The future of the mobile industry hangs in the balance as a battle over intellectual property and royalties between technology titans Nokia (NOK) and Qualcomm (QCOM) comes to a head. Billions of dollars in revenues and profits are at stake. And once again, a dispute involving U.S. companies has landed in the lap of the Brussels-based European Commission, known for its high-profile antitrust victory over Microsoft (MSFT) and more recent pursuit of U.S. chipmakers Intel (INTC) and Rambus (RMBS).
In one corner is Qualcomm, which has built its highly profitable business on developing and licensing intellectual property for mobile communications, especially the CDMA standard, which it invented. Though admired in the industry, Qualcomm also engenders resentment for the rich royalties it collects on its patents. Indeed, rivals say the 'supernormal' profits Qualcomm earns from royalties on third-generation (3G) mobile technology amount to a kind of 'tax' on the entire mobile industry that trickles down to higher prices for consumers.
Qualcomm's intellectual property is at issue because when the 3G mobile standard was being developed a decade ago, the San Diego company held key patents on the underlying technology, known as W-CDMA, that was adopted by the industry. Qualcomm agreed to license those technologies to other companies on reasonable terms, and as a result, its patented inventions became an integral part of 3G.
A formal case against Qualcomm
In the other corner is Nokia, the giant of handsets, with more than 35% market share and plenty of intellectual property of its own. Nokia already pays lots of royalties to Qualcomm. Investment bank Nomura Securities in London figures the fees could amount to nearly $1.1 billion in 2008 alone. But Nokia argues that the royalties are too high relative to the value of Qualcomm's patents, and has teamed up with a half-dozen other tech firms to try to force them down.
Two years ago, Nokia and its allies asked the European Commission's antitrust division to investigate Qualcomm's licensing fees, and on Oct. 1, the Commission opened a formal case against Qualcomm. In their original complaint, Nokia, Broadcom (BRCM), Ericsson (ERIC), Texas Instruments (TXN), NEC (NYPNY), and Panasonic Mobile Communications (MC) alleged that Qualcomm overcharges for its intellectual property and has used potentially abusive techniques to prolong its position in mobile-phone technology.
If antitrust officials find Qualcomm's behavior has breached European competition rules, the Commission could impose fines as high as 10% of Qualcomm's annual revenues. In a worst-case scenario, it could even break apart Qualcomm's chipmaking and licensing businesses.
Holding the industry hostage
The Commission case comes amid a welter of private squabbles between Qualcomm and its adversaries. The company is embroiled in a long-running series of lawsuits with Broadcom, a rival U.S. maker of communications chips. One of the disputes led to a temporary ban on importing handsets containing Qualcomm technology into the U.S. The company devised a way to work around it, but admits that the solution won't solve all of the legal issues in the case (BusinessWeek.com, 8/7/07).
Another dispute led a federal judge to quash two of Qualcomm's patents on compressing video signals, ruling in August that Qualcomm's behavior exposed 'a carefully orchestrated plan and deadly determination to hold hostage the entire industry.' Qualcomm, which is appealing that decision, is so mired in these and other legal battles that it will spend an estimated $200 million in lawyers' fees in 2007 alone.
Nokia and Qualcomm, meanwhile, are deadlocked in their own royalty negotiations after a previous contract between the companies expired on Apr. 9. The Finnish phonemaker claims Qualcomm is demanding too high a price for a new contract, and the companies have been forced to resort to arbitration. A Los Angeles panel will decide who is right, and the result could add or subtract hundreds of millions of dollars in profits for either company.
Qualcomm defends royalty fees
The rest of the mobile industry is likely to use the outcome of the arbitration as a yardstick for future negotiations with Qualcomm, so if Nokia wins, it could whack Qualcomm's business model. 'This is high stakes at the poker table,' says Ben Wood, director of British mobile consultancy CCS Insight.
No doubt about that. Qualcomm earned one-third of its $7.53 billion in 2006 revenues"”and 71% of profits"”from royalties. The company has spent billions of dollars in mobile technology R&D and argues that its fees are deserved compensation for its extensive innovation.
Indeed, Qualcomm turns the tables on Nokia, arguing that the phonemaker asked for the EU antitrust investigation as a way of forcing Qualcomm back to the bargaining table. 'Nokia wants to pay less, and as part of their negotiating tactics they are pulling every lever then can,' says Andrew Gilbert, president of Qualcomm Europe. 'Let's see through this for what it is.'
