Feb. 11-- In the recent antitrust trial attacking Qualcomm's business model, the U.S. Federal Trade Commission drilled down on how the San Diego company leveraged its market power in certain cellular chips to gain the upper hand in patent licensing negotiations with smartphone makers.
It's textbook economics that this type of strong-arm behavior leads to bad things, such as fewer competitors in the smartphone chip market and reduced research and development spending.
In theory, the result over time should be higher smartphone prices, fewer choices and lower quality devices.
But that hasn't happened. In fact, the opposite occurred from 2006 to 2017 in the smartphone market-roughly the period during which the FTC alleges Qualcomm abused its market dominance in 3G CDMA and premium 4G LTE cellular processors to overcharge for patents.
Smartphone shipments grew from 124 million in 2007 to 1.5 billion in 2017, according to industry research firm IDC. The total value of those shipments jumped from $52 billion in 2007 to $452 billion in that time frame.
Adjusted for better cameras, faster download speeds and other features found in today's smartphones, prices have fallen. And the average price of transferring a megabyte of wireless data has plummeted from $8 in 2006 to one cent in 2016.
Today, Samsung, MediaTek, Huawei and Intel have significant market share for cellular modem processors. Qualcomm's piece of the overall market is below 40 percent.
And research and development spending by chip design firms-not only Qualcomm but its competitors-ranks "among the highest you'll see anywhere outside of pharmaceuticals," said Jonathan Barnett, a professor at the University of Southern California Gould School of Law.
The anti-competitive effect of Qualcomm's business practices is a hurdle the FTC must clear to prove the company violated monopoly laws. It likely will be front and center when U.S. District Judge Lucy Koh eventually makes a ruling in the case.
"The FTC seems to argue that no license, no chips is inherently anti-competitive, and they believe they have economic textbooks backing them up ... and look at all these examples of people complaining that they paid too high a royalty rate," said David Reichenberg, a lawyer who specializes in antitrust cases with the Cozen, O'Connor firm in New York.
Qualcomm counters that it has a robust smartphone market, lower prices and burgeoning competition to back up its contention that its business model didn't harm anyone.
"According to Qualcomm, an anti-competitive effect is higher prices, lower choice, reduced quality or actual impact to consumers," Reichenberg continued. "Did the FTC prove that no license, no chips increased the cost of cell phones or reduced the number of cell phone transactions? Qualcomm's very legitimate point, should the court accept it, is that you just don't have any evidence of bad market outcomes when you look at what happened in these markets."
Testimony in the 10-day trial, which strikes at the heart of Qualcomm's patent licensing business model, wrapped up last month.
While Koh is known for making rulings relatively quickly, she cautioned that the complex legal issues and massive amount of evidence in this case will take some time to sift through. She is expect to provide an update this week on the timing of her decision.
Patent royalties have been a leading driver of Qualcomm's success in the smartphone era. They've delivered on average $6.3 billion per year in revenue to Qualcomm over the past decade – funding a good portion of the company's profit, and research and development efforts.
If Koh rules in the FTC's favor, it could result in the dismantling of the business model and jeopardize the company's financial incentives to continue to invest in cutting-edge mobile technologies on the cusp of new 5G mobile networks rolling out next year.
Qualcomm probably would appeal a finding in the FTC's favor. Still, an adverse decision could lead patent licensees to stop paying, putting significant financial stress on the company.
The outcome of the FTC litigation also could bleed over into other upcoming legal actions, including Apple's lawsuit against Qualcomm in San Diego federal court, where Qualcomm claims Apple owes $7 billion in unpaid patent royalties.
Apple's $1 billion demand
The FTC trial pulled back the veil on the complex, rough and tumble negotiations between giant tech companies – with bombshell testimony coming from Qualcomm Chief Executive Steve Mollenkopf and Apple Chief Operating Officer Jeff Williams.
Mollenkopf testified that Apple approached Qualcomm in 2010 about using its chips in upcoming iPhones, which had previously used cellular modems from Infineon.
"So essentially they wanted to use our chip in 100 percent of their iPhones, and they wanted to see if we were interested in it," said Mollenkopf. "But they wanted us to pay them, I think it was $1 billion, to get that opportunity."
Apple refused to provide a volume guarantee, which would have protected Qualcomm from getting into a situation where it paid Apple but didn't get enough orders to make the deal profitable.
So the companies entered into a de facto exclusive agreement where if Apple used another chip supplier in any of its devices during the term of the agreement, it would forfeit payment from Qualcomm.
The FTC alleges this exclusive deal was one of a handful of anti-competitive practices by Qualcomm. It prevented Intel from winning a chip deal to supply a cellular modem for an Apple iPad in 2014.
