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Fireside Chat with the Xperts: Semiconductor Shortage, Fraud, and Counterfeits

FCX 06022021

Host David Kruidhof, Dr. Bill Cardoso, and guest Richard Smith of ERAI join forces to produce “one of the top Fireside Chats we have ever done.”  Mr. Smith brings his considerable experience in electronic component distribution to bear in this conversation about the semiconductor shortage and some of its less obvious consequences.

Creative Electron has supported distributors in the secondary IC market for years, as X-ray inspection has been a key component of their counterfeit mitigation protocols.  Richard Smith, and the folks at ERAI have built and maintained “the largest known database of reported counterfeit and non-conforming electronic components and companies reported for having shipped them.”  It’s natural, then, that this conversation about the semiconductor shortage would focus on an aspect that few have reported on; incidents of fraud as a result of these shortages are up dramatically, and buyers need to be on the lookout for counterfeits.

Mr. Smith provides some unique insights into the problem, as well as some important safeguards.  If you are interested in getting down into the weeds on the impact of the electronic components supply chain issues, look no further.  Enjoy this one, please reach out with any questions, and register for upcoming Fireside Chats with the Xperts and view our archives here.

 

Transcript:

David Kruidhof:
Okay. It’s Wednesday, time for another Fireside Chat with the Xperts. Thank you again for joining us. Today we have a special guest here with us, of course, Dr. Bill Cardoso is joining me again, and we have Richard here with the ERAI, welcome you two.

Richard Smith:
Morning.

David Kruidhof:
Thanks for joining us.

Richard Smith:
Thanks for having me, pleasure to be here.

David Kruidhof:
I think a lot of our listeners who are in the electronic space are probably familiar with ERAI.

Dr. Bill Cardoso:
They should be.

David Kruidhof:
Where they are. They should definitely be. If anywhere they’re involved in the supply chain, of course, but for those outside of that world, probably have no clue. So why don’t you give us a quick introduction of ERAI and who you are and how you fit in?

Richard Smith:
Sure. ERAI was formed in 1995 as an industry association to basically clean up, police, and promote the electronic component distribution world to the manufacturing community. Back in ’95 most of the incidents that we tracked and reported on were basically bad business practices. Then shortly after China joined the World Trade Organization, we got our first report of a counterfeited integrated circuit. Since that time we’ve put together the largest known database of reported counterfeit and non-conforming electronic components and companies reported for having shipped them. So we provide business, industry, governments with databases and tools to help navigate the supply chain, to avoid problem vendors and problem products.

Dr. Bill Cardoso:
Yeah, that’s fascinating. I mean, you were on the ground level, right, when this whole counterfeit problem started.

Richard Smith:
Oh sure. My first job was in 1978 as a field sales guy for an electronic distributor at the time was called Hamilton Avnet, everyone knows them as Avnet now.

Dr. Bill Cardoso:
Avnet now.

Richard Smith:
And of course we sold franchise lines, of course, but there were independent distributors and brokers back then. And although I’m not aware of any incidents of counterfeiting, the way that we see that today, there were some incidents that were counterfeiting. And one of the very common one was little connector pins. Well, one of the upper tier manufacturers like Midland-Ross or Amphenol or something, their little gold pin, sometimes their machined, sometimes their steel, well, brokers would go out and buy them from a machine shop in New England somewhere. And they matched the drawing and they work, but they weren’t marked, you couldn’t tell one from another. But they would buy those for 30 cents and sell them for $2 and 30 cents, which was the price of the brand name. So that kind of thing was going on. Same with the tie wraps and people say, “Well, tie wraps are not a big deal,” but there were name brand known tie wrap manufacturers. And then you come in with maybe a lesser quality, but similar type and they just changed the label. So that kind of stuff had been going on for a long time.

