Qualcomm, ARM: We thought we had such HOT MODELS...

... but IP licensing changing – and what if smartphones DIE?

The Chinese settlement terms

The threat of a full-blown and interminable probe of Qualcomm’s business practices appears to have been a threat to make the US firm more likely to negotiate over royalties (though the settlement does also touch on some fundamental business practice issues like bundling too). The result is that Chinese companies will pay a 5 per cent royalty fee on chips for 3G or multimode 3G/4G devices (any containing Qualcomm’s key CDMA technology), and a 3.5 per cent rate for 4G-only products such as TDD-LTE/FDD-LTE handsets, which will be very important in China’s 4G rollouts.

These rates are reportedly not very different from those charged elsewhere, but the most important change is that, henceforth, the royalties will be based on 65 per cent of a device’s net selling price, instead of the OEM’s full sale price, which in real terms means a fee of 3.25 per cent for 3G/multimode and 2.275 per cent for 4G. Qualcomm’s rates have traditionally been based on the full cost of the handset, though in recent years powerful customers like Apple have been pushing the industry towards rates based on the cost of chips rather than full devices.

In another important and much sought-after change, Qualcomm will offer licences to its 3G and 4G patents separately from licences to its other patents, and will provide patent lists during the negotiation of patent deals. The bundling of its entire patent portfolio has been highly controversial, and while it can represent good value for broad-based vendors, it is seen as unfair by companies which use only a few of the technologies involved.

Qualcomm also said it would not tie baseband chip sales and licences together, a practice it has always denied. It said in its statement: “Qualcomm will not condition the sale of baseband chips on the chip customer signing a licence agreement with terms that the NDRC found to be unreasonable or on the chip customer not challenging unreasonable terms in its license agreement. However, this does not require Qualcomm to sell chips to any entity that is not a Qualcomm licensee, and does not apply to a chip customer that refuses to report its sales of licensed devices as required by its patent licence agreement.”

And it added: “If Qualcomm seeks a cross-licence from a Chinese licensee ... it will negotiate with the licensee in good faith and provide fair consideration for such rights.” Existing licensees will have the chance to switch to the new terms for sales of branded devices for use in China, as of January 1 2015.

On the plus side, Qualcomm will presumably be able to collect royalty fees which some Chinese firms have been withholding until the outcome of the NDRC probe was known. But the pressure will be intense to increase its chip sales in China, to offset the fall in patent fees. The US firm still repeatedly scores over rivals in terms of advanced technology, especially on the modem side, but it is being chased aggressively by MediaTek and others.

Building bridges in China

The move of Chinese and Taiwanese companies into the higher reaches of the mobile market has pushed US giants to seek partnerships in the country, as well as competing head-to-head for the device makers’ favours. Intel has invested in several companies including the holding firm behind Spreadtrum, while Qualcomm has committed significant funds to supporting Chinese startups, and has also expanded its partnership with the largest foundry in mainland China, SMIC. This company will produce 28nm Snapdragon processors, and that will take some business away from Qualcomm’s main foundry, TSMC in Taiwan.

Qualcomm has sought to reduce its reliance on TSMC since the company hit some problems in delivering full volumes of a new Snapdragon in 2013, but the SMIC deal is also a clear bid to convince Chinese authorities that it will invest some of its profits and technology leadership in the country, rather than its still-significant patent fees being one-way traffic.

Regarding the NDRC settlement, Qualcomm said in a statement that it was disappointed with the results of the investigation but was pleased the NDRC has approved its proposals, and that it would not pursue any further legal redress. CEO Steve Mollenkopf said the deal had removed the uncertainty surrounding its business in China. “We will now focus our full attention and resources on supporting our customers and partners in China and pursuing the many opportunities ahead,” he said.

The firm’s president, Derek Aberle, said at January’s Consumer Electronics Show that a Chinese resolution was “one of the highest priorities for our management team”.

As a result of the fine, the company updated its financial guidance for the fiscal year ending on September 27, lowering its GAAP diluted earnings-per-share estimate to a range of $3.56 to $3.76, down from $4.04 to $4.34. However, with the hope of Chinese royalties flowing again, it raised its revenue forecast slightly at the low end of the range – it is now $26.3bn to $28bn, compared to the prior range of $26bn to $28bn.

Qualcomm takes on IEEE

In other areas, Qualcomm is not in a such a mood to compromise. It said this week that it will not follow the new rules on Wi-Fi patent licensing – proposed by the IEEE, the main standards body behind 802.11 Wi-Fi, and recently approved by the US Department of Justice. The chip giant said it was reconsidering its participation in the IEEE altogether because of the change in patent policy, which was formalised on 8 February. The main change is to base royalty fees on the price of components, such as a chip, not of the whole device.

“Qualcomm will not make licensing commitments under the new policy,” the firm said in a statement and promised “alternative licensing commitments” for future contributions to the standard, without defining what those might be. For now it will continue to submit technologies, but will not promise any particular approach to licensing them.

It has some cards to play if this stand-off turns into a test case for the whole structure of patent charging in wireless devices. Qualcomm claims to be the biggest contributor to some areas of emerging 802.11 standards, particularly, thanks to its acquisition of Wilocity, the 60GHz 802.11ad/WiGig specifications.

However, it is also, in some respects, being backed into a corner. Major rivals like Intel – a major Wi-Fi patent-holder itself – and Broadcom have supported the IEEE’s proposals, partly as a way to weaken Qualcomm. And of course, important Qualcomm customers on the chip side, like Apple and Microsoft, are in favor of the new rules and may be hostile to a company which seeks to derail their implementation.

Apple, in particular, has put its weight behind more general moves to component-based royalty fees, and this public policy from a standards body will greatly increase the impetus behind extending this model to all kinds of mobile technologies.

As well as changing the basis of calculating fees, the IEEE’s new rules will prevent holders of patents included in its standards from getting court injunctions against violating products, “unless the implementer fails to participate in, or to comply with the outcome of, an adjudication, including an affirming first-level appellate review”. Calls for injunctions have been a common feature of recent smartphone IPR wars, which can be exploited as a tactic to undermine a rival’s ability to compete.

When calculating a reasonable rate, the IEEE wants to exclude any benefits from “the inclusion of the technology of an essential patent claim in a standard of the IEEE”, and it would ensure that licensing agreements survive any transfer to other parties. It also believes companies should be able to license a subset of patents, rather than all those included in a standard – a rule which would, if extended to cellular, hit Qualcomm in particular, since it licenses its huge range of inventions on a portfolio basis (though no longer in China of course).

Irwin Jacobs, Qualcomm’s founding chairman and CEO Emeritus, said the proposed changes would provide short term commercial benefits to their backers, but by lowering the fees, could in the longer term reduce the incentive for R&D. In a letter to the IEEE, he said the proposals “have been pushed through despite the absence of any evidence of actual real world problems with the existing patent policy”.

Increasingly, however, the pressure for reform of the mobile industry’s shadowy and archaic licensing models is building, from within as well as from regulators and standards bodies. The Chinese deal is just the start of a period of massive readjustment by Qualcomm, and the shifts in technology and chip economics will impact all companies, including ARM and Imagination, whose business revolves around IP licensing.

Copyright © 2015, Wireless Watch

Wireless Watch is published by Rethink Research, a London-based IT publishing and consulting firm. This weekly newsletter delivers in-depth analysis and market research of mobile and wireless for business. Subscription details are here.

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