The future of American semiconductor innovation—and the price of future smartphones—may hinge on what is happening in a San Jose courtroom. In the U.S. District Court for the Northern District of California, companies including Apple, Blackberry, Ericsson, Intel, LG, MediaTek, Huawei and Samsung have testified on behalf of the Federal Trade Commission’s application of traditional anti-trust concepts to rein in practices by Qualcomm that harm consumers, competition and innovation. And the case has the potential to unleash the full force of competition in the market for 5G technology, which is poised to revolutionize the smartphone industry.
The FTC sued Qualcomm alleging that the semiconductor giant used monopoly power to raise prices for key components in Apple’s iPhone and similar devices, preventing other chipmakers from bringing new—and potentially better or cheaper—products to market. That conduct reduces the incentive to innovate and raises the cost of smartphones, a device nearly eight in 10 Americans own.
Founded in 1985 and now valued at almost $70 billion, Qualcomm is a leader in designing and manufacturing semiconductor chips for smartphones. Qualcomm’s chips function as modems, allowing mobile devices to perform online computing over cellular networks. But the FTC and, in a separate lawsuit, Apple—are suing Qualcomm over business practices that are unique in the semiconductor industry.
Every other company that makes chips and other component technology sells its products for one all-inclusive price and recovers the value of its innovations in that price. Qualcomm is different. It requires smartphone makers to both pay for chips and pay a separate licensing fee that is effectively a percentage of smartphone sales revenue. If a company refuses to pay those royalties, then Qualcomm refuses to sell its chips.
The FTC alleges, and the trial evidence shows, that because of Qualcomm’s threats to cut chip supplies, smartphone manufacturers had no choice but to cave to Qualcomm’s terms and pay much higher prices. Qualcomm’s refusal to honor its contractual obligation to standard-setting organizations to negotiate licenses free of this coercion also burdens competitors. Section 5 of the FTC Act prohibits “unfair methods of competition,” which includes efforts to monopolize or otherwise harm competition and the competitive process. If the FTC is correct, the result restricted innovation and raised smartphone prices.
If the federal court agrees with the FTC, it will likely end Qualcomm’s practice of demanding royalties through this extortive “no license, no chips” policy. Based on the testimony and evidence that the FTC has elicited during the court proceedings so far, that certainly would be a victory for American inventors and consumers.
Yet Qualcomm argues that its behavior is legal—and that if the FTC prevails, its victory would cripple innovation by U.S. companies in the emerging 5G cellular market. It claims its unique practices protect its intellectual property, and its high royalties are needed to recoup its investment. Any sharp reduction in licensing revenue that would follow an adverse court ruling, Qualcomm further claims, would deter future investment by Qualcomm and hand the 5G playing field to China’s Huawei Technologies.
Qualcomm is wrong. Ending its unique licensing practice will not disadvantage the United States relative to countries such as China in the fierce competition to develop 5G technology.
First, Qualcomm is not the only American company in the game. Intel has made great progress and is at the leading edge of 5G technology, despite Qualcomm’s conduct. (Disclosure: The author has advised Intel.) American companies will flourish under conditions of open competition, free from the restraints of Qualcomm’s unique business model.
Furthermore, the FTC’s lawsuit will not hobble Qualcomm’s ability or incentive to compete for the current or next generation of smartphones. The FTC is not disputing the ingenuity and value that Qualcomm contributed to prior smartphone technologies or its right to earn a competitive return on its large investments.
But when its patents became part of the industry standards for smartphones, Qualcomm undertook a contractual obligation to license that technology to other chipmakers in exchange for having its patents written into the industry standards, creating more demand to license the Qualcomm patents than otherwise would have existed. If Qualcomm had followed its contractual obligations and had sold licenses to its competitors—at the promised fair, reasonable and nondiscriminatory prices—those companies would be free to develop innovative ways to use that and other technology—and compete on the merits against Qualcomm. Moreover, if other chipmakers could offer similar or better technologies, smartphone makers such as Apple could choose among the competitors to source the best technology sold at the optimal price.
The result would be a steady cadence of new, better and more secure U.S.-designed products critical for 5G deployment—sold at prices dictated by competition in the open market. That’s exactly the kind of competition that U.S. anti-trust law is designed to protect. It’s why I believe the FTC’s case against Qualcomm will and should prevail.