Ruminations … Chapter 1: The Escape That Never Happens (A Leak in Authorized Distribution)

Conventional wisdom holds that counterfeit parts do not enter the supply chain through Authorized Distribution. Electronic part distribution experts claim such events are so improbable, the user community need not apply counterfeit avoidance practices when acquiring parts through authorized channels. Many of these experts have acknowledged, however, that the handling of product returns presents a possible point of vulnerability.

This essay discusses a counterfeit part escape through authorized distribution illustrating a vulnerability associated with processing products returned by customers. Authorized Distribution professionals have referred to this incident as a rarity and, therefore, neither a call for concern by the user community, nor worthy of the attention it has received. I offer some further thoughts to consider before dismissing this escape.

In addition to supplying products acquired directly from Original Component Manufacturers (OCMs), Authorized Distributors occasionally resell products returned by their customers. A customer may request a “Return Material Authorization” (RMA) from a supplier to return defective parts or to request a “return for convenience”. A “return for convenience” typically consists of unconsumed parts the customer no longer needs for a number of reasons, such as a contract cancellation, a design modification, or other events that may change demand for material.

Parts leave the authorized supply chain once an Authorized Distributor ships parts to customers, such as Original Equipment Manufacturers (OEMs), Contract Manufacturers (CMs), or Electronics Manufacturing Services (EMS). The Authorized Distributor no longer has control or visibility into material controls. When accepting “returns for convenience”, the Authorized Distributor takes steps to validate returned parts before reintroducing them to the authorized supply chain. Traceability records are used to verify that returned parts come from original shipments to customers before returning parts to inventory. The Authorized Distributor inspects returned parts for evidence of alteration, mishandling, improper packaging or repackaging. These inspections are similar in scope and coverage to those applied by Independent Distributors for parts obtained from the open market. [1]

rma_return_flow

Some have described instances where a customer did not return the same authentic products acquired from an Authorized Distributor, but, instead, returned other products that were counterfeit. Presumably, the customer had commingled parts acquired from different sources, was unaware of counterfeits it had purchased through the open market, and returned what it incorrectly assumed to be parts it had originally purchased from the Authorized Distributor. If the Authorized Distributor’s system for handling returns from customers should fail, counterfeit parts can pollute the authorized supply chain. One example of such an event is described in a report published nearly one year ago through the Government-Industry Data Exchange Program (GIDEP). [2]

rma_return_flow_escape

Because Authorized Distributors are generally considered to be the most trustworthy sources, events such as this are particularly disturbing, especially to Defense and Aerospace contractors who are becoming less and less tolerant of counterfeit part quality escapes. Several years ago, a number of contractors recognized product integrity risks posed by counterfeits and established practices to avoid them. Since that time, the counterfeit parts problem has increased and new US regulations have established a zero level tolerance for counterfeit part quality escapes. Defense contractors and other suppliers now face financial liability risks and other penalties in the event counterfeit parts appear in electronic equipment destined for use by the US Department of Defense.

Product integrity minded contractors take the advice of Original Equipment Manufacturers (OEMs) and depend on Authorized Distribution as the primary means to avoid counterfeits. Many have taken further advice from OCMs and forgo extensive inspections of products acquired through the authorized supply chain. When products are not available through Authorized Distribution, the contractor will pursue alternatives and resort to the use Independent Distribution as a fall back. The contractor will apply significant expense, time and resources to avoid counterfeits when acquiring parts from Independent Distribution. As a result (1) very few purchases are made from Independent Distribution; (2) little to no counterfeit detection testing is applied for products acquired from Authorized Distributors, who are generally considered to be the most trustworthy sources; and (3) substantial due diligence occurs for products acquired from Independent Distribution, where industry and government reports indicate counterfeits are more likely to appear.

The trust that contractors put in Authorized Distribution can create a point of vulnerability. Because of due diligence dictated by conventional wisdom, it is more likely that counterfeits escaping Independent Distribution will be intercepted. On the other hand, conventional wisdom also dictates that a buyer should not expect to receive counterfeits through Authorized Distribution. As rare as such incidents may be, any counterfeits that escape Authorized Distribution are far less likely to be noticed than counterfeits escaping Independent Distribution. Furthermore, when a buyer acquires parts from Authorized Distribution, the buyer expects to receive products that have not left the authorized supply chain and the buyer is likely unaware that shipments from Authorized Distribution may include parts that have taken a detour. Even if a buyer is aware that shipments may contain product returns, a buyer would not know when shipments contain them or how many are included within a specific shipment.