Dr. Bill Cardoso:
Interesting. Now tell us about InterCEPT, because I know we’ve talked about this before, you and I, and I think it’s a fascinating service you guys are providing, to really fill a gap that we have in the industry. Today especially, so many people now dealing with counterfeit components, right?

Richard Smith:
Right. InterCEPT is an internal ERAI division and it’s a training and certification course. The goal or result of successfully completing an InterCEPT course, you will become a trained component inspector and you will be trained with the ability to make and accept or reject decision across all sorts of components using various inspection and testing techniques that are taught throughout the class. The InterCEPT class and courses are designed to be marketed, purchased, sold, done online. And at the public ERAI page, erai.com. You can look up the InterCEPT box and there’s a two minute video. You can watch it, tells all about it and how to get started. We’re having a fair amount of success with that.

Richard Smith:
All sorts of people are using it. Distributor, broker type people, companies are using it to train their new hires and their incoming component inspectors. Many OEMs are using it now, especially OEMs that are in industries that have not been plagued by counterfeits as long, and as often as say defense and aerospace. So we talked about this earlier. At one point if you’re only buying from franchise vendors, your incoming inspectors, all they had to do was match up paperwork.

Dr. Bill Cardoso:
Exactly.

Richard Smith:
This is the purchase order, this is the line item, check off, go. But now because many OEMs are going to the secondary market because they have a need to… These incoming component inspectors need to be trained on what to look for, what anomalies to spot, how to make and accept or reject decision based on inspection and testing.

Dr. Bill Cardoso:
Yeah. Something as simple as a bad label on a shipping box, right, it’s a sign that something’s wrong and you have to raise a red flag and disqualify, or at least increase the scrutiny of that specific package. Now we often talk about this counterfeit process, right. Which happens when you have a demand capacity at steady state, right? You basically have semiconductor companies like Intel or TSMC or any other guys, supply components at a steady pace to meet demands. And what we saw with COVID was capacity got compromised, because factories were closing and the whole supply chain for them, as well was compromised. And at same time you have this pent up demand, right, it spiked all of a sudden, and the gap creates opportunity, right? For counterfeiters to just fill the gap, because companies need components. Now, what are the… We hear the news all the time. And just this morning, I was reading newspaper, in Brazil, Volkswagen closed the factory again, they don’t have chips, they don’t have components to assemble cars, right. So why is automotive so impacted at this point? They’re just victims and we’re just hearing about them because they have such a big impact on our lives.

Richard Smith:
Okay. Well, we’re seeing this a lot. A couple of things I want to mention from, and this will all come together, from the year 2000 through the end of 2018, every single year, the number one most counterfeited device was some integrated circuit or another. In 2019, for the very first time, the number one most counterfeited device was a multi-level ceramic chip capacitor. And the reason for that is because of the demand, unforeseen demand from the automotive industry caused that spike and that shortage. And if you remember through 2019, 2020, you couldn’t get them.

Dr. Bill Cardoso:
Yeah.

Richard Smith:
And then that created some problems. So for the very first time that I’m aware of, the automotive sector is having to go to the secondary market because of what you described. And it wasn’t all only because factories were closed from COVID. There was a shift in demand, a lot of the automotive companies and other industries said, “Hey, people are going to be holed up for we don’t know how long, let’s cut back our orders.” Well, the orders that went crazy were games, game modules, and consoles, and computer cards and Bitcoin mining boards. And that kind of consumer computer, that demand went crazy. So when automotive turned back on, the supply was taken and the industry just hasn’t been able to pick up. Now that demand has increased. So that has driven the automotive sector into the secondary market, which they’ve never had to do before, because that has traditionally been direct business.

Richard Smith:
And it’s been direct business because of the extended temperature range and the ruggedization of the components and things like that. So automotive is experiencing now what defense and aerospace has been going through since 2006 and 2008. Many of them don’t have the experience or the protocols and plans in place to vet new vendors, to the extent that is required, not to avoid counterfeits and to avoid the bad products. So in the last six months, I have signed several big automotive companies that a year or two ago, would’ve never had a reason to use our database and tools to navigate the supply chain. And now they are.

