1. Counterfeits and the U.S. Industrial Base Office of Technology Evaluation

2. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Bureau of Industry & Security (BIS) MISSION: Advance U.S. national security, foreign policy and economic interests. BIS develops export control policies, issues export licenses, prosecutes violators, as well as monitors the capabilities of the defense industrial base.

3. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) OTE Industry Assessments - Background Under the Defense Production Act of 1950, ability to assess:  Economic health and competitiveness  Defense capabilities and readiness Enable industry and government agencies to:  Monitor trends and benchmark industry performance  Raise awareness of diminishing manufacturing and technological capabilities More than 50 industry studies & 125+ surveys

4. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Electronics Study - Goals Assess the impact of counterfeit electronics on U.S. supply chain integrity, critical infrastructure, and industrial capabilities Recommend best practices to mitigate risk to U.S. supply chain Study sponsored by Naval Air Systems Command with support from Semiconductor Industry Association (SIA)

5. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Electronics - Broad Definition An electronic part that is not genuine because:  An unauthorized copy  Does not conform to original OCM design, model, and/or performance standards  Not produced by the OCM or is produced by unauthorized contractors  An off-specification, defective, or used OCM product sold as "new" or working  Has incorrect or false markings and/or documentation

6. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Electronics Study -OTE s urveys distributed 5 separate but related surveys targeting:  Microchip & discrete electronic manufacturers – 106  Electronic board producers/assemblers – 37  Distributors and brokers of electronic parts – 144  Prime contractors and subcontractors – 147  DOD arsenals, depots, and DLA – 64 498 total survey participants

7. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Electronics Study -Survey Objectives Each survey contained approx. 80 questions  Scale and scope  Past problems and impact  Internal procurement policies and protocols  Testing, inspection, and inventory management  Post-identification procedures  Industry and government best practices Tried to keep questions uniform across surveys.

8. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Type of Company Encountered Counterfeits No Counterfeit Incidents Total OCMs Discrete Electronic Components 122436 Microcircuits182038 Distributors Authorized Distributors 83240 Independent Distributors 311243 Brokers819 Board Assemblers 112132 Prime/Sub Contractors 206181 Total108171279 BIS Counterfeit Electronics Survey – Preliminary Data

9. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Total Counterfeit Incidents: OCMs, Distributors, Board Assemblers, Prime/Sub Contractors 2005 - 2008

10. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Incidents by Product Resale Value: Overall (2007)

11. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Incidents by Product Resale Value: (2005 - 2008)

12. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Incidents by Product Resale Value: Distributors (2007)

13. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeit Incidents by Type (2007)

14. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Counterfeit Incidents Involving In/Out of Production Products 2005 - 2008

15. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) How Companies Are Uncovering Counterfeits (2007)

16. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) How Companies Are Uncovering Counterfeits: OCMs (2007)

17. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) How Companies Are Uncovering Counterfeits: Distributors (2007)

18. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) How Companies Are Uncovering Counterfeits: Prime/Sub Contractors (2007)

19. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) U.S. Customs Notifications (2005 – 2008) Companies have increasingly uncovered counterfeits through U.S. Customs notifications. Year Number of Incidents 20053 200613 2007120 2008473

20. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Companies With Documented Cases of Counterfeits Sold by Specific Entities

21. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) * Each company was asked to provide their top five suspected countries Top Countries Suspected/Confirmed to be Sources of Counterfeits*

22. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Counterfeits Damaging a Company’s Reputation Prime/Sub Contractor Comment: When some businesses report counterfeit parts findings via GIDEP alerts and other companies do not, authorities may think that the reporting companies have more counterfeit issues than non-reporting companies. Distributor Comment: “The entire brokerage industry has experienced a black eye due to some unethical and/or unknowledgeable brokers. We have lost many contracts from large contract manufactures simply due to us being a ‘broker.’” Percent of Companies Indicating Counterfeits Have Negatively Effected Their Image or Reputation Discrete Electronic Component Manufacturers 8% Microcircuit Manufacturers 29% Authorized Distributors 8% Independent Distributors 44% Brokers67% Circuit Board Assemblers 6% Prime/Sub Contractors 3%

23. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Top 10 Reasons Identified by All Companies for Counterfeits Entering the U.S. Supply Chain Reason Number of Companies Less Stringent Inventory Management by Parts Brokers150 Greater Reliance on Gray Market Parts by Brokers140 Greater Reliance on Gray Market Parts by Independent Distributors 124 Insufficient Chain of Accountability119 Less Stringent Inventory Management by Independent Distributors 114 Purchase of Excess Inventory on Open Market101 Insufficient Buying Procedures101 Inadequate Purchase Planning by OEMs98 Greater Reliance on Gray Market by Contract Manufacturers91 Inadequate Planning by Contract Manufacturers88

24. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Pre-Stock Testing By Type of Supplier (Distributors, Board Assemblers, Prime/Sub Contractors Only) Only 66% of Distributors, Board Assemblers, and Prime/Sub Contractors test products they purchase before placing them in inventory. Average Percent of Incoming Parts Tested by Type of Supplier* OCMs51% OEMs47% Authorized Distributors 50% Independent Distributors 54% Brokers54% Internet-Exclusive Sources 32% * Based on those companies who test incoming parts.

25. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Distributors Conducting Pre-Stock Testing

26. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Board Assemblers Conducting Pre- Stock Testing

27. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Prime/Sub Contractors Conducting Pre- Stock Testing

28. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Companies Performing Inventory Audits for Counterfeits

29. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Companies Co-Mingling Identical Parts in the Same Bin

30. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Contractor Testing Problems Five companies had problems with Non-U.S. contractors concerning improper management or theft of electronic scrap after testing. 25 companies, 19% of those employing testing contractors, had problems with U.S.-based firms concerning faulty or forged testing. Twenty of the 25 were distributors.  The parts were cleared by the testing house, but were later found to be counterfeit by the customer. This is an area that deserves further analysis.

31. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Steps Taken After Notification of a Counterfeit Incident: OCMs Notify Internal Company Authorities69% Trace Supply Chain67% Inform Authorized Distributors36% Locate Select Inventory36% Pull Back Inventory24% Perform Random Testing21% Wait for Additional Complaints19% Notify Federal Authorities17% Other16% No Steps Are Taken15% Notify Industry Associations15%

32. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Steps Taken After Notification of a Counterfeit Incident: Distributors Pull Back Inventory77% Notify Internal Company Authorities74% Locate Select Inventory68% Trace Supply Chain65% Notify Industry Associations54% Perform Random Testing46% Inform OCMs45% Inform Authorized Distributors41% Notify Federal Authorities25% No Steps Are Taken19% Other13% Wait for Additional Complaints5%

33. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Steps Taken After Notification of a Counterfeit Incident: Circuit Board Assemblers Pull Back Inventory67% Notify Internal Company Authorities64% Locate Select Inventory64% Trace Part Supply Chain55% Inform Authorized Distributors48% Inform OCMs45% Perform Random Testing39% No Steps Are Taken18% Notify Industry Associations12% Notify Federal Authorities10% Other10% Wait for Additional Complaints6%

34. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Steps Taken After Notification of a Counterfeit Incident: Prime/Sub Contractors Pull Back Inventory68% Notify Internal Company Authorities65% Locate Select Inventory64% Trace Part Supply Chain61% Inform OCM51% Inform Authorized Distributors49% Perform Random Testing44% Notify Federal Authorities30% No Steps Are Taken24% Notify Industry Associations18% Other15% Wait for Addition Complaints4%

35. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Steps Taken After Possession of a Counterfeit Part Action TakenOCMsDistributors Circuit Board Assemblers Prime/Sub Contractors Enter into USG or Industry Database 8%41%9%20% Retain Samples for Reference59%40%21%44% Test Part57%54%42%54% Enter into Company Database51%60%48%47% Quarantine Parts23%42%21%36% Leave Disposal to Party Filing Complaint 25%13%6%8% Random Inventory Testing17%39%42%47% Disposal of Parts Immediately17%32%15%20% Issue Credit15%67%61%37% Turn Over to Law Enforcement Authorities for Analysis 13%11%12%16% Check USG or Industry Database9%47%15%35% Other9%19%9%15% Turn Over to Law Enforcement Authorities After Analysis 9%14%12%21% Return to OCM or Distributor--55%31%

36. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Who Ya Gonna Call? 61% of OCMs, 54% of Distributors 75% of Board Assemblers, and 52% of Prime/Sub Contractors DO NOT KNOW what authorities to contact when they encounter counterfeits. 74% of distributors tell customers to contact their firm if they encounter a counterfeit product. Top Authorities Contacted (As a Percent of Total Companies) None at all44% GIDEP14% State/Local Authorities 9% CBP8% DLA8% FBI7% FAA6% Department of Transportation 4%

37. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Percent of Companies Maintaining an Internal Database to Track Counterfeits

38. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Legal Requirements/Liabilities Related to Counterfeits 31% of companies are aware of legal requirements for the management and/or disposal of counterfeit products. 27% of companies are aware of written instructions or guidance from federal authorities on reporting counterfeit products. 41% of companies are aware of their liabilities related to the distribution, storage, and disposal of counterfeit products. 46% of companies need guidance from federal authorities with regards to civil and criminal liability, and penalties pertaining to the distribution, storage, and disposal counterfeit products.

39. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Full-Time Employees (FTEs) Dedicated to Counterfeit Issues Number of Companies With At Least One FTE Dedicated to Counterfeit Issues (2007) Distributors61% Prime/Sub Contractors 38% OCMs27% Circuit Board Assemblers 27%

40. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) “Fun” Facts 91% of companies accept returns from their customers.  45 of these companies have cases of individual customers returning counterfeit products. 42% of companies find it difficult to identify counterfeit products.  However, 63% of companies find it easier to identify counterfeits today than they did five years ago.

41. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Industry Best Practices – 1,000+ From OCMs: Ensure proper disposal of all scrap – crush all defective/unused products to prevent re-circulation. Train all employees on how to identify and handle counterfeit parts. Tighten contractual obligations with contract manufacturers regarding disposal of unused product. From Circuit Board Assemblers: Audit OCMs/OEMs to ensure that the purchased part is made within their facility and not contracted out. Perform destructive testing if a part cannot be verified by other means. Establish qualifications for supplier purchases. Most common responses – Don’t buy from China – Be wary of Brokers

42. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Industry Best Practices (cont.) From Authorized Distributors: Ask for Certificates of Compliance for all products purchased. Educate your sales team regarding the risk of parts brokers. Create a central database for identifying counterfeit suppliers. Do not approve returns in greater quantities than the original purchase. From Independent Distributors/Brokers: Always purchase parts via escrow payments – Suppliers that believe in their product will not mind waiting for their money. Audit all inventory purchased before anti-counterfeiting measures were put in place. Follow IDEA 1010 for incoming inspections. Use authentic pictures to visually verify parts.

43. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Industry Best Practices (cont.) From Prime/Sub Contractors: Share all information on discovered counterfeit parts with industry and authorities. Incorporate language into supplier contracts to minimize liabilities and impose penalties for counterfeits. Plan for and attempt to design out obsolescence from systems. Create annual training sessions for staff to keep counterfeit detection up-to-date.

44. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) What Should the Federal Government Do? - Industry Suggestions Create education and training opportunities for companies.  Many companies do not know what the Federal government is doing to combat counterfeits.  Create a government-sponsored counterfeits manual. More prosecutions for counterfeiting, including harsher penalties. Centralize counterfeit databases and encourage higher levels of reporting.

45. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Press other countries, particularly China, to regulate their domestic industry and enforce intellectual property laws. Facilitate communication and cooperation within U.S. industry, particularly between OCMs and independent distributors/brokers. Establish programs to recycle/destroy electronic waste, the supply source for counterfeiters. What Should the Federal Government Do? - Industry Suggestions (cont.)

46. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Company Comments “It is encouraging that the U.S. government has finally recognized the scope of the problem and seems to be taking meaningful steps to counteract the counterfeiting plague.” - Independent distributor “Our participation in this Assessment has heightened our level of attention and understanding concerning the importance of being proactive in combating counterfeit products … We appreciate the information that was presented within this Assessment and plan to implement appropriate internal/external actions necessary to mitigate the potential for a counterfeit incident to occur within our operation.” - Authorized distributor

47. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) Next Steps Continue compliance on the DOD survey Begin final analysis of data Draft report and release public document in mid 2009 Work with industry and government to develop and implement best practices

48. U.S. Department of Commerce – Preliminary Data (as of November 21, 2008) BIS/OTE Contacts Brad Botwin  Director, Industrial Studies  Office of Technology Evaluation  202-482-4060  bbotwin@bis.doc.gov Teresa Telesco  Industry Analyst  202-482-4959  ttelesco@bis.doc.gov www.bis.doc.gov