How Qualcomm shook down the cell phone industry for almost 20 years

[Karlston]

How Qualcomm shook down the cell phone industry for almost 20 years

We did a deep-dive into the 233-page ruling declaring Qualcomm a monopolist.

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Getty / Aurich Lawson

In 2005, Apple contacted Qualcomm as a potential supplier for modem chips in the first iPhone. Qualcomm's response was unusual: a letter demanding that Apple sign a patent licensing agreement before Qualcomm would even consider supplying chips.

 

"I'd spent 20 years in the industry, I had never seen a letter like this," said Tony Blevins, Apple's vice president of procurement.

 

Most suppliers are eager to talk to new customers—especially customers as big and prestigious as Apple. But Qualcomm wasn't like other suppliers; it enjoyed a dominant position in the market for cellular chips. That gave Qualcomm a lot of leverage, and the company wasn't afraid to use it.

 

Blevins' comments came when he testified earlier this year in the Federal Trade Commission's blockbuster antitrust case against Qualcomm. The FTC filed this lawsuit in 2017 partly at the urging of Apple, which had chafed under Qualcomm's wireless chip dominance for a decade.

 

Last week, a California federal judge provided the FTC and Apple with sweet vindication. In a scathing 233-page opinion [PDF], Judge Lucy Koh ruled that Qualcomm's aggressive licensing tactics had violated American antitrust law.

 

I read every word of Judge Koh's book-length opinion, which portrays Qualcomm as a ruthless monopolist. The legal document outlines a nearly 20-year history of overcharging smartphone makers for cellular chips. Qualcomm structured its contracts with smartphone makers in ways that made it almost impossible for other chipmakers to challenge Qualcomm's dominance. Customers who didn't go along with Qualcomm's one-sided terms were threatened with an abrupt and crippling loss of access to modem chips.

 

"Qualcomm has monopoly power over certain cell phone chips, and they use that monopoly power to charge people too much money," says Charles Duan, a patent expert at the free-market R Street Institute. "Instead of just charging more for the chips themselves, they required people to buy a patent license and overcharged for the patent license."

 

Now, all of that dominance might be coming to an end. In her ruling, Koh ordered Qualcomm to stop threatening customers with chip cutoffs. Qualcomm must now re-negotiate all of its agreements with customers and license its patents to competitors on reasonable terms. And if Koh's ruling survives the appeals process, it could produce a truly competitive market for wireless chips for the first time in this century.

Qualcomm’s perfect profit machine

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JeanbaptisteM

Different cellular networks operate on different wireless networking standards, and these standards change every few years. For much of the last 20 years, Qualcomm has enjoyed a lead—and in some cases a stranglehold—on chips that support major cellular standards. So if a smartphone company aspired to sell its wares around the world, it had little choice but to do business with Qualcomm.

 

For example, in the early 2010s Qualcomm enjoyed a big lead on chips for the CDMA standards favored by Verizon and Sprint in the US and some other carriers overseas. Qualcomm Chief Technology Officer James Thompson bluntly explained in an internal 2014 email to CEO Steve Mollenkopf how this gave the company leverage over Apple.

 

"We are the only supplier today that can give them a global launch," Thompson wrote, according to court documents. "In fact, without us they would lose big parts of North America, Japan and China. That would really hurt them."

 

It wasn't just Apple. BlackBerry was in a similar predicament around 2010. In a deposition, BlackBerry executive John Grubbs stated that without access to Qualcomm's chips, "30 percent of our device sales would have gone away overnight if we couldn't have supplied CDMA devices."

 

Over the last two decades, Qualcomm has had deals in place with most of the leading cell phone makers, including LG, Sony, Samsung, Huawei, Motorola, Lenovo, ZTE, and Nokia. These deals gave Qualcomm enormous leverage over these companies—leverage that allowed Qualcomm to extract patent royalty rates that were far higher than those earned by other companies with similar patent portfolios.

 

Qualcomm's patent licensing fees were calculated based on the value of the entire phone, not just the value of chips that embodied Qualcomm's patented technology. This effectively meant that Qualcomm got a cut of every component of a smartphone—most of which had nothing to do with Qualcomm's cellular patents.