Dr. Bill Cardoso:
Wow, that’s incredible. Now people say that, people talk about our vulnerability to semiconductor manufacturing overseas, right? How much of our components, let’s start there, I mean, is that true? Are we vulnerable to this out of the country supply chain for semiconductor?

Richard Smith:
Sure. Well, it’s somewhere in the neighborhood of 52% of the global semiconductor supply comes from the island of Taiwan. So you have more than half of all the integrated circuits in one location. Now, Taiwan does a great job. And there’s several companies that do that. The biggest one obviously is Taiwan Semiconductor, but that creates some problems. Should Taiwan experience, I’m speculating, any geopolitical upset, a weather upset, an earthquake. Whatever the case may be, any upset to that island would further disrupt the supply chain. So that’s something to consider. I like to mention, I talk about this all the time. When I got into this business in 1978, all mil-spec semiconductors had to be built on the continental 48 United States on a separate production line with either an in-house or visiting military government inspector. And that inspector ensured the process flow. And all the quality was going to be built into the part. They also vetted all the employees to work on that military line, and it was extensive, but it worked. And then I guess it was in the late ’80s, probably ’90s, the government shifted to COTS, commercial off the shelf. And then that changed things. And they became more price driven, and that has opened some windows for counterfeit activity and substandard quality and things like that.

Dr. Bill Cardoso:
Yeah, it’s interesting that the-

Richard Smith:
Having it all in one spot is tough. We’re dealing with it now. I think Taiwan Semiconductor, Intel, various others are building new fabs and trying to increase our capacity here in the U.S.

Dr. Bill Cardoso:
Yeah. That’s what I was going to ask you. Right? I mean, people say, “Oh yeah, just bring manufacturing to U.S. I mean, how hard can that be?” Right. So how hard is that?

Richard Smith:
I’m a little bit out of touch. I don’t know what sort of fabs we have, legacy fabs we have in the U.S., but a couple of things have happened. The technology has changed. I remember when the sub-micron stuff was so far away. When I first got into it, chips were millimeters, two, three millimeters, they were big. I sold the first 170, one of the first 1702 EPROMs. And that was before the 2708, which became the 2716. And the chip in that thing was as big as my thumbnail.

Dr. Bill Cardoso:
Yeah.

Richard Smith:
So you need new equipment and new machinery to do these three micron type, 4.5 micron type chips. So that’s expensive. For many years, I used the number just arbitrarily, 1 billion to build a wafer fab. I read recently that it’s more like 4 billion minimum, and this multi-billion dollar investment that companies are building, are spending now to enhance our semiconductor manufacturing capacity here in the States. But it’s an expensive proposition. And it takes time to get these fabs up and running.

Dr. Bill Cardoso:
And another topic that has followed, right? This conversation of setting new semi foundries in U.S. is labor, right, qualified labor. These plants require a lot of very qualified, very specialized people to run those factories, which reminds me of Foxconn in Wisconsin, right? Where they set up manufacturing and look around like, “Whoa, wait a minute. Where are the people to run this facility?” Right? I mean, that’s been their line, that they don’t have the proper, enough people to run the factory. So where do you think, I mean, both Intel and TSMC are making investments, and these are very smart companies, right, who have been around for a while. How do you think they’re going to follow to backfill those foundries with qualified people?

Richard Smith:
This is a little outside my area of expertise. I have visited several wafer fabs, going back to in the ’80s, when we would visit the factories of, that we sold for as a franchise distributor, I believe that the numbers are there for a workforce here in the U.S., training is certainly going to be required because semiconductor manufacturer is a specialty. I would think many of those production jobs that would be best served learning that in a trade school environment, that’s not necessarily academic. Now, some of the recipes, if you will, in the design and all that, obviously those are degreed engineer type guys that are required. Even doctors like yourself, I would think.

