As the Market Rebounds, Smuggling and Counterfeit Concerns Rise

The semiconductor market is expecting a rebound later this year. Cautiously optimistic about the extent of the recovery, experts forecast that two of the primary growth drivers this year will be artificial intelligence (AI) and memory components. DRAM manufacturers intend to resume strategic production cuts through 1H24 to keep supply demand tight. Manufacturers are buying some DRAM components to bulk stockpiles as undelivered DDR5 orders fuel market uncertainty.  

A possibility is that large language models (LLMs) and generative AI could lead the market back into a shortage state from the high AI demand. Bottlenecks over 2023 for graphic processing units (GPUs) used to run large-scale AI applications have fueled some concerns. Memory market uncertainty, especially in high bandwidth memory (HBM) products, also required in AI products, is contributing to such fears.  

Should a shortage occur, will it be like the global semiconductor shortage? The jury’s out on that one, especially with inventory overhang weighing down the semiconductor industry for the first half of 2024. However, ongoing geopolitical volatility from export restrictions on advanced semiconductors used in AI and manufacturing equipment could increase illegal operations and counterfeiting to avoid sanctions.

Ambitious Smuggling Operation Worth Millions Discovered

If there’s a market, there will be counterfeits. The same can be said for smuggled goods. One doesn’t have to look too far in history to know there’s a considerable market for illicit or banned goods. Current restrictions on advanced semiconductor sales have led to widespread demand for coveted chips like Nvidia’s flagship GPUs.

Nvidia has been working with companies in countries subjected to export restrictions to develop components that work around these bans. However, the U.S. government has edited language within these trade restrictions to prevent exportation of these restriction-friendly components.  

Shortages alongside tightening trade restrictions have contributed to rising concerns about the growth of illegal operations. Desperate times call for desperate measures, after all. A chip smuggling operation that funneled nearly $12 million worth of chips recently made headlines after its bust.

Operating during the height of the pandemic, “Company A” legally bought and then smuggled chips into countries under trade restrictions. “Company A” had been successful in these endeavors, with its actions only being discovered in late 2023. This beat the previous record-holding bust of nearly $4 million in CPUs, SSDs, and other components in 2023. Expensive smuggling operations are only the tip of the iceberg, with even small-scale smugglers attempting to do the same.  

Going into 2024, geopolitics will challenge supply chain operations due to ongoing conflicts and export restrictions between countries. Continued AI popularity will likely keep demand for restricted components high, possibly leading to more attempts like we’ve seen over the last few years.  

A more significant challenge is the transport and sale of counterfeit components, as counterfeiters can easily find new targets during difficult times.

Counterfeit Chip Stock Seized

Geopolitical conflicts, bottlenecks, and sanctions are the perfect breeding ground for increased counterfeit risk.  

Last summer, in collaboration with Bulgarian Customs, Portuguese Customs, Frontex, Europol, and EUIPO, officers seized over 61,246 counterfeit electronic devices. Unfortunately, this rise doesn’t come as a surprise. The Electronics Reseller Association International (ERAI) reported in 2022 that counterfeit electronic components circulating the market showed a 35% year-on-year increase over 2021. Similarly, statistics indicate a dramatic increase in supply chain risks caused by counterfeits in the following years.  

The U.S. Chamber of Commerce estimates that counterfeit components cost up to $500 billion across all industries worldwide. This high number includes the additional costs required to buy authentic replacement stock, recall the compromised devices, and even legal fines for selling products containing counterfeit parts. The semiconductor industry is a vast and profitable market for counterfeiters and smugglers, making it the perfect target.

When the risk of supply chain disruptions is exceptionally high, the danger of purchasing counterfeit components increases. No better example can be found than during the global semiconductor shortage. Long lead times, high prices, and unavailable stock left many original equipment manufacturers (OEMs), contract manufacturers (CMs), and others with two choices. They could either experience partial or complete production shutdowns or purchase from unauthorized sources, gambling against the higher counterfeit risk.

Unfortunately, those who bought from unauthorized sources often ended up in more precarious situations than before.  

“There is more incentive than ever to profit off counterfeit components just by advertising that you have them available within the supply chain when no one else does,” said Nick Martin, Director of the Pentagon’s in-house semiconductor supplier, the Defense Microelectronics Activity.

Counterfeits can be found in any industry supply chain and are especially dangerous within high-reliability markets. It is suspected that in June 2020, the death of an Air Force pilot could have resulted from 10 counterfeit and faulty transistors and semiconductors causing a malfunction in the jet’s ejection seat. The Air Force Research Laboratory said that the lab would need further analysis to determine the counterfeit status, but no further confirmation has been announced.  

The U.S. and other government bodies are doing their best to crack down on counterfeits with a multi-pronged approach, but due diligence on buyers will still be necessary. One of the contributing factors to how counterfeits can slip into high-reliability supply chains like defense contractors is the lack of transparency over the entire supply chain.  

A 2022 report by McKinsey found that only 45% of organizations can see as far as their first-tier suppliers, lacking a large chunk of upstream visibility. Counterfeit products and even compromised raw materials can easily avoid detection with incomplete visibility.  

This lends credence to the fact that companies must invest in greater visibility despite aid from regulatory bodies to secure supply chains against smuggling and counterfeits. Additionally, holding distributors and suppliers to a high standard by purchasing from organizations that possess certification to aid in establishing a rigorous quality management system (QMS) should be prioritized.  

During global shortages, purchasing solely from certified distributors can be difficult when bad actors display enticing offers and high availability. Purchasing from suppliers that can promise secure supply through proper certification to catch undetected counterfeits is far more cost-effective in the long run.

What a Trusted Distributor Should Have to Prevent Counterfeits

The best thing a buyer can do to lower counterfeit risk is to purchase from distributors that have strict QMS procedures. Suppliers with ISO 9001:2015 certification utilize plan-do-check-act methodology and process-oriented approaches to help suppliers establish documenting and reviewing structure, responsibilities, and procedures to achieve excellent quality management.  

The 2015 revision to ISO 9001 emphasizes risk-based thinking to help enhance process approaches. These processes help ensure product quality is organized and streamlined to keep the inspection line moving properly.  

Due to the sophistication of counterfeits, suppliers must regularly invest in new testing methods to better detect nonconforming parts. Sometimes, the acetone test isn’t enough to uncover whether a part is counterfeit.  

Sourceability is devoted to component quality, using sophisticated testing equipment to determine component authenticity including:

• High Power Microscopy Capabilities Keyence VHX5000, VHX7000, Olympus DSX1000
• Heated Chemical Testing (HTC)
• RoHS Testing with X-Ray Fluorescence (XRF) Equipment Olympus: Xpert Model
• NISENE Jet-Etch Pro Acid Decapsulation System
• RPS Cadence Steam Aging System

Under Sourceability, parts sold through Sourcengine undergo the same rigorous quality authentication through this extensive detection process. In the ultra-rare event that buyers experience an issue with their procured stock from Sourcengine, all parts sold through Sourceability come with a three-year warranty to ensure quality lasts. A market rebound is coming this year, and demand for components used in AI applications will continue to grow. Desperation increases the risk of counterfeiting and smuggling in the electronic components industry. Buying from a distributor that eradicates those problems is essential to safeguarding your supply chain from these suspect parts.