 

"Qualcomm charges us more than everybody else put together," Apple executive Jeff Williams said. "We've never seen such a significant licensing fee tied to any other IP we license," said Motorola's Todd Madderom.

 

Internal Qualcomm documents supported these claims. One showed that Qualcomm's patent licensing operation brought in $7.7 billion in 2016—more than the combined patent licensing revenue of 12 other companies with significant patent portfolios.

No license, no chips

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Qualcomm

These high royalties reflected an unusual negotiating tactic called "no license, no chips." No one could buy Qualcomm's cellular chips unless they first signed a license to Qualcomm's patent portfolio. And the terms of these patent deals were heavily tilted in Qualcomm's favor.

 

Once a phone maker had signed its first deal with Qualcomm, Qualcomm gained even more leverage. Qualcomm had the right to unilaterally terminate a smartphone maker's chip supply once the patent licensing deal expired.

 

"If we are unable to source the modem, we are unable to ship the handset," said Motorola executive Todd Madderom in a deposition. "It takes many months of engineering work to design a replacement solution, if there is even a viable one on the market that supports the need."

 

That made Qualcomm's customers extremely vulnerable as they neared the expiration of a patent licensing deal. If a customer tried to negotiate more favorable terms—to say nothing of formally challenging Qualcomm's patent claims in court—Qualcomm could abruptly cut off the company's chip supply.

 

"We explained that we were contemplating terminating the license," Lenovo executive Ira Blumberg testified during the trial. A senior Qualcomm executive "was very calm about it, and said we should feel free to do that, but if we did, we would no longer be able to purchase Qualcomm chips."

 

"You're looking at months and months, if not a year or more, without supply," Blumberg said in a deposition. That "would be, if not fatal, then nearly fatal to almost any company in this business."

 

Judge Koh found that Qualcomm used this tactic over and over again over the last 20 years: Qualcomm threatened to cut off Samsung's chip supply in 2001, LG's chip supply in 2004, Sony and ZTE's chip supplies in 2012, Huawei and Lenovo's chip supplies in 2013, and Motorola's chip supply in 2015.

Qualcomm’s chip deals boxed out competitors

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Getty Images | Boonrit Panyaphinitnugoon

An obvious question is how Qualcomm maintained its stranglehold over the supply of modem chips. Partly, Qualcomm employed talented engineers and spent billions of dollars keeping its chips on the cutting edge.

 

Qualcomm also bolstered its dominant position by selling systems on a chip that included a CPU and other functions as well as modem functionality. This yielded significant cost and power savings, and it was hard for smaller chipmakers to compete with.

 

But besides these technical reasons, Qualcomm also structured its agreements with customers to make it difficult for other companies to break into the cellular modem chip business.

 

Qualcomm's first weapon against competitors: patent licensing terms requiring customers to pay a royalty on every phone sold—not just phones that contained Qualcomm's wireless chips. This gave Qualcomm an inherent advantage in competition with other chipmakers. If another chipmaker tried to undercut Qualcomm's chips on price, Qualcomm could easily afford to cut the price of its own chips, knowing that the customer would still be paying Qualcomm a hefty patent licensing fee on every phone.

 

Judge Koh draws a direct parallel to licensing behavior that got Microsoft in legal trouble in the 1990s. Microsoft would offer PC makers a discount if they agreed to pay Microsoft a licensing fee for every PC sold—whether or not the PC shipped with a copy of MS-DOS. This effectively meant that a PC maker had to pay twice if it shipped a PC running a non-Microsoft operating system. In 1999, a federal judge ruled that a reasonable jury could conclude this arrangement violated antitrust law by making it difficult for Microsoft's competitors to break into the market.

 

And some of Qualcomm's licensing deals included terms that explicitly discouraged companies from using non-Qualcomm wireless chips. Qualcomm would offer cell phone makers rebates on every Qualcomm chip they sold. But cell phone makers would only get those rebates if they used Qualcomm chips for at least 85 percent—or in some cases even 100 percent—of the phones they sold.

 

For example, Apple signed a deal with Qualcomm in 2013 that effectively guaranteed that Apple would exclusively use Qualcomm's wireless chips. Under the deal, Qualcomm paid Apple hundreds of millions of dollars in rebates and marketing incentives between 2013 and 2016. However, Qualcomm would stop making those payments if Apple started selling an iPhone or iPad with a non-Qualcomm cellular chip.