Dr. Bill Cardoso:
Yeah.

Richard Smith:
But the plants, I think we have the workforce, they’re going to need some training.

Dr. Bill Cardoso:
Yeah, so… Go ahead.

Richard Smith:
And these are smart companies, been out a long time. I think they will probably be getting ahead of that in training so that they have a trained workforce about the time they’re ready to flip the switch on a new facility.

Dr. Bill Cardoso:
So, which are, so that’s the capacity side of the equation, right? Going back to the counterfeits, what do you tell a company, right. Brand new company, buying, OEM company that we buy from, buying direct forever, right? All of a sudden the lines are stopped because they can’t get parts and buyers desperate calling their cousins, somebody tried to sell stuff out of the trunk of a car. Now they have to go there, right? Because they have options. What do you tell people in this predicament?

Richard Smith:
Well, it’s test, test, test. I mean, if you’re able to find something and it comes from your unapproved supply chain, you need to test. What I would tell people not to do, and if you looked at the ERAI incident reports in recent months, there’s a global criminal enterprise of wire frauds. And I’m going to tell you a story that happens all the time. Along these lines, the company cannot get a product. You’ve got a professional purchasing team who’s told the engineering and the manufacturing guys that this product is not available. Someone gets upset, whether it’s an engineer or manufacturing manager and they run to their desk and they do a Google search and they find this really slick looking web store. And they punch in the part number, lo and behold, they have 50,000 pieces in stock and they’re half the price that they’re used to paying.

Richard Smith:
So they go to the buyer’s desk and they throw it on there to say, “I found the parts because you don’t know what you’re talking about. And you need to place this order.” The buyer calls management says, “Hey, what do you think?”

Richard Smith:
“Well, we have to roll the dice so.”

Richard Smith:
“Well, it’s wire transfer in advance. Do you want me to send $50,000?”

Richard Smith:
“Yes, I do.” They wire transfer the money and all conversation with that company ceases. And we have dozens and dozens and dozens of these that we’ve been following and tracking. They’re all linked to common bank accounts in Hong Kong, to common IP addresses, to common street addresses. And whenever the hate gets too high, they just set up another really slick web store and they do it again. So working with your vendors is a big deal. You give them as much notice as you can. And when you get caught short, you have to be creative.

Richard Smith:
Now I’m a big fan of the secondary market. And I’m talking about these independent distributors and the reason they have been thriving and growing since the 1930s, I mean Harry Krantz is no longer Harry Krantz, but they’ve been around since the ’30s, and other companies. And the reason they grow and thrive, and I’ve been saying this in my 43 year career, on any given day, the franchise authorized supply chain simply cannot meet every requirement on the planet. So some of these independent guys, they’re good as it gets, they do a good job. They plan ahead. And I recommend everyone has every company has a few of those guys that they can work with and depend on.

Dr. Bill Cardoso:
Yeah, no, that’s a great suggestion. I mean, people don’t realize the, how low the barrier of entrance is to become a fraudulent criminal enterprise in this market, right. I mean, from what you described is wire fraud. No components were exchanged, right? Nothing, the criminals, they didn’t have to make anything, right?

Richard Smith:
Right.

Dr. Bill Cardoso:
Other than a website, which is pretty much very, very easy nowadays. And I think you told me a story once that a good way to test a website is you put your phone number as a part number and see if they have it in stock, right?

Richard Smith:
ERAI did that some years ago when part sourcing tools became a big deal and we were trying to stress the point that you can’t believe everything you see on a part sourcing site. So Mark Snider, founder and president of ERAI, he punched in the company phone number, a request for quote, I don’t know how many pieces he was looking for. And within about two days he was getting, this was pre-email, he was getting faxes saying, “Hey, we have this part in stock, 23927,” whatever, whatever it was. And so they will… Counterfeiters are rather aggressive and they become more sophisticated since that time. But you just have to be very careful.