The heart of the European Commission case is whether Qualcomm's licensing terms are 'fair, reasonable, and non-discriminatory.' This legal principle, often applied in intellectual-property cases, says that owners of essential patents should not be able to hold an industry hostage by charging exorbitant prices for access to the technology. This is especially important when companies have had their patents incorporated into an industry standard, as was the case with Qualcomm and W-CDMA.
Little choice but to license
'Qualcomm became dominant based on a promise not to charge monopoly rent and not to distort competition in downstream products,' says Jay Johnson, a vice-president and assistant general counsel at Texas Instruments, one of the complainants in the EC case. 'Once the W-CDMA standard was fixed on that basis, they turned around and did exactly what they promised not to do. That's bad for manufacturers, standards, and consumers.'
Europe's mobile industry never really wanted to license Qualcomm's technology in the first place, but it had little choice. The homegrown European GSM standard was running out of gas"”and the best alternative for next-generation mobile hinged on the Qualcomm-controlled CDMA. The companies agreeing to the standard now say they assumed Qualcomm would charge proportionally less for the patents used in W-CDMA than it did for the older CDMA because its technology represented a smaller percentage of the total intellectual-property content of a 3G phone. But instead, they say, Qualcomm still charges around 5% of the wholesale price of each handset"”the same rate as for CDMA.
That fee, said the European Commission in a statement when it launched its Qualcomm case, may have raised the cost of 3G, slowed its rollout, and brought about 'all the related negative consequences for economic efficiency associated with inhibited growth of the standard.' The Commission also says that Qualcomm's alleged misbehavior could harm the standard-setting process more generally, as well as the adoption of the future generations of mobile technologies.
Damning allegations
Not surprisingly, Qualcomm has a different view, arguing that it's the quality not quantity of patents that count. Because 3G is utterly dependent on CDMA technology, Qualcomm says it has the right to charge the same rate. What's more, the economic arguments put forth by Qualcomm's adversaries may not fly. Analyst Richard Windsor of Nomura Securities thinks the Commission will have a tough time proving that Qualcomm's pricing has hurt 3G. Handset prices have dropped dramatically in the last six months, to about €100 ($142) and the entire 3G market finally seems to be thriving, Windsor argues.
Other issues raised by Qualcomm's adversaries could be more damning. They allege that the company has engaged in exclusionary business practices, such as offering better royalty terms to customers who agree to buy all their W-CDMA chips solely from Qualcomm. The Commission might have an easier time proving such behavior and putting a stop to it. Rivals also say Qualcomm tries to skew technical standards in its favor by pressuring handset makers to vote for Qualcomm's proposals"”or risk supply disruptions or other punishment. Qualcomm's Gilbert says he is 'very confident' that European officials will find all of these allegations 'baseless.'
Is the Commission's case another sign of European regulators run amok‾ After all, this is the same antitrust group that has pursued Microsoft and Intel and is now investigating memory-chip designer Rambus. (Rambus is alleged to have participated in a standard-setting process without revealing its own pertinent patents and then attempting to collect royalties from users of the standard, a practice known as 'patent ambush.') It's true that European antitrust officials are more aggressive these days than their U.S. counterparts. But their investigations aren't being dreamed up by bureaucrats in Brussels: All of these cases were initially demanded in part by U.S. companies, including Sun Microsystems (JAVA), Novell (NOVL), and Advanced Micro Devices (AMD).
One of many battles
Maurits Dolmans, an attorney in the Brussels office of Cleary Gottlieb Steen & Hamilton who represents plaintiffs in both the Qualcomm and Rambus cases, argues that the weighty questions being considered by the Commission are essential issues for the digital age. 'If these companies get away with distorting the standards process, it could stifle standardization in all areas, depriving consumers of the benefits of standards,' Dolmans says. 'This type of behavior slows down innovation and makes technology more expensive.'
The Commission has put the Qualcomm case on a fast track, but it will still be at least a year before a decision. In the meantime, the mobile industry awaits the Los Angeles arbitration ruling between Nokia and Qualcomm"”and the outcome of a score of other legal battles involving patents and intellectual property. One way or another, a lot more such disputes are likely to end up either in court or in the hands of the European Commission.
Schenker is a BusinessWeek correspondent in Paris.
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