Counterfeits in the Supply Chain

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United Stationers CEO talks industry trends in part II of an MDM interview; and learn how to ensure you are complying with government contracts in the wake of allegations against Grainger.

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Suppliers fight to protect intellectual property in a global market

Here’s an overview of the scope of global counterfeit trade, as well as what a few companies in one industry – electrical goods – have been doing to protect their intellectual property and, more importantly, the health and safety of product end-users. The second article in this series, published March 10, 2008, will focus on the changing face of product liability in regard to both counterfeits and private label.

Square D, best known in the U.S. as the flagship brand for the Schneider Electric North American Operation Division, realized there might be a problem with counterfeiting of its circuit breakers when the manufacturer started seeing an increase in defective product returns.

“When we would go to check the returned product, we would find out they were counterfeit, and that we hadn’t manufactured them,” says Bill Snyder, vice president for channel development.

Counterfeiters had taken their own products and slapped fake Square D labels on them. Historically, counterfeits have been easy to detect. But the counterfeiters have grown more sophisticated, Snyder says, making it more difficult to name a product counterfeit with just a cursory examination.

“The external appearance – labels and markings – looks very much like genuine product,” Snyder says. “That’s the problem because that’s where it stops. The mechanisms and material are incredibly substandard.”

It may not be obvious that a product is not real. “The counterfeiters do enough just to fool,” says Clark Silcox, National Electrical Manufacturers Association general counsel. NEMA wants counterfeits to register on the radar of distributors, contractors and other end-users.

In the case of the electrical industry, counterfeiters often are not trying to copy the underlying technology, though in some cases they have. They are copying the cosmetic appearance of the product and its trademarks. Doing this capitalizes on the premium the brand name brings without the costly technology and marketing the brand represents.

Counterfeiters have also copied Underwriters Laboratories Inc. labels, which certify a product as meeting certain safety standards.

“There’s no brand loyalty among counterfeiters,” says Square D’s Assistant General Counsel Stephen A. Litchfield. “They don’t care what the industry is.”

Manufacturers of apparel, luxury goods, DVDs and other consumer goods have been facing this issue for years. But as counterfeiting seeps into products such as electrical goods, safety products, spare parts for aircraft and autos, roofing shingles, toys, medical equipment and drugs, a crucial element enters the picture: serious health and safety risks to the end-user, making the issue even more important for distributors to keep an eye on. Selling counterfeit products has clear legal risks, sold with or without knowledge.

The Counterfeiting Intelligence Bureau estimates counterfeiting accounts for 5 percent to 7 percent of world trade. High-volume, low-cost and easily copied products are targeted by counterfeiters, according to Underwriters Laboratories.

It’s difficult to quantify in dollar terms the impact of counterfeiting on the global or U.S. economy due to the nature of the business. Seizures of counterfeit goods at ports vary widely by region and country, but most agencies that attempt to keep track agree that the prevalence of counterfeit goods trade has grown significantly since 2000.

The growing global market combined with the rise of the Internet as a mode of commerce has helped push this increase. Most counterfeit goods (close to 95 percent) can be traced back to China, according to a report from the International Anti-Counterfeiting Coalition.

“The entire area of property rights management is probably the biggest thing any company is dealing with in the global economy today,” says John Selldorff, CEO of the North American division of electrical manufacturer Legrand.

“Whether you’re in the motion picture industry, in music distribution, in branded products like Calvin Klein, or in the intellectual property area of product technology, it’s pretty easy to reverse-engineer and build it yourself if you don’t have anybody to say, ‘Wait a minute – you can’t do that.’”

With that, product liability is spreading up and down the supply chain, a new development for distributors and contractors who before depended on manufacturers to take responsibility for product defects.

As Square D dug more deeply into its counterfeit problem, it discovered how widespread the practice was – and how complex. The company has filed 13 lawsuits against unauthorized distributors and their sources for the counterfeit Square D product.

In each instance, the company was able to track the product back to one of the fastest-growing economies on the planet. “Everything we’ve stopped has had the trademarks put on the packaging in China,” Litchfield says.

Most of the counterfeit suppliers connected with the U.S. resellers via the Web. The rise of e-commerce has made it more difficult to enforce Intellectual Property Rights agreements as well as federal laws. “The Internet has made it possible for people to represent themselves more readily to more people in a professional manner that makes it look like they are legitimate,” says Legrand’s Selldorff. “This is a reality we all must face. In this world of messaging and instant information, we have to ensure that when it looks good and feels professional, that it is what it represents.”

Some Chinese counterfeiters also use Free Trade Zones in other countries as a middleman, per se, to make the product appear legit to an unsuspecting end-user or reseller.

Square D’s situation is a good example of the brazenness of counterfeiters; real Square D circuit breakers that have been targeted by counterfeiters in China are not even made in China. They are made in Lincoln, NE, and Tijuana, Mexico. “There’s no authority for it to be made anywhere else in the world,” Litchfield says.

In addition to its legal action against domestic resellers and their sources, Square D has filed complaints against Chinese manufacturers. “But the effectiveness is questionable,” Litchfield says, because of the multicountry enforcement required after a judgment. Criminal and civil actions in China, as well as criminal prosecution in the U.S., are also being considered.

Square D officials say that in the process of discovery in their court cases, they have learned that the online presence of counterfeit suppliers often includes photos of facilities those manufacturers supply to potential resellers. And at least one manufacturer has provided resellers documents that said: “We sell Square D fakes,” which makes it clear that many resellers know they are not selling the real thing.

