Smugglers Return iPhones to China

February 19, 2008

SHANGHAI — Factories here churn out iPhones that are exported to the United States and Europe. Then thousands of them are smuggled right back into China, writes Ryan Pyle for The New York Times

The strange journey of Apple’s popular iPhone, to nearly every corner of the world, shows what happens when the world’s hottest consumer product defies a company’s attempt to slowly introduce it in new markets. The iPhone has been swept up in a frenzy of global smuggling and word-of-mouth marketing that leads friends to ask friends, “While you’re in the U.S., would you mind picking up an iPhone for me?”

These unofficial distribution networks help explain a mystery that analysts who follow Apple have been pondering: why is there a large gap between the number of iPhones that Apple says it sold last year, about 3.7 million, and the 2.3 million that are actually registered on the networks of its wireless partners in the United States and Europe? The answer now seems clear. For months, tourists, small entrepreneurs and smugglers of electronic goods have been buying iPhones in the United States and then shipping them overseas. There the phones’ digital locks are broken so they can work on local cellular networks, and they are outfitted with localized software, essentially undermining Apple’s effort to introduce the phone with exclusive partnership deals, similar to its primary partnership agreement with AT&T in the United States.

“There’s no question many of them are ending up abroad,” said Charles R. Wolf, an analyst who follows Apple for Needham & Company.

For Apple, the booming overseas market for iPhones is both a sign of its marketing prowess and a blow to a business model that could be coming undone, costing the company as much as $1 billion over the next three years, according to some analysts. But those economic realities do not play into the mind of Daniel Pan, a 22-year-old Web site designer in Shanghai who says a friend recently bought an iPhone for him in the United States. He and other people here often pay $450 to $600 to get a phone that sells for $400 in the United States. But they are happy.

“This is even better than I thought it would be,” he said, toying with his iPhone at an upscale coffee shop. “This is definitely one of the great inventions of this century.”

Mr. Pan is among the new breed of young professionals in China who can afford to buy the latest gadgets and the coolest Western brands. IPhones are widely available at electronic stores in big cities, and many stores offer unlocking services for imported phones. Chinese sellers of iPhones say they typically get the phones from suppliers who buy them in the United States, then have them shipped or brought to China by airline passengers. Often, they say, the phones are given to members of Chinese tourist groups or Chinese airline flight attendants, who are typically paid a commission of about $30 for every phone they deliver. Although unlocking the phone violates Apple’s purchase agreement, it does not appear to violate any laws here, though many stores may be avoiding import duties.

Considering China’s penchant for smuggling and counterfeiting high-quality goods, the huge number of iPhones being sold here is not surprising, particularly given the popularity of the Apple brand in China. Indeed, within months of the release of the iPhone in the United States last June, iPhone knockoffs, or iClones as some have called them, were selling here for as little as $125. But most people opt for the real thing.

“A lot of people here want to get an iPhone,” says Conlyn Chan, 31, a lawyer who was born in Taiwan and now lives in Shanghai. “I know a guy who went back to the States and bought 20 iPhones. He even gave one to his driver.”

Negotiations between Apple and China Mobile, the world’s biggest mobile-phone service operator with more than 350 million subscribers, broke down last month, stalling the official release of the iPhone in China. Long before that, however, there was a thriving gray market.

“I love all of Apple’s products,” said a 27-year-old Beijing engineer named Chen Chen who found his iPhone through a bulletin board Web site. “I bought mine for $625 last October, and the seller helped me unlock it. Reading and sending Chinese messages is no problem.”

An iPhone purchased in Shanghai or Beijing typically costs about $555. To unlock the phone and add Chinese language software costs an additional $25. For Apple, the sale of iPhones to people who ship them to China is a source of revenue. But the company is still losing out, because its exclusive deals with phone service providers bring in revenue after the phone is sold. If the phones were activated in the United States, Apple would receive as much as $120 a year per user from AT&T, analysts say. But there are forces working against that. Programmers around the world collaborate on and share programs that unlock the iPhone, racing to put out new versions when Apple updates its defenses. While Apple has not strongly condemned unlocking, it has warned consumers that this violates the purchase agreement and can cause problems with software updates. Some analysts say abandoning the locked phone system and allowing buyers to sign up with any carrier they choose, in any country, could spur sales.

“The model is threatened,” Mr. Wolf, the analyst, said. But “if they sold the phone unlocked with no exclusive carrier, demand could be much higher.”

An Apple spokeswoman declined to comment on the proliferation of iPhones in China. When asked about the number of unlocked iPhones during a conference call with analysts last month, Timothy D. Cook, Apple’s chief operating officer, said it was “significant in the quarter, but we’re unsure how to reliably estimate the number.”

The copycat models are another possible threat to Apple. Not long after the iPhone was released, research and development teams in China were taking it apart, trying to copy or steal the design and software for use in knockoffs. Some people who have used the clones say they are sophisticated and have many functions that mimic the iPhone. In Shanghai, television advertisements market the Ai Feng, a phone with a name that sounds like iPhone but in Chinese translates roughly as the Crazy Love. That phone sells for about $125.

Some of the sellers of the copycats admit the phones are a scam.

“It’s a fake iPhone, but it looks nearly the same,” said a man who answered the phone last week at the Shenzhen Sunshine Trade Company, in southern China’s biggest electronics manufacturing area. “We manufacture it by ourselves. We have our own R. &D. group and manufacturing plant. Most of our products are for export.”