Dr. Bill Cardoso:
Yeah. And I think for any company out there, buying on the secondary market, looking at buying secondary market, step one should become an ERAI member, right? Join the organization and get, have access to this database to avoid making those mistakes, right? To avoid, I can see the pressure because if you have a line stopped, an SMT line stopped, it’s thousands and thousands of dollars a minute sometimes that you are not making, you’re wasting, right?

Richard Smith:
Many manufacturing companies, OEM companies have learned that ERAI members are, I promote them as a pool of pre-screened vendors. Now I want to point out there are millions of fine high quality, very good companies in the world that are not ERAI members. The minimum expectation of an ERAI vendor member is: they’ve been in business over one year. They’ve been well-vetted by us in that we have contacted six customer and six vendor references, all positive. We’ve got a cursory financial check to make sure that they’re solvent. We have checked the databases, public records, and legal databases of whatever country, city, state they reside in. If they are a Chinese company, we have confirmed their VAT tax number to make sure that they are a legit registered company and they have no complaints against them in the marketplace. So that’s the minimum expectation and OEMs are using the ERAI part sourcing tool now, because when they can’t find a part of their approved vendor supply chain, they’re looking at the ERAI members, looking at part numbers to see if they’re there and they can spend less time vetting them. We still recommend that they align themselves with companies, ERAI members or not, that meet their quality criteria and things like that. But being an ERAI member goes a long way toward shortening their vetting process. And many manufacturers look at that as sort of a Good Housekeeping seal.

Dr. Bill Cardoso:
And the other thing you get is this internal correction system, right? So that if you are a member and you are a bad character, right. ERAI has instruments to eventually kick you out, if you don’t behave well, right?

Richard Smith:
Well, yeah. And the way this works is you do not have to be an ERAI member to report a part or a company. You have to be an ERAI member to view our data. And we help anyone who has a problem with a vendor, ERAI member or not. You come to us with a complaint either by telephone or website or email, you’re assigned a case manager. And we worked that just as hard as anyone. And if it’s an ERAI member who has been investigated and documented of some deliberate bad act, they will lose their ERAI membership. There’s no partiality there, I mean, ERAI has done a pretty good job of being like Switzerland, where we’re pretty neutral. We find that companies that go through our vetting process are not likely to get caught up in that sort of problem, this happens, but it doesn’t happen often.

Dr. Bill Cardoso:
Exactly. I mean, my experience working with a lot of these distributors is that you find that there are some bad actors and they tend to pop up, right, in different places and they kind of, whack-a-mole, they don’t ever go away. They keep moving around. But for the most part, people are trying to do a good job. And an honest job, because it is a market where most employers know each other, right?

Richard Smith:
Yeah. Well, it’s like all walks of life. It only takes a few bad actors to really cause a problem. ERAI, our investigative team, they do a really good job in linking together individuals and companies that are reported for bad acts. And then we hear quite quickly when the names or the alias. We have several in our database, different companies, all at the same street address and they all have complaints with them. So we work very closely with our members and non-members all around the world to be aware of people that are shutting down and reopening. And I could show you in our database at some point just pages and pages of those types of incidents.

Dr. Bill Cardoso:
So we have a couple of minutes left. And so, but before I let you go, I wanted to ask you a question that I’m sure you get asked all the time, which is why do counterfeiters exist, right? I mean, you talk about ceramic capacitors, it’s a fraction of a cent per part. Why would he counterfeit it, I mean…

Richard Smith:
Well, counterfeiting is all about opportunity and generating revenue. I’m going to tell you that I spent [inaudible 00:27:31] of five years in China. And when I left China for the last time, at the end of 2013, the median income, the 1.3 billion Chinese people on mainland China was the equivalent of 5,505, 5,500 U.S. Dollars, $5,500. So to counterfeit a few reels, 50,000 piece reels of multi-level ceramic chip capacitors, which are cheap and easy to do, to do a $500 counterfeit deal. People can increase their standard of living by 10%, just in the one deal.