 

Apple was even required to pay back some of those funds if it used non-Qualcomm cellular chips before February 2016. One internal Qualcomm email calculated that Apple would owe $645 million if it launched an iPhone with a non-Qualcomm cellular chip in 2015.

 

Qualcomm made similar deals with other major cell phone makers. In 2003, Qualcomm signed a 10-year deal granting Huawei a reduced royalty rate of 2.65 percent if Huawei purchased 100 percent of its CDMA chips for the Chinese market from Qualcomm. If Huawei bought non-Qualcomm CDMA chips, the royalty rate jumped to five percent or more.

 

A 2004 deal gave LG rebates if LG purchased at least 85 percent of its CDMA chips from Qualcomm. The deal also required LG to pay a higher patent royalty rate when it sold phones with non-Qualcomm cellular chips. A 2018 deal makes incentive payments to Samsung if the company buys 100 percent of its "premium" cellular chips from Qualcomm—as well as lower thresholds (the exact percentages are redacted) for lower-tier chips.

“It is unlikely there will be enough standalone modem volume”

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Ken Hawkins

These exclusive or near-exclusive terms were important because huge scale is required to profitably enter the cellular modem business. It costs hundreds of millions of dollars to design a competitive cellular chip from scratch. And designs are only useful for a few years before they become obsolete.

 

This means that it only makes sense for a company to enter this business if it already has some major customers lined up—customers willing and able to order millions of chips in the first year. And there are only a few customers capable of placing those kinds of orders.

 

Qualcomm's executives clearly understood this. In a 2010 internal email, Qualcomm's Steve Mollenkopf wrote that "there are significant strategic benefits" to signing an exclusive deal with Apple because "it is unlikely that there will be enough standalone modem volume to sustain a viable competitor without that slot."

 

This was more than a theoretical issue. Apple hated being dependent on Qualcomm and was looking to cultivate a second source for modem chips. The strongest candidate was Intel—which didn't have a significant modem chip business but was interested in building one. By 2012, Apple was already planning to have Intel design a cellular chip for the 2014 iPad.

 

Apple's 2013 deal with Qualcomm forced the company to put that plan—and its larger relationship with Intel's cellular team—on the back burner. Apple's Blevins testified that "we cut off the work we were doing with Intel on an iPad" after it was signed. And without Apple as an anchor customer, Intel had to put its own modem chip work on the back burner as well.

 

Intel and Apple resumed their collaboration ahead of the 2016 expiration of Apple's deal with Qualcomm. That year Apple introduced the iPhone 7. Some units shipped with Qualcomm modems while others used new Intel modems.

 

Apple's commitment to buy millions of Intel wireless chips allowed Intel to pour resources into its development efforts. After securing its deal with Apple, Intel acquired VIA Telecom, one of the few companies struggling to compete with Qualcomm in the CDMA chip market. Intel needed CDMA chips to make its wireless offerings competitive worldwide and lacked the capacity to develop them internally on the schedule Apple demanded. Acquiring VIA helped Intel accelerate its CDMA work. But Intel's own projections showed that the VIA acquisition would not have been financially viable without the volume of business Apple promised to Intel.

 

The relationship with Apple helped Intel in other ways, too. The knowledge that the next iPhone would sport Intel cellular chips motivated network operators to help Intel test its chips on their networks. Intel also found that its status as an Apple supplier gave it more clout in standard-setting organizations.

The empire strikes back

Enlarge / A 5G Intel logo is seen during the Mobile World Congress on February 26, 2019 in Barcelona.

Miquel Benitez/Getty Images

Apple's deal with Intel posed a serious threat to Qualcomm's dominance of the cellular chip business. Once Intel developed the full range of cellular chips Apple needed for the iPhone, Intel could turn around and offer the same chips to other smartphone makers. That would improve every smartphone maker's leverage when it came time for them to renew their patent licenses with Qualcomm. So, Qualcomm went to war with Apple and Intel.

 

Freed of Qualcomm's chip supply threat, Apple began to challenge Qualcomm's high patent royalty rates. Qualcomm responded by cutting Apple off from access to Qualcomm's chips for new iPhone models, forcing Apple to rely entirely on Intel for the cellular chips in its 2018 models. Qualcomm sued Apple for patent infringement in courts around the world, while Apple pressed the Federal Trade Commission to investigate Qualcomm's business practices.

