You can choose to view Qualcomm as a little guy being picked on by bullies.
In just the last 10 months, after all, the San Diego semiconductor company has been fined $853 million by South Korean antitrust regulators, sued by the Federal Trade Commission for allegedly monopolizing a key cellphone technology, and sued for $1 billion by Apple, its largest customer, for allegedly squeezing excessive royalties out of its aging patents.
Or you can choose to view Qualcomm as the biggest bully of all. That’s how its adversaries paint the company in court — as a ruthless profiteer from its patents, some of which date back more than a decade. Those patents are becoming less relevant with every new generation of smartphones. But they’re a long, long way from becoming totally irrelevant, and until that point is reached, it’s almost impossible to do without them.
The patents at issue govern cellphone technologies extending from the so-called 2G era, which began in the 1990s, right up to the LTE, or “Long-Term Evolution,” fourth-generation networks being rolled out today worldwide. Qualcomm isn’t wrong when it asserts, as it does in a countersuit against Apple, that its inventions are “necessary for the entire cellular network to function.” (The italics are Qualcomm’s.) Without its technologies, Qualcomm says, you wouldn’t have such apps and services as “Uber, Snapchat, Spotify, Apple Music, Skype, Google Maps, and Pokemon GO.”
No one disputes that Qualcomm should earn pots of money from its patents. The question is whether the company has been grasping at so much money that its own customers finally got fed up. The cases filed over the last year maintain that Qualcomm’s fees are so excessive they’re interfering with innovation and the free market. One way Qualcomm keeps the fees elevated, the plaintiffs say, is by refusing to license its technology to competing chip manufacturers, effectively barring its rivals from the marketplace.
Qualcomm paints the litigation as something of an Apple conspiracy, contending that the iPhone maker induced the Korean government and the FTC — and regulators in other countries — to bring their cases in order to force down Qualcomm’s licensing royalties. The FTC lawsuit bears a family resemblance to the Apple case, which was filed only three days later. (Apple didn’t respond to a request for comment.)
The lawsuits have weighed on Qualcomm, which makes most of its profit from licensing its technology. The company’s stock fell 15% in the days after the Apple lawsuit was filed and hasn’t recovered; it’s down more than 20% year-to-date, and its battle with Apple has been topic A in management’s meetings with Wall Street investors all year.
Qualcomm argues that Apple may be aiming to preserve the stupendous profitability of the iPhone, which by some measures accounts for more than 90% of all smartphone profits. “They’re looking...to squeeze out from their suppliers each drop of profit,” Don Rosenberg, Qualcomm’s general counsel, told me. “We’ve always been at the top of their list...as one of the few companies that was very difficult for Apple to challenge.” With sentiment in patent law shifting toward users from inventors, and the FTC temporarily composed of a Democratic majority, “this is an opportunity to sweeten their profits at our expense.”
Qualcomm’s critics say that its patent-licensing methods suggest that it knows its days as the undisputed king of cellular network technologies may have passed. They say Qualcomm’s cellular modem chips play an ever-shrinking role in smartphones, which are also cameras, video and music players, data-storage devices and personal companions of the future.
Qualcomm’s view is exactly the reverse. The more functions get packed into your handheld device, it asserts, the more valuable the connectivity its chips enable. “You take pictures,” Rosenberg says, “and you immediately want to ... upload them, download them, you want to do all kinds of things with those photos that you couldn’t do without our technology.”
That’s why Qualcomm sells only “device-level” patent licenses, rather than licenses for its individual chips. Apple, like other phone makers, effectively pays Qualcomm a single royalty covering all the technologies that might go into the phone, even for functions Apple isn’t using or that it acquires from non-Qualcomm suppliers. The royalties are set at 5% of the net selling price of the phone, which is the price Apple pays its contract manufacturers, such as Taiwan-based Foxconn, not the list price at the Apple Store. (The net price could be as little as 40% of the list price, which means even if Apple wins, you won’t save much on your next iPhone.)
What may be most intriguing about this battle is how the two chief adversaries have chosen to portray themselves. Qualcomm calls itself the “R&D arm” of the cellphone industry, and suggests that the assault on its patent licensing will jeopardize innovation in the field possibly for decades. In its lawsuit, Apple calls itself the victim of Qualcomm’s “scheme of relentless extortion,” as though it’s a violin-toting youth cornered by a schoolyard tough. With a market capitalization of more than $833 billion, Apple is about 11 times as valuable as Qualcomm — its cash hoard of $261.5 billion would be enough to buy Qualcomm three times over. Who’s the David, who’s the Goliath?
The FTC and Apple cases turn on Qualcomm’s obligations as a cellular network innovator.
When companies participate in the creation of universal standards that happen to rely on their own inventions, those patents are designated “standard-essential patents.” That’s good for the companies, because it means that everyone in the market will have to license their technologies. But the international organizations that set those standards impose limitations on the companies in return, including requiring them to license their patents to all comers on “fair, reasonable, and non-discriminatory” terms, known by the acronym “FRAND.”
One problem with FRAND is that no one defines it in advance. “The work of the standard-setting bodies is to figure out the technology,” says Jack Lerner, an expert in patent law at UC Irvine law school. “It’s not within their expertise to figure out what it’s worth.”
That task is kicked down the road to negotiations between patent owners and licensees or, when they can’t come to an agreement, to the courts. And that’s where Qualcomm, after years of squeezing its essential patents for all they were worth — and arguably more — has landed.
“They’ve been a bad actor in this space for well over a decade,” Lerner told me.
He’s referring chiefly to a notorious 2005 federal lawsuit Qualcomm brought against Irvine chipmaker Broadcom, alleging patent infringement. Broadcom’s defense was that Qualcomm had waived its patent claims by participating in the standard-setting process for video encoding that incorporated its technologies, a claim Qualcomm flatly denied.
Only after the trial ended did it emerge that Qualcomm had concealed more than 46,000 documents, many of which would have proved that it did participate — an effort a federal judge labeled a “monumental and intentional discovery violation.” The judge threatened six Qualcomm attorneys with disciplinary sanctions and levied a penalty of $8.6 million on the company. (The sanctions were eventually lifted but the penalty stuck.)
Qualcomm’s approach in the Apple and FTC lawsuits is different. The company maintains that it’s honoring its FRAND commitments, but they don’t include an obligation to license its technology to competing chip makers. It hasn’t tried to interfere with rivals by threatening them with patent lawsuits, for example, even though it believes that anyone selling a chip that enables a smartphone to connect with the communications network is almost certainly infringing its rights.
“The general understanding of FRAND has been that you license to everybody, and you can’t discriminate between competitors and noncompetitors,” says Herbert Hovenkamp, an antitrust expert at the University of Pennsylvania. “The question will be, is Qualcomm refusing to license a particular patent that’s under a FRAND obligation?”
The answer may not be simple. Device-level licensing isn’t a Qualcomm invention, but “a common business practice” in tech manufacturing, says Jonathan Barnett, director of the media, entertainment and technology law program at USC’s Gould School of Law. How it conforms with FRAND, and whether FRAND is enforceable under the antitrust theory underlying the FTC lawsuit, hasn’t been widely tested in court. “They’re open questions,” Barnett says.
Rosenberg depicts tampering with the tradition of device-level licensing as a potentially cataclysmic event. Breaking down the licensing of the thousands of technologies buried inside a smartphone into its component parts, he says, “is going to create confusion, it’s going to create all kinds of mischief, it’s going to create enormous inefficiencies….We are going to be the primary company harmed by this in the short run, but it’s going to have a terrible impact on the whole industry.”