The proportion of purchases from Authorized Distribution also calls for a closer look at potential points of vulnerability. The following chart depicts the total volume of a product integrity minded contractor’s procurement of parts from distribution sources over the course of a year. The proportion of purchases from Independent Distribution is exaggerated in this chart for illustration purposes. The actual quantity of these purchases is too small to be visible.

ad_purchases

Two suspect counterfeit parts were discovered among these procurements – one escaped Independent Distribution, and one escaped Authorized Distribution due to a lapse in product return processing. From this analysis, even the hyper-vigilant buyer might conclude that the probability of counterfeit parts polluting Authorized Distribution is insignificant. This thinking, however, does not account for the fact that the escape from Authorized Distribution occurred within a specific subset of shipments consisting of parts that took a temporary detour out of the authorized supply chain.

Lets look at the make up of the purchases from Authorized Distribution. Research in the aftermath of the counterfeit part escape described earlier included a review of shipments by Authorized Distributors that include products returned by other customers. The proportion of shipments by Authorized Distributors on an ongoing basis that include product returns is significantly less than one percent of all shipments. Using the data set for the chart above, the proportion of shipments consisting of product returns is highlighted in the following chart. This subset of shipments is also exaggerated in this chart for illustration purposes.

ad_purchases_returns

Further analysis reveals that the portion of total shipments from Authorized Distributors that consisted of product returns (where the counterfeit part escape occurred) is the same order of magnitude as the total purchases from Independent Distributors. Given this analysis, I find it difficult to dismiss this incident.

The SAE G19AD committee developed a new standard for counterfeit avoidance and detection applied to Authorized Distribution — AS6496.[3] While G19AD was developing this standard, I brought this incident to the committee’s attention. After studying the factors contributing to the counterfeit part escape described here and after considering this analysis of a contractor’s purchases from distribution sources, the G19AD committee included further controls within AS6496 for product returns. While a number of contractors are encouraged by the work of the G19AD committee, many have considered forbidding Authorized Distributors from shipping products consisting of parts returned by other customers. Some Authorized Distributors have voluntarily decided to limit the resale of returned products, but this practice has not been widely adopted.

Time will tell if controls applied to product returns will prevent future counterfeit part escapes and sustain a high level of confidence in Authorized Distribution.

Henry Livingston

[1] IDEA-STD-1010 — Acceptability of Electronic Components Distributed in the Open Market. Published by the Independent Distributors of Electronics Association (IDEA)

[2] GIDEP Report CLS-P-14-01 (04 November 2013)

[3] SAE Aerospace Standard AS6496 — Fraudulent/Counterfeit Electronic Parts: Avoidance, Detection, Mitigation, and Disposition – Authorized/Franchised Distribution (August 2014)

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4 thoughts on “Ruminations … Chapter 1: The Escape That Never Happens (A Leak in Authorized Distribution)

  1. Bill Cariello says:

    Great discussion of the vulnerability in the AD supply chain.

  2. Chuck Amsden says:

    So as we have discussed before Henry, are customers willing to give up returns for convenience in exchange for no RMA parts in orders? Also doesn’t this point out that customers lack traceability contribute to the problem? I have had Primes tell me it was too expensive to implement.

    • Hello Chuck,

      We have indeed discussed the “RMA return” issue a few times over the past year or so. You bring up a very good point about horse trading “returns for convenience” for “shipments free RMA returns”.

      As you know, I have made the rather provocative recommendation for DoD and aerospace contractors to forbid suppliers from shipping products consisting of product returns. I have also made an even more provocative recommendation — since parts leave the authorized supply chain when an Authorized Distributor ships parts to customers, perhaps RMA returns should not be considered to be authorized product. Neither of these suggestions have been well received by authorized distributors, and the solutions communicated to the user community are (1) trust that such an event will never occur again, and (2) let Authorized Distributors continue with the status quo. We now have a brand new standard that communicates this posture.

      While I understand your thought about not accepting returns for convenience from a customer who forbids shipments consisting of product returns, I am still having difficulty understanding the relevance of this trade off. According the a number of large authorized distributors, the proportion of shipments consisting of product returns on an on going basis is in the low tenths of one percent. I have difficulty understanding why such a small number of shipments would impact a distributor’s business calling for an increase in pricing and lead times. On more than one occasion, this has been the comeback to my suggestion about forbidding shipments consisting of product returns. This doesn’t add up and I speculate there is something else to this that has yet to be explained to me.

      You also bring up a good point about the genesis of the event I describe. According to the GIDEP report on this incident, the customer of the authorized distributor returned what it thought were parts originally purchased from the authorized distributor. Though this is not explicitly stated, it is reasonable to believe that this customer lost traceability as you suggest and could not distinguish commingled parts in its inventory. (Another possibility is the customer knew it was returning bad parts obtained from another source.) Assuming loss of traceability of commingled stock contributed the return of the wrong parts (which happened to be counterfeit), I would agree that the root cause is likely the customer’s loss of traceability. In my view, however, the Authorized Distributor needs to protect itself and its other customers from this sort of mishap. …. More on this coming in a future chapter.

      Henry

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