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X-Rayted Files: The Dark Side of the Chip Shortage—Counterfeits

It’s February 2021, and as the world slowly recovers from the COVID-19 pandemic, another problem plagues the global economy: the electronic component shortage. What some economists have deemed to be a decade of immense prosperity and growth, the “roaring ‘20s” started with a hiccup. From cars to videogames, the lack of electronic components in the market has created a shockwave that is causing delivery delays and billions in losses to companies worldwide. U.S. car giant General Motors, for example, announced that it is shutting three plants and slowing production at a fourth due to the semiconductor shortage. The Detroit car manufacturer said this shortfall will cause a $2 billion reduction in its 2021 profits. GM is not alone. Ford said in January that it was shuttering a factory in Germany for a month, while Volkswagen said in December it will make 100,000 fewer cars this quarter as a result of the shortage.

All that in a year filled with excitement around the long-waited introduction of electric cars in the market: Ford with the passionate Mustang Mach-E, GM with the 1,000 hp insane HUMMER EV (yes, all caps), and Volkswagen with the sensible ID.4. All that excitement has been partially halted because a few ($60 billion worth of them) semiconductors are missing from the supply chain.

For sure nothing else can go wrong, right?

You should know by now, based on last year, that you should never ask this question. Of course, there’s plenty else already going wrong. What most people don’t realize is that right behind the chip shortage shockwave is another shockwave that is as damaging and as dangerous: the counterfeit components shockwave.

The following (non) scientific graphic displays how supply chain disruptions create the counterfeit shockwave (Figure 2). Let’s start prior to the disruption. The world is trotting along, no major disruptions, and in this case supply and demand are well matched. In this case, there’s not much for counterfeiters to do other than explore smaller pockets of disruption often found in the obsolete markets. Military and aerospace companies are big targets because they constantly consume components that are no longer made due to their need to maintain platforms that must operate for 20 years or more.

Figure 2: This graphic details how supply chain disruptions create the counterfeit shockwave.

Suddenly, a pandemic hits the world, millions of people are working from home and millions of kids are going to school on Zoom. The spike in the need to work remotely and study created a spike in the demand for electronic devices, thus creating a spike in the demand for components. The peak in the demand for components is not immediately matched by a spike in supply. Why not? There are several different reasons.

One, it’s very expensive to ramp up the capacity in the electronic component supply chain. Semiconductor foundries are in the billions of dollars and take years to plan. And even if capital is available to make this supply investment, it is also unknown how long the demand peak will last. What if your brand-new plant is ready when the demand drops, and your multibillion-dollar investment is now collecting dust? In other words, the return-on-investment time profile is uncertain. The large companies that make semiconductors don’t like that.

The supply-demand mismatch creates the supply chain gap we see in the plot above (Figure 2). This vacuum builds an incredible opportunity for the counterfeiting criminal enterprise. They see it as an amazing opportunity to partially fill this supply chain gap with fake components as desperate customers scour the market for parts. The desperation grows as companies see losses in the millions and billions because their manufacturing lines are halted, and as a result they are (sometimes) willing to look for these components in less reputable suppliers. That’s how billions of counterfeit electronic components infiltrate the supply chain, causing unknown damages to the products they are assembled in and the companies that sell them.

Unfortunately, it is hard to quantify these damages, as they are often masked as product defects that are seldom investigated as caused by a counterfeit component. The lack of transparency in how companies deal with counterfeits is a major impediment to our understanding of how grave this problem really is. After all, I don’t recall a single manufacturer happy to share how often they encounter counterfeit components. This information is usually shared under the veil of NDAs. Thus, I invite all companies to come forward: How often do you find counterfeit components? Let’s be open; that’s the only way we can improve this problem.

Companies that never find counterfeit components are often the ones that are not looking for them.

That brings me to the last piece of the puzzle: What to do with all these counterfeit components? This is not the first counterfeit shockwave we’ve seen. Every economic boom has created a similar shockwave. What’s unique about the current shockwave is the impact the pandemic had on the supply chain. Not only do we have a spike in demand, but this increase is also met with a proportional decrease in the supply chain’s ability to react. It's a double whammy.

We forecast an extended counterfeit shockwave, the size and extent of which we haven’t experienced. It’s never been more critical to have a good counterfeit mitigation program in place. That’s the topic of our next column, so stay tuned!

Dr. Bill Cardoso is CEO of Creative Electron.