 

The dispute put both Apple and Intel in a precarious position. Qualcomm was trying to use its patent arsenal to get iPhone sales banned in jurisdictions around the world. If Qualcomm scored a win in a major market, it could force Apple to come to the table. Then Qualcomm might force Apple to buy fewer Intel chips, endangering Intel's wireless chip business—especially since other potential customers would be wary of leaping in front of Qualcomm's patent buzzsaw.

 

At the same time, Apple was relying on Intel to keep its phones on the cutting edge of wireless technology. Intel successfully developed modem chips suitable for the 2017 and 2018 iPhone models, but the wireless industry is due to make a transition to 5G wireless technology over the next couple of years. The iPhone is a premium product that needs to support the latest wireless standards. If Intel failed to develop 5G chips quickly enough for use in the 2020 iPhone model, it could put Apple in an untenable position.

 

It appears that this latter scenario is what ultimately happened. Last month, Apple announced a wide-ranging settlement with Qualcomm that required Apple to pay for a six-year license to Qualcomm's patents. Hours later, Intel announced that it was canceling work on 5G modem chips.

 

While we don't know all the behind-the-scenes details, it appears that earlier this year Apple started to doubt Intel's ability to deliver 5G modem chips quickly enough to meet Apple's needs. That made Apple's confrontational posture toward Qualcomm unviable, and Apple decided to cut a deal while it still had some leverage. Apple's decision to make peace with Qualcomm instantly cut the legs out from Intel's modem chip efforts.

Qualcomm has long refused to license its patents to competitors

The story of Qualcomm's battle with Apple and Intel illustrates how Qualcomm has used its patent portfolio to buttress its chip monopoly.

 

Chipmakers are ordinarily expected to acquire patents related to their chips and indemnify their customers for patent problems. But Qualcomm refused to license its patents to competitors, putting them in a difficult position.

 

"The prevailing message from all of the customers I engaged with was that they expected us to have a license agreement with Qualcomm before they would consider purchasing 3G chipsets from MediaTek," said Finbarr Moynihan, an executive at chipmaker MediaTek.

 

If a chipmaker asked to license Qualcomm's patents, Qualcomm would only offer a promise not to sue the chipmaker itself—not the chipmaker's customers. Qualcomm also demanded that chipmakers—its own competitors—only sell chips to a Qualcomm-supplied list of "Authorized Purchasers" who had already licensed Qualcomm's patents.

 

Needless to say this put Qualcomm's competitors—and would-be competitors—at a disadvantage. Qualcomm's patent licensing regime not only allowed it to impose a de facto tax on its competitors' sales, it effectively let Qualcomm choose its competitors' customers. Indeed, Qualcomm demanded that other chipmakers provide it with data on how many chips it had sold to each of its customers—sensitive commercial data that would allow Qualcomm to figure out exactly how much pressure it needed to apply to prevent a rival from gaining traction.

 

An internal Qualcomm presentation prepared within days of a 2009 deal with MediaTek ("MTK" in this slide) provides a comically candid visualization of Qualcomm's anticompetitive approach:

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"WCDMA SULA" refers to a Qualcomm patent license. Qualcomm believed that limiting MediaTek to Qualcomm-licensed companies would prevent MediaTek from getting more than 50 customers for its forthcoming 3G chips. Meanwhile, Qualcomm aimed to deprive MediaTek of cash it could invest in the chips.

 

A few smaller chipmakers like MediaTek and VIA agreed to Qualcomm's one-sided terms. Even more significant, a number of more formidable companies were deterred from entering the market—or encouraged to exit—by Qualcomm's tactics.

 

Qualcomm twice refused to grant patent licenses to Intel—in 2004 and 2009—delaying Intel's entry into the wireless modem business. A joint chip venture between Samsung and NTT DoCoMo called Project Dragonfly was rebuffed by Qualcomm in 2011; Samsung wound up making some modem chips for its own use but not offering them to others. Qualcomm refused LG a patent license for a potential modem chip in 2015.

 

Qualcomm refused patent licenses to Texas Instruments and Broadcom ahead of their departures from the modem business in 2012 and 2014, respectively.