But Qualcomm countered that Intel's chips did not meet Apple's technical requirements for iPhones until 2016. And when they did, Apple began using them despite the agreement with Qualcomm.
Apple's Williams testified that various agreements between Apple and Qualcomm resulted in Apple paying an effective patent royalty rate of $7.50 per iPhone for access to Qualcomm's mobile patent portfolio.
That is lower than the estimates of Apple payments by some Wall Street analysts, who pegged the royalty rate at around $10 per phone. It likely raised the eyebrows of other smartphone firms paying royalties to Qualcomm.
Expert witnesses may be key
While the testimony of top executives grabbed headlines, it probably won't be as important to Koh's final decision in the case as the testimony of expert witnesses on both sides – all of whom faced tough cross examination aiming to poke holes in their conclusions.
"When you have a case like this, the basic question is did the defendant achieve its position in the market because it is just the best at doing that, in which case it is free to charge what it wishes," said Barnett, the USC law professor. "Or is a part attributable to taking exclusionary actions, which are generally defined as actions in which there is no legitimate business justification other than to exclude competitors."
According to the FTC, Qualcomm's monopoly in CDMA and "premium" LTE chips enabled it to negotiate higher patent royalty rates than it otherwise would have achieved without the chip leverage.
The FTC and Apple call this a tax on the industry, and the result was delaying Intel and MediaTek from entering the CDMA and premium LTE markets, forcing Broadcom and others to abandon cellular modems and reducing research and development spending by rivals, among other things.
The FTC contends these are anti-competitive effects.
While they are the type of things that are considered, it is tough to say whether they are, by themselves, sufficient proof that competition overall and consumers were harmed, said Reichenberg.
"When you think of anti-competitive effects, you usually think of overall market outcomes," he said. "If you pick to sue in a growing technology market, you should ideally have a case proving that as great as this market was, here are all the tangible ways it could have been even better. For example, phones would be $100 less. The iPhone X would be $30 less. You didn't see that here."
Qualcomm put on testimony on how Intel, Ericsson, Broadcom and others made strategic missteps that led to them being behind or leaving the cellular chip market.
According to the company, it achieved its success through innovation, better engineering and better products that have driven the industry from 2G to 3G to 4G and now 5G over the span of three decades.
Qualcomm also contends it negotiated royalties at the same rate when it didn't have market power – even before it had a chip business. The FTC never asserted that Qualcomm had market power in so-called WCDMA chips, where there were several solid competitors.
But Qualcomm patent royalty rates for WCDMA customers are the same as those that the FTC claims were coerced from smartphone makers who relied on Qualcomm's CDMA and premium LTE chips.
The FTC put on an expert who testified that Qualcomm's royalties were significantly higher than all other standard essential patent holders in the industry combined. But his models were strongly challenged as flawed by Qualcomm lawyers in cross examination.
With his own experts, Qualcomm worked to show that its royalties are based on the market value of its intellectual property, not coercion-though their methodology also was contested by the FTC.
The role of antitrust
The case highlights the tension around the legal rights of wireless technology patent holders and efforts by smartphone makers such as Apple to lower patent royalties.
"I think history will show that this is an important case for setting the legal structure for the industry," said Barnett, the USC law professor.
The FTC sued Qualcomm under Section 5 of the FTC Act, which has broader latitude to find an "unfair methods of competition" violation than the Sherman Act, where well developed case law sets the bar on what's anti-competitive.
While regulators should target bad practices, they also should be careful about bringing lawsuits against policies that either aren't harming consumers or have good economic justification, said Barnett.
"Given the fact that the evidence doesn't match this particular theory, that raises concerns that the regulators are targeting a practice that is either harmless or actually beneficial to the market," he said.
Parade of litigation:
Qualcomm and Apple are fighting a legal war in courts worldwide. Here are some upcoming dates for U.S. legal disputes.
March 4: Patent infringement trial where Qualcomm has accused Apple of infringing on three non-essential patents and seeks damages. The proceeding will be held in U.S. District Court in San Diego.
March 26: The U.S. International Trade Commission is set to review an administrative law judge's finding that Apple infringed on a Qualcomm patent but shouldn't face an iPhone import ban. The review was delayed because of the government shutdown.
April 15: The wide ranging breach of contract and antitrust lawsuit between Apple and Qualcomm kicks off in before U.S. District Judge Gonzalo Curiel in San Diego.
(c)2019 The San Diego Union-Tribune
Visit The San Diego Union-Tribune at www.sandiegouniontribune.com
Distributed by Tribune Content Agency, LLC.