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A Scrum Over Qualcomm's Fees

Qualcomm (QCOM) has never been greatly beloved in the mobile-phone industry. The San Diego company invented and brought to market in the 1990s a radically better technology for second-generation digital mobile phones, called Code Division Multiple Access, or CDMA, that is now used by around 400 million customers worldwide and half the cell-phone operators in the U.S.

But Qualcomm has always been one tough cookie, tightly defending its intellectual property while charging others rich royalties to use its patents.

Its biggest coup came in 1999, when the International Telecommunications Union standards body chose CDMA as the basis for both flavors of the third generation in mobile technology, known by the generic name 3G. That six-year-old decision lies at the heart of a bitter battle launched on Oct. 26 -- but not revealed until 48 hours later. Shares of Qualcomm fell 4.6% on Oct. 28, to $41.07.

DRIVING UP THE COST? Six companies sent separate letters demanding that the European Commission's powerful antitrust czar, Neelie Kroes, open an investigation into alleged misconduct in Qualcomm's licensing of key CDMA patents. The complainants are handset makers Nokia (NOK), NEC (NIPNY), and Panasonic Mobile Communications, chipmakers Texas Instruments (TXN) and Broadcom (BRCM), and the world's leading seller of mobile networks, LM Ericsson (ERICY).

The companies charge that Qualcomm, which owns about one-quarter of the essential patents used in the W-CDMA (Wideband Code Division Multiple Access) version of 3G, is charging royalties that are "excessive and disproportionate."

The impact, they say, is higher prices for W-CDMA phones and networks, which are passed on to consumers and which hold back adoption of 3G. Nobody knows how big the royalties really are because specific terms are locked up in confidential contracts. However, Qualcomm made about $415 million last year from W-CDMA royalties, and researcher Gartner figures there were 18 million W-CDMA phones sold, which works out to $23 per phone.

"LEGALLY MERITLESS." Gartner analyst Alan Brown says total royalties for W-CDMA phones likely amount to 8% to 10% of their selling costs. And Qualcomm's share is roughly half of that, figures analyst Albert Lin of American Technology Research in San Francisco. That means the total intellectual-property burden of a 3G phone approaches $50 -- making it tough to deliver phones priced less than $250 at retail.

But royalty rates aren't the only thing bothering the companies seeking action. They also allege that Qualcomm has engaged in exclusionary business practices, such as offering better royalty terms to customers who agree to buy all their W-CDMA chips exclusively from Qualcomm.

"They are trying to exclude rivals from the market and prevent the entry of new rivals," says Maurits Dolmans, a partner in the Brussels office of law firm Cleary Gottlieb, which represents Nokia. In a statement issued on Oct. 28, Qualcomm said that the reported allegations are "factually inaccurate and legally meritless."

JOINING FORCES. At the heart of the dispute is a problem arising with growing frequency in the fiercely competitive yet incestuous technology sector. To set widely adopted industry standards, companies often join forces in private consortiums or under the auspices of international bodies.

Frequently, essential pieces of intellectual property have already been invented and patented by one or more members of the group. So in the interest of the standard, those companies are pressed to make the technologies available to others -- not necessarily for free, but licensed on "fair, reasonable, and nondiscriminatory" terms.

That's what Qualcomm did when its CDMA patents were selected to be included in both the W-CDMA standard and a Qualcomm-backed alternative called CDMA 2000. But the six companies complaining to the EC contend Qualcomm isn't playing by the rules, charging more than its patents are worth and using them as a lever to gain business. "They implied they would license on fair and reasonable terms, but they welched on the deal," says David Dull, general counsel for Broadcom.

BLISTERING RULING. In its statement, Qualcomm replied that it has already struck licensing deals with five of the six complainants. "The action appears to be nothing more than an attempt by these licensees to renegotiate their license agreements by seeking governmental intervention," the company said.

The complainants' choice of the EC to hear the complaint is intriguing. Its competition directorate is the outfit that, under previous head Mario Monti, blocked General Electric's (GE) proposed merger with Honeywell International (HON) and issued a blistering antitrust ruling against Microsoft (MSFT), including the largest antitrust fine ever levied in the EC's history.

The directorate also is now reportedly mulling an antitrust case against Intel (INTC) with the backing of new Commissioner Kroes. The Commission declines to comment on the new mobile-phone matter, other than to acknowledge that it has received the complaints.

TRIED AND FAILED. The next step will be for the agency's staff to probe the claims and decide whether to proceed. It would then issue a so-called "Statement of Objection," the EC equivalent of an indictment, and finally a decision, which both sides could appeal.

The process could take years, but the complainants are clearly hoping Qualcomm will negotiate a settlement instead. "We're hoping to bring them back to the table," says Cleary Gottlieb's Dolmans.

The new complaints are but the latest chapter in a long-running legal battle between Qualcomm and its rivals. Several of the companies involved in the latest skirmish tried and failed years ago to get Qualcomm's patents invalidated in court. In 1998, Ericsson dropped three patents from a lawsuit it had filed against Qualcomm and surrendered claims regarding two others. And last July, Broadcom filed a lawsuit in the U.S. District Court for the District of New Jersey outlining allegations similar to those brought up in the latest complaint.

"THERE'S A PRICE." To evaluate the merits of the case, the EC will lean on a small number of legal precedents dating back years, including rulings against British Airways (BAB) and tiremaker Michelin saying they abused their dominant market positions through sales-incentive schemes and other exclusionary practices.

But Dolmans says the plaintiffs aim to rely less on the legal precedents than on solid economic arguments about the allegedly damaging effect Qualcomm's royalties have on 3G prices. They'll also harken back to several notorious cases in which companies have participated in standards-setting processes, only to come back later and assert unexpected patent claims against users of the standard.

In one such incident, dating back to 1993, computer maker Dell (DELL) participated in the fashioning of a new interface for PC graphics -- even signing two agreements asserting that it had no intellectual-property claims -- only to later pursue users of the technology for violating its IP rights. The U.S. Federal Trade Commission ordered Dell to stop in 1996.

What makes this situation different -- and what could work against the complainants: There was no dispute when W-CDMA was approved over the nature of Qualcomm's intellectual property. The only bone of contention is how much it charges for licenses.

But as analyst Lin point out: "If [Qualcomm's technology] is the best way, then there's a price." Its rivals won't be able to renegotiate their contracts until 2008 or 2009 anyway. By that time the wheels of European justice probably will have turned and -- who knows -- the market will be fussing over 4G or other new technologies not yet even dreamed up.


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