Fair, reasonable, and non-discriminatory

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Brent Lewin/Bloomberg via Getty Images

When a standards group is developing a new wireless standard, it assembles a list of patents that are essential to implement the standard—these are known as standards essential patents. It then asks patent holders to promise to license those patents on fair, reasonable, and non-discriminatory (FRAND) terms. Patent holders usually agree to these terms because incorporating a patent into a standard enhances its value.

 

But Qualcomm doesn't seem to be honoring its FRAND commitments. FRAND patents are supposed to be available on the same terms to anyone who wants to license them—either customers or competitors. But Qualcomm refuses to license its standards-essential patents to other chipmakers.

 

And when handset manufacturers tried to license Qualcomm's standard-essential patents, Qualcomm usually bundled them together with its larger patent portfolio, which included patents that were not subject to FRAND commitments and in many cases had nothing to do with modem chips. As a result, handset makers effectively had to pay inflated prices for Qualcomm's standards-essential patents.

 

But no one was in a good position to challenge Qualcomm's creative interpretation of FRAND requirements. Qualcomm didn't directly sue other chipmakers, so there was no easy way for them to challenge Qualcomm's policies. Meanwhile, Qualcomm's chip supply threats deterred customers from challenging Qualcomm's licensing practices.

 

Judge Koh ruled that Qualcomm's failure to honor its FRAND commitments was a violation of antitrust law. Qualcomm had an obligation to license its patents to anyone who wanted to, she ruled, and Qualcomm had an obligation to do so at reasonable rates—rates far lower than those Qualcomm has been charging in recent years.

No more “no license, no chips”

Enlarge / Judge Lucy Koh.

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Judge Koh orders several changes that are designed to stop Qualcomm's anticompetitive conduct and restore some competitive balance to the marketplace.

 

The most important change is to decouple Qualcomm's patent licensing efforts from its chip business. Koh ordered Qualcomm not to "condition the supply of modem chips on a customer's patent license status." Qualcomm must renegotiate all of its patent licenses without threatening anyone's supply of modem chips.

 

Koh also ordered Qualcomm to license its standards-essential patents to other chipmakers on FRAND terms, submitting to arbitration, if necessary, to determine fair royalty rates. These licenses must be "exhaustive"—meaning that Qualcomm is precluded from suing a chipmaker's customers for violating patents licensed by the chipmaker.

 

Third, Koh bans Qualcomm from entering into exclusivity deals with customers. That means no more rebates if a customer buys 85 or 100 percent of its chips from Qualcomm.

 

Patent expert Charles Duan argues that Koh's ruling "deals with the largest problems that people have observed in terms of Qualcomm's behavior."

 

A big winner here could be Samsung, one of the few major technology companies to have retained significant in-house modem capabilities. In recent years, Samsung has often shipped smartphones with its own Exynos chips in some markets, while selling Qualcomm chips in others—particularly the United States and China. It's not clear exactly why it does this, but a reasonable guess is that Samsung believes that it's more vulnerable to Qualcomm's patent threats in those countries.

 

Now it'll be easier for Samsung to use its own chips worldwide, simplifying product design and giving the company greater economies of scale for its own chips. Eventually, Samsung might start offering those chips to other smartphone makers—as it tried to do back in 2011.

 

On the other hand, Koh's ruling might come too late for Intel, which announced it was shuttering its 5G chip efforts last month and may not have the appetite (or enough time) to restart them.

 

Koh's most important requirements, however, may be her mandate for seven years of monitoring by the FTC and the courts.

 

"I imagine that over the next year or so Qualcomm will come up with some new way to get back to [its] old revenue model," Duan told Ars in an email. It will take continued vigilance by the authorities to ensure Qualcomm complies with both the letter and the spirit of Koh's ruling.

 

But first the ruling must survive an appeal to the Ninth Circuit Court of Appeals. On Tuesday, Qualcomm asked Koh to put her ruling on hold until the appeals court has a chance to weigh in. Qualcomm's customers and competitors won't be able to truly breathe easy until the appeals process is over.

 

Source: How Qualcomm shook down the cell phone industry for almost 20 years (Ars Technica)

[mkc21]

can't wait to get my hands on a qualcomm powered laptop. F intel btw