What's Reasonable to Qualcomm Isn't to Apple
During Apple Inc.’s earnings conference call last week, an analyst asked Chief Executive Officer Tim Cook about the company’s patent dispute with Qualcomm Inc. Here’s how Bloomberg live-blogged his answer:
Cook says that Qualcomm has not given Apple fair pricing on its patent and technology. … “We can’t pay something when there is a dispute about an amount,” [Cook said]. “Qualcomm is trying to charge Apple a percentage of the total iPhone value. They do some great work around standard-essential patents, but Qualcomm’s component is only one small part of the iPhone. We don’t think that’s right, so we’re taking a principled stand on it, and we strongly believe we’re in the right. I am sure they think they’re in the right, and that’s what courts are for.”
I know it sounds arcane, the kind of fight that is of intense interest to the parties and their lawyers, and of no interest to anyone else. But as an aficionado of patent disputes, I decided to dig into it a little. It turns out to be a pretty big deal. If Apple wins, it could change one of the most prevalent practices in Silicon Valley -- while wreaking havoc on the business model of not only Qualcomm, but also Nokia Oyj, Ericsson AB and other companies that rely on patents for their profits. If Apple loses, patent licensing practices will continue to throw sand in the wheels of commerce -- and cost consumers money.
Most people think of Qualcomm (if they think of Qualcomm at all) as a maker of chips that enable cellular data. For instance, its technological advances helped usher in 3G and 4G and is now doing the same for just-over-the-horizon 5G. But it also licenses its technology to smartphone makers even when they don’t use its chips; indeed its patents are so vital that a number of them have been labeled “standard-essential patents.” That means that if you’re a phone maker, you have no choice but to pay Qualcomm to license its patents. Because those patents are indispensable, however, the institute also mandates that Qualcomm set a licensing fee that is “fair, reasonable, and non-discriminatory.”
To get a sense of just how much Qualcomm relies on patent licensing, take a look at its earnings for fiscal year 2016, when it made $1.8 billion pre-tax on $15.4 billion in chip sales. Its licensing revenue was less than half that amount -- $7.7 billion -- but the licensing division earned over three times the profit: $6.5 billion. The company calculates that it charged a fee on about 1.37 billion 3G and 4G devices. Among smartphone makers, that fee is known as the Qualcomm toll.
No one is arguing that Qualcomm doesn’t deserve to make money from its patents, not even Apple. (“They do some great work around standard-essential patents …”) Instead, the dispute is over how much Apple -- and all the other companies that make smartphones -- should pay.
Although the idea behind designating a patent “standard-essential” is to ensure that every company has access to the technology -- at a “reasonable” price -- its critics charge that Qualcomm has turned the idea on its head. When it develops a new technology, it works hard to get the engineering institute to label it standard-essential, and then it charges fees that, in the view of Apple and many other companies, are exorbitant. (A Qualcomm spokesman declined to comment for this column.) Because Qualcomm had the right to go to court to seek an injunction against companies that refused to pay its fees, most companies tended to pay up, however grudgingly.
In February 2015, however, the Institute of Electronic and Electrical Engineers, an important standards organization, made several critical policy changes that seemed to give the smartphone makers the upper hand. It suggested that patent fees should no longer be paid as a percentage of the entire price of the phone, but rather as a percentage of the component that used the technology. That would radically lower the fees the Apples of the world paid to Qualcomm. And it also took away a key piece of Qualcomm’s leverage by saying that licensing companies should not seek an injunction when there was a dispute. (The U.S. Supreme Court has also made it much more difficult to get an injunction to halt sales due to a patent dispute.)
Thus it was that early this year, Apple filed a $1 billion suit 1 against Qualcomm -- on the heels of a Federal Trade Commission filing accusing Qualcomm of “an anti-competitive ‘no license, no chips’ policy,” as Techcrunch put it. In a statement at the time, Apple said that “despite being just one of over a dozen companies that contributed to basic cellular standards, Qualcomm insists on charging Apple at least five times more in payments than all the other cellular patent licensors … combined.”
According to a recent court filing, this is the heart of Qualcomm’s argument:
Apple’s iPhones and other products enjoy enormous commercial success, but without lightning fast cellular connectivity -- enabled in large part by Qualcomm’s inventions -- Apple’s iPhones would lose much of their commercial appeal. Apple has built the most successful commercial products in history by relying significantly on cellular technologies pioneered by Qualcomm. … Now Apple wants to pay less than fair value for a license to Qualcomm’s patents.”
At the end of April, Apple made it known -- and Qualcomm confirmed -- that it would simply stop paying royalties for Qualcomm’s patents. There is pretty much no way that Qualcomm could ever get an injunction to stop sales of iPhones, nor can it force Apple to stop using the technology. Which is not to say it isn’t plotting to retaliate: As Bloomberg reported last week, Qualcomm is planning to ask the federal government to ban imports of iPhones. 2 This is the technology equivalent of a Hail Mary pass.
Why is this all happening now? Because 5G is on the way and Qualcomm is quite likely to get standard-essential designations for its 5G patents. Indeed, the company has geared it future prospects to its ability to sell 5G chips and license 5G patents. It wants to generate as much money as possible for them, just as it did with 3G and 4G.
Apple and the other smartphone makers want to have a new fee arrangement in place before 5G becomes the standard -- because they don’t want to be as beholden to Qualcomm as they were for 3G and 4G technology. If the courts agree that Qualcomm must base its fees on the component rather than the entire smartphone, it will be a huge victory for the phone makers and a significant blow to Qualcomm.
“How much does a patent contribute to the product?” said Robin Feldman, a law professor at the University of California Hastings College of the Law. “That’s the real issue. We don’t have a good system for deciding that. In a saner world, you would have some kind of regulatory body that would tell you, ‘This is worth x.’ Instead, we have long, drawn-out court battles.”
Which Apple v. Qualcomm will surely be.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Apple is also embroiled in similar litigation with Nokia. And late last year, it settled patent litigation with Ericsson.
IPhones, of course, are manufactured in Asia and then shipped around the world.
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