Counterfeit-Part Risk Expected to Rise as Semiconductor Market Shifts into Higher Gear

May 10, 2012 -- With the semiconductor industry entering a phase of accelerating growth, the number of counterfeit-part incidents also is expected to rise to new record highs, according to an analysis of trends conducted by information and analytics provider IHS (NYSE: IHS).

The number of counterfeit parts reported in the electronics supply chain historically has risen and fallen generally in concert with the annual performance of the global semiconductor industry, as presented in the figure below. Chip sales and component counterfeits expanded in tandem during the period from 2001 to 2007—a time of expansion for the semiconductor industry. Counterfeits then plunged when semiconductor revenue contracted in 2008 and 2009 as the global economy went into recession. However, when semiconductor industry revenue rebounded by a hefty 33 percent in 2010, reports showed that counterfeit reports surged by a whopping 152 percent.

This year the semiconductor industry is entering a new expansion cycle, with revenue growth accelerating to 4.3 percent, up from 1 percent in 2011. Growth is expected to rise to 9.3 percent in 2013.

With supply chain participants in 2011 reporting 1,363 separate counterfeit-part incidents worldwide—a record level—conditions now are prime for counterfeit reports to reach new highs in 2012.

“The semiconductor industry is exhibiting the classic signs of the start of a new growth cycle, with tightening supplies, broad-based price increases and a lengthening of lead times for the delivery of products,” said Rick Pierson, principal analyst for semiconductors at IHS. “These are prime conditions for suppliers of counterfeit parts, which are eager to fill supply gaps with their fake goods. For semiconductor purchasers, the rise in counterfeits represents a major risk, bringing downsides in terms of financial losses, damage to company reputations and even safety concerns in some products.”

Prime breeding ground for counterfeits

Most electronic components appear to be experiencing a tightening of supply along with an increase in pricing and lead times. Price increases are expected to continue rising throughout 2012.

IHS now predicts that demand will exceed supply in the third and fourth quarters for many widely used components, including capacitors, NAND flash, dynamic random access memory (DRAM), power semiconductors and logic chips.

Such shortages represent a prime environment for counterfeiters to thrive.

“Counterfeiters have gotten more sophisticated,” Pierson noted. “They watch the market and know where the weaknesses are. They know which products are in short supply and can generate profits. And they also know when market conditions are shifting in their favor.”

For example, counterfeits surged in the wake of theJapandisaster when concerns regarding supply shortages prompted panic buying of semiconductors and other components.

To defend themselves against the counterfeit scourge, electronics buyers must arm themselves with knowledge.

“It’s critical to discuss the counterfeit issue, to understand the reasons why incidents of fake parts are on the rise and to identify the markets where these phony parts are appearing,” Pierson observed. “This is because the counterfeiters are certainly analyzing the electronics market, probing for weak points and seeking opportunities to exploit opportunities as they arise.”

Supply chain pitfalls

Amid the strain of keeping production lines running, the issue of counterfeit parts is sometimes neglected. However, companies that fail to pay attention to the issue face a range of risks. A 2009 survey conducted by IHS showed that electronics buyers have an array of concerns.

For buyers in the defense and aerospace industries, concerns include failures in aircraft safety and compromises to systems that are critical to national security. For players in commercial markets, issues range from damage to company image, to erosion in customer trust, to loss in revenue, to increased delivery time, to rising risk of legal action arising from product failure.

The task of avoiding the pitfalls of counterfeits is not always straightforward.

“To reduce counterfeit incidents, electronics buyers strive to restrict their purchasing activities to their customary supply chains, sourcing parts directly from their suppliers or from franchised distributors,” Pierson said. “However, the mandate for electronics makers is to keep their production lines running at all costs. And sometimes to do that—especially during a time of rising demand and short component supplies—they go outside of the supply chain to obtain parts.”

Even franchised distributors sometimes buy excess inventory from other companies that could introduce counterfeit parts to the supply chain, Pierson noted.

Forewarned is forearmed

To mitigate the counterfeit problem, electronics buyers must develop a plan to ensure continuity of supply. Such plans, similar to companies’ contingency preparations for disasters, require firms to update their listing of suppliers, parts/materials, life cycles, logistics and internal operations. For every supplier, buyers must create and update the supply profile of that entity.

Doing this is more important in times when counterfeit activity is on the rise. It’s also critical to identify which parts and markets are more susceptible to counterfeit activity.

For more information

IHS provides content, software and expert analysis about worldwide electronics for component selection, sourcing, and logistics as well as integrated obsolescence management, BOM management, environmental compliance, and counterfeit risk mitigation. IHS offers 100 percent of the verified counterfeit-incident report information, of which more than 90 percent is availed only though the exclusive IHS and ERAI partnership.

To learn more, please visit: http://www.ihs.com/info/sc/a/combating-counterfeits/index.aspx

IHS also offers detailed information on electronics component pricing, supply and lead time trends through the CHW service. For further information on the IHS iSuppli Component Health Watch, please visit: http://www.isuppli.com/Manufacturing-and-Pricing/Pages/Component-Demand-on-a-Growth-Cycle.aspx

Finally, IHS delivers the most complete semiconductor forecasting service in the market research industry, the IHS iSuppli Application Market Forecast Tool (AMFT). To learn more, please visit: http://www.isuppli.com/Semiconductor-Value-Chain/Pages/Wireless-Growth-Offsets-PC-Semiconductor-Decline-in-2011.aspx

About IHS (www.ihs.com)

IHS (NYSE: IHS) is the leading source of information, insight and analytics in critical areas that shape today’s business landscape. Businesses and governments in more than 165 countries around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. IHS has been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, IHS employs more than 5,500 people in more than 30 countries around the world.