Information about how the gray market works has always been murky. Industry people say it's the unauthorized sale of components. But who exactly is doing that selling? And who is doing the buying? Well, that's what makes it gray. It sounds like every link in the supply chain contributes to the gray market at some point, in some way, including OEMs, contract manufacturers, independent distributors, and even authorized distributors.
Now Xilinx is shining a spotlight on the inner workings of the gray market. In December, it sued Flextronics International, accusing the contract manufacturer of “fraudulent and unfair business practices.” The complaint, filed in the Santa Clara Superior Court of California, says Flextronics misrepresents whom it was purchasing Xilinx parts for. Specifically, Flextronics falsely claims to be buying for a preferred Xilinx customer, meaning one that Xilinx sells to at a lower price based on the high volumes of chips the customer buys each year, the complaint said. The suit also claims Flextronics over-orders components for preferred customers. Then Flextronics sells those parts to a different company at a higher price and pockets the difference, making “large, wrongful profits at Xilinx's expense,” the complaint read.
Flextronics wouldn't comment on the suit, but a spokesperson sent a statement saying it is “committed to complying with all the laws and regulations in every jurisdiction where we operate, [and] deeply committed to operating with the highest standards of ethics and integrity.”
The suit also charges Flextronics purchases gray market and counterfeit Xilinx devices from unauthorized distributors and resells them to Xilinx customers. In addition, Xilinx accuses Flextronics of making unauthorized sales of Xilinx chips to “unknown purchasers in Asia” without obtaining export licenses, a violation of US export control laws and possibly creating a threat to US national security. (Xilinx chips are used in advanced aerospace and defense systems.)
The examples Xilinx gives of how it discovered the alleged fraudulent activity reveal how the gray market works. Last June, it noticed large discrepancies between sales forecasts and consumption levels for two customers, Airvana Network Solutions and Checkpoint Systems, and so started analyzing Flextronics' purchasing history. It found that Flextronics had purchased about 60,000 more Xilinx parts than indicated by the sales forecast of Airvana, which was a preferred customer and thus got a price of $7. Meanwhile, Xilinx confirmed that Checkpoint — which was not a preferred customer and thus paid $11.50 for the same part — had about 40,000 more Xilinx parts in stock than its order history indicated. When asked, Checkpoint confirmed it had purchased the additional parts from Flextronics. Tellingly, Flextronics had previously asked Xilinx for a price quote on an order for 40,000 of these parts for Checkpoint, but had never placed the order, the complaint said.
A second example, however, is less convincing. Flextronics notified Xilinx when a part purchased for Ericsson failed Flextronics' quality testing. When the part number on the failed part didn't match with the parts Xilinx sent to the distributor (Arrow Electronics), Xilinx investigated further.
Xilinx then tested the part itself and found it to be a lower-quality Xilinx part that had been relabeled as high performance. The complaint says that Xilinx confirmed that Arrow had shipped the right parts to Flextronics, and so concludes that “it was at Flextronics that the device was switched with a defective and remarked chip in order to permit Flextronics to make a higher profit from selling to Ericsson. Flextronics then sold the original, authorized Xilinx chip to an unauthorized customer for an even more substantial profit.” A lot of that seems conjecture, without much evidence to back it up in the complaint.
Finally, the suit charges something that seems incredible: that Flextronics has designed its cost procurement system to make it impossible to trace the origin of parts. The contract manufacturer has eight to 10 unauthorized distributors that scour the gray market for low-performance Xilinx chips to switch for the higher-priced devices in customer products, the suit claims. Xilinx charges that Flextronics' procurement system masks these purchases and deliveries.
If this lawsuit goes to trial, even more of the machinations of the gray market might be revealed. I hope it does. Someone needs to turn on the lights in this dark area of the supply chain.