buyers can also leverage the expertise of their supply chain partners such as EMS providers, franchised and independent distributors. Major distributors and many EMS providers have set up operations in China over the last five years and know the sourcing landscape.
In some cases it makes sense for an OEM to rely on the EMS provider to source low cost parts from indigenous suppliers if the EMS provider has been in China for a longer period of time.
Some OEMs and contract manufacturers have international procurement offices (IPO) to be the eyes and ears of the company in China. The IPO checks out new suppliers, visits their facilities to make sure they have a quality system and are reputable. However, as more OEMs manufacture in China, the function of the IPO becomes incorporated in the strategic purchasing and commodity management organization to support their Chinese manufacturing operations.
Independent distributors can be a filter against counterfeit parts. Some have established strategic relationships with suppliers and will check out whether parts are counterfeit.
"If I get in five million parts from a vendor overseas, say an 0402, a tiny ceramic capacitor from Murata, I bring the parts in and they look fine on the label," says Klein. "Because it comes from overseas, I call Murata and I say 'I would like to send you a digital photo of what I have received and I'd like to you to run it through, verify the code lot.' They either say this is not our date code and the part is counterfeit or they say the part is fine."
Abelson reminds purchasers looking to source in China for low cost parts that the best price may not be the lowest cost. "That's especially true when sourcing from emerging markets because the total cost in terms of quality and setting up logistics channels and chasing orders, expediting, currency conversion, the total cost may be much higher than the piece price would indicate."
He also says it is important not to put 100% of sourcing for a commodity in any one place, including China. "A prudent thing to qualify sources inside China and allocate some percentage of your purchasing to that company. But make sure that you are not entirely dependent on just one company or one country."
Now Playing: 