David Kruidhof:
Unreal.

Richard Smith:
So they’re driven by, it’s a financial driven thing. There is a strong criminal element. I don’t want to get too far into details. It’s, my purpose and job at ERAI is to sell our website database and tools to the manufacturing community around the world. At a certain level at ERAI, we work very closely with law enforcement.

Richard Smith:
And I can tell you that there is a terrorist angle to counterfeiting, to generate the revenue to go do whatever terrorists do. And there are criminal elements. There are some people out there that are employed in that business. Now I’ve been to some of these sites in China where they just melt circuits off the hundreds of millions of tons of scrap PC boards that Europe and the U.S. and South America sends to China. So they’re taking this stuff off. Well, the people working in that toxic environment, sucking fumes, sitting over a Bunsen burner melting [inaudible 00:29:16] circuit boards all day. They’re just trying to scrape out a living.

Dr. Bill Cardoso:
Yeah.

Richard Smith:
But it’s a big industry, counterfeiting. Now in recent years, it’s become more sophisticated and many government agencies and defense and aerospace companies in any quality conscious company, they are now concerned with not the criminal element for revenue generation, but the insidious code, the evil intent, things like that are becoming a bigger concern in counterfeiting and cloning. You can take all the reasons for potentially for counterfeit. It’s not always an obsolescence. It’s not always part shortage. It all comes down to opportunity and counterfeiters will use whatever opportunity they have to generate revenue. And in the case of the multi-level ceramic chip capacitors, one could say the opportunity was presented because of the increased demand. Well, I say the opportunity was presented because of the hundreds of millions, if not billions of circuit boards, they could just take those parts off of.

Dr. Bill Cardoso:
Exactly.

Richard Smith:
And when you’re generating, just like the wire fraud cases, if you look at those wire fraud cases, it’s not all big money. Some of them were 40, $50,000. Some of them were 150 bucks, $450. It doesn’t matter because whatever, it’s all going one way-

Dr. Bill Cardoso:
Exactly.

Richard Smith:
And they’ll take it all. People try to nail that down. At the end of 2019, we took the day at ERAI and we went back and looked at the last 1000 reported parts. And we ran them through one of another company’s database. And we found that 51% of all the parts reported as counterfeit. The last 1000 were all standard readily available product. Because you can pick up the phone and buy from stock on a distributor. So it’s not always obsolescence. A lot of it has to do with average selling price, $12 parts. If the counterfeiters have the opportunity, the materials, they’re more likely to spend time counterfeiting that than the sub one penny capacitor.

Dr. Bill Cardoso:
That’s insane.

Richard Smith:
But it, counterfeiting, it’s a moving target. It hasn’t changed. It’s not going to change. We just try to fight it. And we give our members the tools and navigate the current known bad products and problem suppliers.

Dr. Bill Cardoso:
Well thanks for the work you do man.

David Kruidhof:
Awesome.

Dr. Bill Cardoso:
Appreciate it.

David Kruidhof:
Yeah, thank you.

Richard Smith:
We have job security. I’m sorry, David.

David Kruidhof:
I said, thank you for joining us, Richard, it’s been really good.

Richard Smith:
It’s been my very great pleasure, erai.com. If anyone has an interest, give me a call. I’d be happy to tell them more, or address any specific concerns that they may have. Bill, always a pleasure to see you. And I hope we get to run into each other, and traveling again soon. So hopefully that’ll be back up and running.

Dr. Bill Cardoso:
I look forward to that, Richard.

Richard Smith:
All right. [inaudible 00:32:25], I want to thank you. Have a great day.

Dr. Bill Cardoso:
You too, bye-bye.

Richard Smith:
Until we speak again, please, stay safe. Stay well.

Dr. Bill Cardoso:
You too, bye-bye.

David Kruidhof:
Bye.

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