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How counterfeits enter the gray market

Editor's note: This is not a “how-to” guide

Marc Hermann recently got to view a marketplace for counterfeit electronics fist hand. (See: A Gray Market for Electronics.) Marc's post also raised some questions regarding a “black” market vs. a “gray” market. Without delving into legal definitions, my sense is that the word “gray” has been used in the electronics supply chain because a lot of what's happening is not outright illegal.

For example, there's no law against an OEM or EMS provider selling excess components to an interested buyer. Unless a distributor or supplier is willing to take excess inventory back, there's really no other recourse for manufacturers that simply ordered too much components.

Additionally, not all products in the electronics gray market are counterfeit. In fact, they probably are what sellers say they are. The issue is whether or not the component manufacturer will take responsibility for a problem with the part. In many cases, the answer is “no.”

The US International Trade Commission (ITC) recently published the first part of a study on IP infringement in China. Although China is used as the main example in the report, the methods of counterfeiting described are used everywhere. Here is how the ITC says bogus ICs enter the marketplace:

    There are a number of different ways trademarked products reportedly are infringed in China. A contract manufacturer may produce more than the original contract called for, or may continue to produce after the contract ends, and market the overproduction without the knowledge or consent of the IP owner.

    Counterfeiting can also occur with an internal breach at a factory, whereby a current or former employee will take know-how gained there to another factory in which counterfeit goods are produced. Counterfeit goods may be produced from salvaged or recycled products that are re-marked and sold without the authorization of the trademark owner. Counterfeit goods also may be produced by individuals or enterprises unrelated to the owner of the branded product based solely on a visual examination or the deconstruction and copying of the original.

    In the case of production continued past contracted amounts or deadlines, the product is identical to that of the trademark owner, but is produced without the trademark owner’s permission. This type of counterfeiting may be labeled a “ghost” or “third shift” operation. When produced in this way, the end product is generally indistinguishable from the original although quality control during such third shifts is reportedly lacking.

    Similarly, counterfeiting may occur when current or former employees train others to produce the trademarked product. Employees of the brand owner may assist counterfeiters in setting up a production line, using the skills and trade secrets learned making legitimate goods. In the footwear industry, for example, sources commented on the production of “super fakes” made in this way; the counterfeit shoes are so similar to the original that they can only be distinguished by cutting them open.

    An example of counterfeiting by recycling is seen in the counterfeiting of integrated circuits (ICs) from electronic waste (e-waste). China collects e-waste from around the world to salvage components from it. Some components are legitimately recycled, but others enter the counterfeit IC market when ICs are salvaged, remarked as new, and “recycled” back into the distribution stream.

    Another source of IC counterfeits is called “second source,” where lower-performance ICs are re-marked as higher-grade ICs or where nonfunctional ICs are re-marked as new. Old chips can be placed in new packaging; this method of counterfeiting is extremely difficult to detect. Industry sources report that in some cases production has become more disaggregated, with false labeling added at the very end of the process in order to avoid detection and seizure.

See our previous blogs — (More on Anti-Counterfeiting: Defending Your Brand) and (In Search of Counterfeiting’s Silver Bullet) — for discussions and possible solutions to counterfeiting, and look for the discussion to continue next year.

18 comments on “How counterfeits enter the gray market

  1. saranyatil
    December 28, 2010

    thx barbara, most important point is people prefer china as a place for implementing their ideas into a product because the operating cost is comparitively cheaper and is faster. as far as i know china manufacturers are capable of duplicating or replicating products of other companies within seconds for example if a new mp4 player is being manufactured in china, the same features, aesthetics like colour, size may be the chips inside can be the same or different ones but their functions remain similar and these goods are even sold in front of the same showrooms ( original owner/ company of the products) i have witnessed lot of such incidents especially in the watch market which have very tiny IC s. something has to be done to strengthen the meaning of IP, it should be drilled into the heads of all the people involved in the manufacturing chain this will help to stop products entering into the gray markets.

