Tuesday, January 15, 2019

Qualcomm and Apple bridged the wide gap between their FRAND perspectives through complicated arrangements

Yesterday (Monday) was Day 5 of the FTC v. Qualcomm antitrust trial in San Jose (Northern District of California). In a first summary shortly after the court session, I provided an overview of how, after most of the day had gone extremely well for the FTC, Qualcomm got what athletes call a "second wind" and made tremendous headway against one of the FTC's three expert witnesses, Michael Lasinski. This is now a follow-up post with a focus on negotiation dynamics and deal structures, which was the #1 topic on Friday.

Apple's Chief Operating Officer Jeff Williams was first to testify on Monday morning. He was a member of the team that created the original iPhone, and has interacted with Qualcomm ever since. What we learned from him contributed to a better understanding of Qualcomm's dealings with other companies.

In an antitrust case pitting the U.S. government against a patent-wielding U.S. chipmaker, Apple obviously plays an important role--but many observers of this proceeding appear to miss the grand picture by focusing too narrowly on that company. Only one of the FTC's four key issues is specifically about Apple: exclusivity arrangements. Even that one is ultimately about a pattern, just that the related agreements between Apple and Qualcomm are the only manifestation of that pattern at issue in this case.

At the moment, Apple appears to be Intel's only customer. Qualcomm elicited testimony from Intel's Aicha Evans confirming that at certain points she wasn't even interested in a couple of potential customers. There may have been any number of reasons for that as Intel needs to ramp up its baseband chip business step by step, but there's no reason to assume that Intel wouldn't be interested in growing its business in this field and in having a broader customer base.

Qualcomm's practices have been a concern for the industry at large. I heard this from companies like BlackBerry and (when it was at its peak as a handset maker) Nokia, and some I can't mention due to NDAs (other than saying they're not Apple), before I first became aware of Apple's positions--which I did only in connection with the KFTC (Korea Fair Trade Commission) antitrust proceeding.

The testimony from industry players--of all sizes and from multiple countries--that the FTC has presented is extremely strong. In fact, it's so strong that the FTC's expert witnesses (we'll hear the only trained economist among them, Professor Carl Shapiro, in a few hours) are going to be much less influential in this case than they would be in others. Those industry witnesses have established so many facts relating to the question of anticompetitive harm that I don't think Qualcomm can this around by winning the "battle of the experts," which it may or may not.

As I've stated before, it's advisable not to overrate the importance of who--Apple or Qualcomm--was first to propose exclusive arrangements. If a company is made an offer that serves its anticompetitive objectives in illegal ways, it still has the obligation under the antitrust laws to refuse it. That said, we're all curious about how that type of deal came into being.

Mr. Williams nuanced Apple's proposal by differentiating beween short-term and long-term exclusivity. At the time the parties were negotiating the original (2011) Transition Agreement (which was about Apple discontinuing its relationship with Infineon and exclusively sourcing baseband chips from Qualcomm), Apple apparently had no problem with short-term exclusivity based on the market landscape. But Apple did not want to enter into an exclusive deal for the long haul, given that things can change in this industry within a relatively short period.

Qualcomm presented evidence (including Apple-internal emails, at least one of which was written by Steve Jobs) that a one-year term was to short for Apple's purposes. So the original Transition Agreement became a two-year deal (2011 and 2012). Obviously, two years still fall far short of what one would consider "long term."

A first amendment to the Transition Agreement was negotiated, and it covered the period until including 2016. Accoring to Mr. Williams, Apple did not take the initiative to propose exclusivity in that situation. And Mr. Williams mentioned a situation in which Apple had made a counterproposal to Qualcomm in which the exclusivity commitment was redlined, triggering a response by Steve Mollenkopf (now Qualcomm's CEO) that those "general design commitments" (a euphemism for exclusivity requirements with a clawback clause) were really important to Qualcomm.

It's key to view the 2011 and 2013 agreements in the wider context of Apple and Qualcomm struggling to work out mutually acceptable deal terms. Apple was by far not the only company to take issue with Qualcomm's requirement that others had to grant back a royalty-free license to all patents of their own. We heard about that from various witnesses, most recently Ericsson.

But after the enormous risks Apple had taken with the original iPhone (trying to enter an industry that was an oligopoly, with BlackBerry having been the only successful new entrant--prior to Apple--in a long time), and knowing Apple's emphasis on differentiation, it does not surprise me that Apple was particularly opposed to Qualcomm's grant-back condition.

The face-saving solution that allowed both companies to remain consistent with their principles was that Apple obtained only an indirect license--through contract manufacturers like Foxconn. The CMs were obviously unable to license Apple's patents to Qualcomm, but they were able to secure a license from Qualcomm covering the devices they manufacture(d) on Apple's behalf.

Fundamental, philosophical disagreements between Apple and Qualcomm related not only to the grant-back requirement but also to the royalty base and, directly related to it, the amount. We learned yesterday that Apple would have accepted Qualcomm's 5% royalty rate if applied to the cost of a baseband chip. Just like with the extortionate grant-back clause, it also makes sense that Apple, from the beginning, took issue with Qualcomm's royalty base (complete devices). Prior to the iPhone there had been some relatively unsuccessful personal digital assistants and early "smartphones" made by various companies such as Nokia. Also, BlackBerry added email to voice and short-message texting. But only the iPhone represented a complete paradigm shift from "mobile phones" that gradually got more and more computing functions to a "mobile computer." That's where Apple as a computer manufacturer and maker of handheld devices (at the time, the iPod was already reasonably popular) brought the two worlds together in a way that established the primacy of computing functionality over telephony. The computer absorbed the phone, not the other way round. So Apple was particularly concerned about Qualcomm seeking to be compensated for functionality its patented inventions weren't related to.

According to Mr. Williams, Apple didn't care about whether Qualcomm formally lowered its royalty or just agreed to incentive payments that had the same bottom-line effect. The royalty Apple could live with at the time (while still believing this number was not FRAND) was $7.50 per device, and that was simply because it was the average of what everyone else was paying Qualcomm. No matter what Qualcomm then claimed to be the royalty base, the net effect from Apple's point of view was that Qualcomm got compensated for the equivalent of a feature phone, not for what Apple's mobile computer offered on top.

But, as we know, Apple had to make concessions to Qualcomm. Exclusivity (under the 2011 Transition Agreement and its 2013-2016 amendment) was known before. Yesterday Mr. Williams said that under the very first agreement between Apple and Qualcomm, Apple was required to publicly renounce the WiMax standard.

The FTC is not going after Qualcomm for deals under which it paid device makers like Apple to say negative things about, and refrain from implementing, standards that might have been alternatives to standards that Qualcomm had greater benefits from (because of greater leverage over those standards, such as particularly CDMA). But I hope that at some point, in whatever jurisdiction but ideally in the United States, a regulator or a court of law or, if all else fails, a legislature will take action against such competition-distorting deals, too.

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