assessments

May 23, 2019 | 09:30 GMT

7 mins read

What Does the New Qualcomm Ruling Mean for 5G and the U.S.-China Tech War?

A smartphone displays Qualcomm's company logo.
IGOR GOLVNIOV/SOPA Images/LightRocket via Getty Images)
Highlights
  • A U.S. district judge has ruled in favor of the U.S. Federal Trade Commission against U.S. 5G tech leader Qualcomm, declaring that the company broke antitrust laws.
  • Qualcomm will almost certainly appeal the ruling, but the company's business model is at risk, along with its ability to fund and finance crucial research and development for future wireless communications technology.
  • Qualcomm leads the U.S. development of essential standard-setting patents for future wireless technology. Legal limitations against it will likely benefit the United States' tech war adversary, China.
  • In just one week, the two most important global 5G players — China's Huawei and the United States' Qualcomm — have experienced assaults on their fundamental business models that could dramatically reorder the development and sales processes in the global 5G sector.

In what could become a landmark case, a United States district judge on May 21 sided with the U.S. Federal Trade Commission (FTC) against Qualcomm over its licensing prices. Judge Lucy Koh said that the San Diego-based telecommunications innovator broke U.S. antitrust law by "strangling competition" in the semiconductor chip industry and using its position as a key patent holder to demand unreasonably high licensing fees. Qualcomm will almost certainly appeal the ruling to a higher court, but if it stands, Koh's decision will hit at the heart of Qualcomm's business model, weakening the company at a time when it is in a heated competition with Chinese tech developers.

The Big Picture

The United States and China are locked in a war over the future of technology, and advancements in 5G technology play a critical role in that fight. Previous generations of wireless technology focused on communication between people, but 5G's potential is far-ranging; it would further enable connections between devices and advance the "internet of things." Qualcomm is the United States' most important innovator in the 5G space. And forcing it to change its business model could limit its investment in crucial research and development.

A Controversial Case

The FTC's case against Qualcomm has been controversial since it was filed, and U.S. President Donald Trump — as well as some of his trade commissioners — do not support it. The commission's case against Qualcomm centers on two different but related issues: Qualcomm's chip sales to device manufacturers and its licensing practices for the technology underpinning wireless communication. The FTC specifically argued that Qualcomm was both the dominant supplier of certain chips and also the holder of so-called standard-essential patents — that is, patents that companies must use to conform with industry standards (in this case for telecommunications) — and that Qualcomm abused those two positions to harm its competition. Standard-essential patents are treated uniquely in patent law because if a company refuses to license them, it can essentially remove potential competition and achieve a market monopoly.

The FTC argued that Qualcomm refuses to sell its chips to manufacturers unless they enter a licensing agreement for Qualcomm's standard-essential patents — a "no license, no chips" policy — and that Qualcomm's required fees were unreasonably high. It also argued that Qualcomm refused to sell licenses to its competitors at all, which violates industry agreements with standard-setting bodies. Finally, it argued that Qualcomm also entered exclusively agreements with certain manufacturers (though the main complaint in that case was about a deal with Apple and was settled by Qualcomm last month).

A chart of the top 5G standard-essential patent owners.

Koh sided with the FTC on all of the issues it brought up. She ruled that Qualcomm had to license its standard-essential patents to its competitors on so-called FRAND terms — "fair, reasonable and non-discriminatory." She ordered Qualcomm to end its "no license, no chips" policy and renegotiate terms for all deals that currently involve that policy. And she also ordered that Qualcomm be subject to compliance monitoring for seven years.

Among FRANDS and Enemies: Why Qualcomm Matters

Qualcomm will appeal the ruling, but if it loses future appeals, the company's finances will take a major blow. Already, investors' quick reactions to the ruling have driven down Qualcomm's stock price value by as much as 12 percent. Chip sales, which currently represent about 75 percent of Qualcomm's revenue, are likely to decline as more of Qualcomm's chipmaking competitors gain access to its patents and can thus sell competitive products. But even more importantly, the court's demand that Qualcomm follow FRAND guidelines to license its standard-essential patents to other modem chip suppliers will drive down the financial gains Qualcomm has been getting from its "no license, no chip" licensing agreements, which account for just 25 percent of the company's revenue but are far more profitable for its business model.

Currently, Qualcomm's licensing practices allow it to license at the device level (that is, for an individual iPhone) and withhold chip-level sales. This allows it to receive royalties based on a fixed percentage of the device's value — currently 3.25 percent for standard-essential patents. Smartphones sell for hundreds of dollars, and even the value cap of $400 nets Qualcomm a lucrative royalty figure of $13 per device. By comparison, the cost of the modem chips that go into smartphones is typically around $15 to $20, and a royalty based on the value of the chips instead of the device will yield smaller returns. Indeed, earlier this year, JP Morgan Chase estimated that a shift toward licensing at the chip-level could more than halve the value of Qualcomm's stock.

With less money floating around, Qualcomm will be less able to invest in much-needed research and development in the future. And a hit to Qualcomm's research and development expenditures could have global ramifications. Qualcomm's powerful research and development department is one of the key reasons the company is an undisputed leader in wireless technology — it's why Qualcomm has developed so many foundational technologies in its industry, why it has been able to hold the patents for these technologies and why its technology solutions often become international standards, allowing the company to hold standard-essential patents. In 5G wireless communications standards, specifically, no other American rival — not Apple, not Microsoft, not Intel, not Micron — can compete with Qualcomm.

Global 5G Leadership in Flux

In terms of designing and developing 5G and 5G-related technologies, two of the most dominant companies are Qualcomm and China's Huawei. Other players exist, including South Korea's Samsung, China's ZTE and Sweden's Ericsson, but Huawei and Qualcomm hold many of the most important patents, have the most resources and set the most standards. Indeed, they are leading companies in the broader U.S.-China tech war, and their successes and setbacks have the power to tilt the scales for the competitors.

Qualcomm and Huawei are the leading companies in the broader U.S.-China tech war, and their successes and setbacks have the power to tilt the scales for the competitors.

The White House even sees 5G technological development as a national security issue, and it strongly values Qualcomm's 5G business. Last year Trump nixed Broadcom's $117 billion attempt to take over Qualcomm, citing national security concerns about Broadcom's relationship with third parties — specifically China. Republicans have even called on the White House to try to stop the FTC's case against Qualcomm and get it to settle. (Functionally, this is unlikely given the FTC's status as an independent agency and one of only two parts of the U.S. government that can see certain kind of antitrust cases, along with the Department of Justice.)

Critics of Koh's ruling have argued that by destabilizing Qualcomm and potentially limiting its research and development, the U.S. government is essentially shooting itself in the foot in the tech war with China. Earlier this month while Koh was still weighing her decision, the Department of Justice filed a briefing warning that the case could hurt U.S. companies' competitiveness in the 5G realm, which would ultimately benefit China. And, indeed, representatives from Huawei itself were eager to testify in the case to try to weaken its competitor.

But Huawei's global competitiveness — and by extension China's — has suffered recently too. A U.S. decision last week to place the company on the U.S. Commerce Department's Entity List means that U.S. suppliers must ask for the department to grant a permanent license to export to Huawei. This barrier will likely prevent some suppliers from working with Huawei, hurting the company's ability to remain a global smartphone competitor and 5G vendor and limiting its own investment into research and development.

Koh's decision – if upheld – will be a landmark one for the telecommunications industry. Not only will it fundamentally change the way that Qualcomm works in the industry by forcing a potential change to its business model, but it will have global ramifications in the broader tech war between China and the United States.

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