Most people here seem to want the glory that comes with showing off a real iPhone to friends.

“My friends envy me a lot,” says Mr. Pan, the Web designer. “They say, “Wow, you can get an iPhone.’ ”

John Markoff contributed reporting from San Francisco.

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ahmad isa @ February 19, 2008

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The true cost of counterfeit

January 26, 2008

The problem of component counterfeiting is an increasingly serious and complex  issue, and one which affects virtually every manufacturer or assembler of electronic equipment.

The commercial pressures of international competition and increasingly tough legislative environments have created a fertile environment for the unscrupulous to profit at the expense of legitimate business. Far from being a “victimless crime”, the cost  – both human and commercial – of counterfeiting can be devastating. With so many companies now sourcing on the international market, counterfeiting is an issue that nobody can ignore. Companies need to be aware of the problem and the steps that can be taken to avoid falling victim.

Worldwide, it is estimated that counterfeit goods account for between 5% and 7% of all world trade, worth a colossal $450-$500 billion a year. While fake clothing, consumer durables and automotive components account for a large part of that, counterfeit electronic components are a significant and growing proportion of the total.  An estimated 10% of all technology products sold worldwide now contain fake components. That equates to a staggering $100 billion annually. The cost to industry in terms of product failures, loss of reputation or litigation is potentially much more.

The origins of the majority of these forged and counterfeit components lie in South Asia and the Far East. The EU imports €10.6 billion of goods every year from China alone – mainly computers, electronic components, mobile phones & cameras. While the vast majority of trade is entirely legitimate, with such volumes even a few percent of counterfeiting represents a significant quantity of substandard components arriving into the EEA every year.

In contrast to fake designer clothing or consumer goods, counterfeit components used in electronic sub-assemblies are often very difficult to spot. Today’s counterfeiters have become very adept at producing convincing forgeries and have developed sophisticated techniques for introducing them into the legitimate supply chain. Given the difficulties of enforcing contracts and international intellectual property rights legislation in China and India, the unscrupulous agent or manufacturer has very little to lose from being caught, and everything to gain. The complex ways in which components and sub-assemblies are traded and sourced can work to the advantage of forgers, enabling them to hide their tracks behind a complex series of transactions. The international outsourcing of procurement means that components can often pass through the hands of several procurement agents before delivery; agents that in some cases actually “own” the components for a matter of minutes before selling them on.

The problem is compounded by the number of ways that components can be faked and the sophisticated ways in which unscrupulous suppliers introduce them into the market. Deliberate forgeries are perhaps the most obvious way in which companies can fall victim to the counterfeiters. Bearing a recognised makers name and trademark, an encapsulated component may look – superficially – very convincing. Often, the forged component may even perform to specification, at least initially. Internally, of course, it is a very different matter: Sub-standard materials and production techniques, and lax quality control mean components that can fail suddenly with potentially disastrous consequences.

The remarking of components is more difficult to spot. In this case, genuine components will have their markings modified to denote a component of a higher specification from the same manufacturer. For example, a faster processor or greater memory capacity. In the post RoHS world, remarking can also be one way that non-compliant components can be passed off as legitimate. The unexpected discovery of non-compliant components could easily spell disaster for an equipment manufacturer or sub-contractor, even if no actual failures occur in service. Even without re-marking, non-compliance at component level is very difficult to spot without costly and thorough analysis by specialist companies.

The passing-off of recycled components as new is also a growing trend. Low labour costs coupled with the legislative requirements for the disposal of hazardous waste means that the shipping of obsolete equipment to China and India for disposal and recycling is an increasingly profitable enterprise. In a few cases, parts salvaged in this way can sometimes find their way back into the market as new parts. Although genuine, components are stressed during the salvage process and are often at the end of their useful lives anyway resulting in short-lived and unpredictable performance.

Sourcing only from reputable suppliers is an obvious way in which companies can protect themselves from forged components. But in an increasingly competitive world, the temptation to look to the so-called grey-market for components may well prove an overwhelming one for hard-pressed businesses. But in doing so, companies expose themselves to risk.

Some manufacturers operate a scrap allowance scheme, by which they pay distributors to scrap overstocked inventory. However as this scrapping process is itself often outsourced, these components may well find their way back onto the grey market rather than being destroyed. Although genuine, as far as the manufacturer is concerned they do not exist and so will not be covered by any guarantee.

Even by dealing only with authorised suppliers does not necessarily ensure fake-free components. If an authorised supplier operates a returns policy, this may provide the means for fake components to enter the legitimate supply chain. For example, if a company sources components through both authorised and grey market sources, it is entirely possible that “fakes” from the grey market sources can end up getting mixed in, either deliberately or unwittingly, with genuine returned components. Once a batch of genuine components is contaminated in this way, the fakes become almost impossible to spot.

In combating the menace of component counterfeiting, the best defence that businesses have is to arm themselves with knowledge. For the first time, the subject of component counterfeiting will be addressed at Southern Electronics 2008 (February 6th-7th, Farnborough) as part of the free seminar programme. Hosted by Bob Willis of the SMART group, the presentation on February 6th will take a detailed look at the problem of forged and counterfeit components together with the practical measures businesses can take to ensure they do not fall victim to this pernicious trade.  

 


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