Phone A Friend

By Rob McCreary

In the Game Show “Who Wants To Be A Millionaire” when they were unsure of their final answer contestants had three lifelines.  My favorite was Phone A Friend because the interaction was often hilarious, usually unexpected and often wrong.

Who Wants To Be A Trillionaire?

I could not stop thinking about a similar game show being played by Apple right now.  With A Trillion Dollar market cap in sight earlier this year there were nonetheless a few unanswered questions about Apple’s future. The first was whether Apple would be permitted to sell its iPhone’s in China. The second was how could Apple pressure their suppliers, especially Qualcomm, to lower royalties to improve cell phone profitability.

By way of background Qualcomm is a chip maker for cell phones, but its real profitability derives from a prodigious patent portfolio that has a monopoly on how cell phones connect to the internet. That monopoly is a legal monopoly because it is secured by patents and billions of dollars of R&D investment by Qualcomm.

Phone A Friend On Different Continents

Apple decided to phone a friend in  2016 and 2017 when it filed a formal complaint with The Federal Trade Commission alleging that Qualcomm was using its monopoly power by charging patent royalties based on the price of cell phone instead of the price of their chips as well as withholding chip supply to any party who would not accede to their royalty arrangement. The FTC agreed to investigate Qualcomm.

Interestingly, Qualcomm also phoned a friend. While Qualcomm is a US company headquartered in San Diego it prevailed on the courts in China to enforce Qualcomm’s patent portfolio against Apple. Apple had been using Qualcomm’s proprietary technology for more than two years without paying royalties.

It is ironic that China, not the US, in response to Qualcomm’s allegations of infringement by Apple suspended Apple’s sale of iPhone’s in China on the basis that Apple was infringing Qualcomm patents.

Then File A Lawsuit Against Qualcomm

Independently, Apple phoned their best real-world law firm in January 2017 to sue Qualcomm in a private action to obtain the same remedies they were seeking from the FTC investigation. The pre trial discovery started in 2017 and the parties actually arrived in the courtroom on April 14, 2019. Opening arguments had not been completed when Apple and Qualcomm agreed to a global settlement of all open claims including the claims of monopolization, unfair pricing, failure to ship, and withholding intellectual property as a hammer in negotiations. The details of the settlement are sealed and we can only conjecture about how much of their royalty structure Qualcomm gave up in the six year arrangement. Here is a chart of Qualcomm’s market cap rising by $41 Billion in the days after the settlement was announced and then cratering when the FTC announced its decision one month later.

Legal observers suggest the real world legal settlement was prompted by three coterminous events:

  1. China decision to bar Apple cell phone sales in China until Apple stopped infringing Qualcomm’s patents.
  2. Intel’s decision after losing more than $1 Billion to abandon being a second source of supply for Apple on chips for next generation technology called 5G.
  3. Pre-trial discovery uncovered Apple’s own highly favorable assessments of the quality and distinctiveness of Qualcomm’s intellectual property based on patents (a legal monopoly). Apple had asserted that Qualcomm was charging much more that a fair and supportable royalty – the standard for royalties based on essential patents- by saying Apple’s intellectual property was no more valuable than other suppliers like Huawei, Samsung and Hitachi. It turns out Apple admitted internally that they could replace other suppliers, but Qualcomm’s patents were irreplaceable. This set the table for irrefutable admissions by Apple they saw a commercial rationale for a sky-high royalty approach.

The real world had spoken and commercial foes had settled on the basis of truth found in the Apple files. The little guy’s modem turned out to be irreplaceable and Apple had to use it. While Apple is 10x the size of Qualcomm, here David slew Goliath on the courthouse steps.

US Regulators Undeterred

The FTC case, however, continued. The judge overseeing the monopolization claims was undeterred by Apple’s capitulation and one month later the Honorable Lucy Koh issued a 233 page opinion finding Qualcomm had abused its monopoly. The FTC press release summarizes its finding as follows:

“Yesterday’s decision that Qualcomm’s practices violate the antitrust laws is an important win for competition in a key segment of the economy. FTC staff will remain vigilant in pursuing unilateral conduct by technology firms that harms the competitive process by taxing its competitors’ baseband processor sales, reduces competitors’ ability and incentive to innovate, and raises prices paid by consumers for cell phones and tablets.”

Qualcomm has appealed to the Ninth Circuit Court of Appeals in San Francisco. One of the remedies requires Qualcomm to submit to the supervision of the FTC for seven years. Another remedy might require it to supply its Chinese and Korean competitors who are attempting to win the fight for next gen 5G dominance.

In fact, phoning the friend may end up being a windfall for Apple competitors but no help for consumers. It appears Apple and Qualcomm’s six year settlement is not affected by the FTC ruling and US consumers won’t get cheaper cell phones after all.

The largest irony is just like I Want To Be A Millionaire the Phone A Friend at FTC is probably wrong and oblivious about the real commercial stakes. The FTC’s analysis contradicts many aspects of antitrust law under the Sherman Act. The Justice Department has already asked the FTC to hold hearings on modifying the remedies. This never happens.

Our Chinese and Korean competitors are quite pleased.

The stock market was not pleased with another situation where a zealous regulatory body funded by taxpayers with nothing but reputation at stake had overruled a real-world contest worth Billions of market cap in complete contradiction to how the real contestants had already settled the dispute. 

Rob McCrearyPhone A Friend

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