In a small number of incidences, Square D has found authorized distributors with counterfeit products. This usually occurs only when that distributor accepts returns of product purchased elsewhere, or acquires product from an unauthorized source, and it ends up as counterfeit. Litchfield says this rarely happens.

“The real risk is through unauthorized wholesalers,” he says. These are brokers, selling on sites like eBay. The brokers buy on cost only and some “turn a blind eye to the quality of the product.” “People that buy from these companies take a risk,” Litchfield says. “You may get damaged or defective goods because you don’t know where they’ve been.”

The other risk of course is that these goods may be counterfeit. To ensure contractors and other end-users are getting an authentic product, Litchfield says, they should buy from an authorized distributor.

“When you see a really good price,” Snyder says, “a lower price than anywhere else, if that doesn’t cause you to wonder, I think you’re turning a blind eye. In commerce, you’re supposed to know your sources. Ignorance is not a good defense.”

Patent infringement is not as common as trademark infringement because of its cost, according to a recent report by the Organization for Economic Cooperation and Development, but it does happen. Trademark infringement is more upfront, while Underwriters Laboratories-label counterfeits (showing a product passes certain safety standards, when it doesn’t – see sidebar) and product design that is copied from a patent-holding manufacturer are less common.

Pass & Seymour/Legrand, the U.S. subsidiary of Legrand, recently filed a complaint with the U.S. International Trade Commission against a group of suppliers, resellers and distributors. P&S is a manufacturer of wiring devices, accessories and home systems in North America.

The complaint alleges infringement of up to seven U.S. patents by Chinese manufacturers of ground fault circuit interrupters (GFCI). The patents are related to safety features in the GFCIs that were invented by Pass & Seymour. P&S has asked the commission to stop the importation of the GFCIs as well as their sale in the U.S. “If we’re going to justify the investment we have in research and development, then we have to be able to defend our work,” Selldorff says.

Like Square D, P&S has also sought relief in the courts. It filed a complaint in U.S. District Court for the Northern District of New York, alleging infringement of nine patents by Chinese manufacturing companies and some of the resellers and distributors named in the ITC complaint.

In the electrical industry and others, the issue of intellectual property rights protection is being addressed at many levels – company-specific moves, including agreements with “authorized distributors” of their products and legal recourse; industry-wide efforts via associations; national government policies; and international agreements that were formed as part of the World Trade Organization. The policies and laws are varied in their ability to effectively crack down on the trade in counterfeits.

Companies like Square D and Legrand realize that their participation in national and international efforts is key to slowing the flow of counterfeits; however they also recognize that the first step is taking action in a mostly short-term fix by prosecuting U.S. companies that buy counterfeit goods for resale. Square D and other companies in the industry are also educating customs officials on the differences between legit and counterfeit product.

“It’s a multifaceted issue that many industries have a stake in,” Selldorff says. “It’s overwhelming for one company to single-handedly move the needle, so we have a number of initiatives through NEMA to lobby Washington D.C. for reform.”

Despite strides made in the past two decades to protect intellectual property rights, all parties involved say there is still a long way to go.

The Organization for Economic Cooperation and Development recently released a first draft of its in-depth report on the consequences of counterfeiting and piracy. In addition to an overview of the problem, the organization looked at five industry sectors impacted by the trade in counterfeit goods.

A few complexities noted in the report: Counterfeiters sometimes use a variety of different companies’ logos on the same line of product. And many products with unauthorized trademarks are not actually in the portfolio of the real trademark-holders. In addition, counterfeiting is many times done by registered companies who are unafraid to promote legit and illegit goods at the same trade fair.

In the recent OECD report, industry sectors surveyed said that even when adequate laws exist in countries such as China, they are not always adequately applied, leading to difficulty in identifying and apprehending counterfeiters, delaying prosecution, and inadequate penalties when convictions are obtained. This has lead to a high incidence of repeat offenders.

Industry reps in the report suggest anecdotally that local and regional governments sometimes tolerate counterfeiting and piracy as a way to bring employment and income to their area. Another challenge in stopping the trade is simple: By definition, the counterfeiters do not follow the rules. Indeed, many counterfeit operations fund criminal and terrorist organizations.

There are also cultural issues involved with protecting intellectual property rights. Many articles on the topic will point out that copying can be a form of flattery and efficiency in China.

The U.S. seems to be on the right track with a new anti-counterfeiting agreement with key trading partners. It has also been aggressive in pursuing China under the auspices of the World Trade Organization and has other tools in its belt that are used to boost compliance of intellectual property rights protection agreements.

Bill Primosch, National Association of Manufacturers’ senior director of international business policy, says it is crucial to strike a balance in dealings with China, the top source for counterfeit goods worldwide but also a major and growing player on the world stage. The more aggressive the U.S. is, he says, the more sensitive and defensive China becomes. And despite its position as the top producer of counterfeits, China has made great strides in compliance with WTO standards in the form of stricter laws, though officials say they aren’t always enforced.

On the U.S. side, one of the challenges is getting government agencies that have responsibility in tracking, enforcing and creating policy related to counterfeit goods to work together. Primosch says that he feels NAM’s efforts in this area in the past few years have been fruitful, but there is still a long way to go.

Manufacturers can take steps in the near-term to increase the protection their products see in the global market, Selldorff says: Be clear in the value your product adds, and ensure it is not so simple that someone can copy it; invest in research and development. Protect that investment through trademarks and intellectual property patents. When the rules are broken, take action.