  2. Taimoor Zubar
    December 28, 2010

    I would agree that China is increasingly becoming one of the largest producer of counterfeit products. The counterfeit products are being supplied all over the world. I think the root cause behind this is that the Chinese government has failed to enforce regulations which protect copyrights and prevent counterfeit products from being produced or distributed. Unless there are restrictions from the Chinese government, there is very little that external organizations can do.

  3. Anna Young
    December 28, 2010

    Are we to take it that counterfeiting does not occur in the United States and Western nations? Does it take place only in China or why exactly was the ITC report so narrowly focused on China? What I would like to know is how counterfeit products infiltrate the supply chain in developed economies. Any thoughts?

  4. Ms. Daisy
    December 29, 2010

    What happened to the principle of supply and demand? For as long as we have high demand for these counterfeit products in the West and other developing nations, you bet you will get increase in its supply from China and the Chinese governement cannot do anything about it.

  5. Taimoor Zubar
    December 29, 2010

    @ Ms Daisy: I agree that as long as there is demand for a product, suppliers will continue to make it to make profits. This is the basic free market principle. However, this is one of the downside of the free-market. If left unchecked and uncontrolled, the free-market will lead to unethical and illegal practices. That's one major reason why you need government intervention in the markets to ensure that companies do not engage in unethical practices.

  6. Mydesign
    December 29, 2010

          Now a day’s almost all electronic industries are facing different types of challenges for their existences and counterfeit is one of the major threat for the industry.  Before going to deep, we have to consider and analyze different factors like, why peoples and local authorities are encouraging the counterfeit products? Why there is major cost difference between these products. The best part is China and neighboring countries are the leading players in this market. If we are analyzing how china becomes the leader, the availability of cheap raw materials and less labour cost may be the answer.

         But again how Chinese companies are capable to make this counterfeit products, from where did they get all these product designs and ideas. Again it’s a fault from the original vendors and design companies, so by different ways we are providing the chances to Chinese companies for making counterfeit products. If we want to avoid counterfeit products, strictly follow the copyright acts, keep away Chinese companies from original manufacturing process and more over make the cost justifiable with the value and features of the products.

  7. Clairvoyant
    December 30, 2010

    In my opinion I think counterfeits will always exist in the marketplace. A question for the others here, is do you think this problem will become a larger or smaller issue in the future of electronics?

  8. maou_villaflores
    December 31, 2010

    Its already a big issue. For example in China, you can a buy a counterfeit Iphone for 150-200 dollars theres a big difference from the price of the original item. This will have a big impact in the profit of the manufactures they are competing against their clone. 

  9. hwong
    December 31, 2010

    I don't think China can enforce regulations on counterfeit because of political interests. Government officials would not want to effect anything that may take away their own profits.

  10. Hardcore
    December 31, 2010

    The China government is not as 'Gung-Ho' about E-waste , as you would imagine or you might have heard.

    Specifically becuse with several Billion people, they already have a bit of an 'E-Waste' problem, without actively making it worse by importing other Countries E-waste.

    There used to be a problem with other countries using China as a cheap dumping ground for all sorts of waste , but if you can imagine being a customs official your not really going to want to deal with a load of  plastic' toxic' waste.

    A taraf structure exists on goods re-entering China , specifically becasue the  rubbish merchants tried several systems including setting up dummy factories to accept 'valuable' waste, in reality it was just an exercise to get the crap into China then abandon it.

    So now there is a tax system , any return goods have to be reworked and out of the country within 30 days, after which a sliding  customs tax takes over, plus you need special paper work to bring 'rework' goods back into China.

    Don't think for one minute that the Government has any interest in turning China into a dumping ground  for every toxic asset in the world, there is no long term future in that.

     

     

     

  11. Backorder
    December 31, 2010

    Tired of reading all the gray and black market stories, I have a question for all invoved in the industry. People who are buying the counterfeit cellphones are aware that it is not a genuine product. Generalising this, every link in the supply chain is ready to accept the gray nature of his source only because of some advantage! Is it not time then for the authorized sources and original manufacturers to re-evaluate strategy? If you are worried about all the people who are buying a clone of your product knowing very well that thee product willl not meet the quality standard set originally, is there not a case for making market targeted products? In countries where you can not stop them from hurting your interests with public and govt. support, you have to become one of them to ensure survival. Maybe a little far fetched, but well worth stepping back and strategising!

  12. bolaji ojo
    December 31, 2010

    Backorder, Absolutely. This is a reality in the market and many companies are already responding with products that scale down the market. However, what people who buy fake products want is something as close to the original as possible minus the high cost, two things original equipment manufacturers cannot offer them and still make the same profit. For instance, Apple is unlikely to start selling iPods and iPhones that mimick the original but are not quite the original just to attract the consumers who buy from the gray market.

    You are right, though. OEMs tend to encourage the proliferation of products that don't quite make the grade by adopting policies that literally stiffle the market. Let's go back to Apple and its iPhone again. The company sells the iPhone in the US currently to only one service provider AT&T. Forget about gray market buyers in Asia or Africa, if I want the iPhone in the US and I don't want to sign up with AT&T, I am forced to either buy a new one from Apple and then find a way to “jail-break” it or buy from the “gray” market. Those are my options or stay away from Apple products!

  13. Backorder
    December 31, 2010

    Also at some point companies like Apple, as you rightly mention, will need to compromise their assumption of high quality/price – exclusive market in favor of reasonable quality/price – broad market. Maybe, they choose not to accept the profitability of this but the sheer volume connected to it can outweigh every other strategy. This is exactly what companies like Micromax have achieved in India.

  14. Taimoor Zubar
    December 31, 2010

    I think the problem here is not so simple. Even if the companies could come up with cheaper versions of their products, it would end up destroying their reputation. If every other person starts carrying original Apple's iPhones, they would certainly become less valuable. The novelty is one factor that makes them so desirable for consumers.

  15. Redding McLemore
    January 3, 2011

    I believe some of us are missing the point regarding counterfeits.  It is one thing to buy a fake “you name it” and know you are doing so.  It is quite another to buy something you believe to be a legitimate product or component only to later find out it is not real and a sub-par device.   It causes industries to put in place expensive priocedures for every component they procure to ensure it is legitimate.  It adds cost to the entire system; costs that legitimate suppliers must also bear in order to reassure their cutomers their parts are real.

  16. Barbara Jorgensen
    January 4, 2011

    For finished goods, I think there is a way for an OEM to sell less-than-perfect products without damaging the brand: outlet stores. In my area, we have a Sony outlet and they sell last year's model at a discount and they sell refurbished products at a steeper discount. Customers know what they are buying and, in fact, Sony provides an extended service program at a pretty good rate. I've bought both year-old and refurn products there and I'm happy with both. Even Bose has an outlet in the same mall.

    At the component level, I think it's a different story. I can't see vendors selling “seconds” at discount rates. Because of the volumes that pass through the channel, even a slightly higher failure rate in a batch of components is risky. Every component on a board is designed in for a reason, so a single component can make or break the end product. When it comes to components. I think one has to guard more carefully against counterfeits and against the risk of less-than-perfect products.

  17. elctrnx_lyf
    January 4, 2011

    It is clear that most of the counterfeits are actually result of the excessive inventory maintained in the EMS or the technology stealed by the people inside the EMS companies. But the third case looks interesting where the recycled components are collected and made as a finished product. But where do the people develop the software for these devices. Is these devices contain a different software and applications but look just similar to the original goods?

  18. Hardcore
    January 4, 2011

    Generally the software is 'ripped' as well.

    In some cases if you can get to the devices underlying poerating system, you would be able to see it tying itself in knots trying to find missing or ill configured parts of 'clone' system but identify them as the real device.

    There is a big stink with Chinese tablet computers at the moment, where one company produced a model, but then multiple companies ripped the hardware and software.

    To make matters worse, some of these companies used substandard parts or re-furbished components.

    Part of the thread can be seen here:

    http://www.slatedroid.com/index.php?topic=12192.0

    But as I say… once you get into the underlying operating system you can see many of the issues related to why these devices are going bad.

    So really even in this field there are companies operating at multiple levels with no real hard and fast rules as to how you can identify 'fake' products.

     

     

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