Qualcomm Ordered to Stop Overcharging for Cellphone Modem Chips

In a decision that might eventually benefit consumers by reducing the cost of mobile phones, a federal judge agreed with the Federal Trade Commission (FTC) that Qualcomm violated antitrust laws by using its monopoly power over certain modem chips to extort unreasonably high prices for those chips. Since cellphone manufacturers likely pass those costs on to consumers, some mobile phones cost a few dollars more than they should be because of Qualcomm’s anticompetitive behavior.

Cellphone Standards

Cellphone signals connect to networks that operate according to cellular communications standards. Those standards determine how mobile phones send and receive voice calls and data. The technical specifications for those standards are developed by standard-setting organizations (SSOs) that collaborate in worldwide partnerships.

The SSOs create standards that allow cellphone users to communicate with each other. To make that possible, the standards must be adopted by manufacturers of devices (including cellphones and modem chips) and by service providers (including carriers and infrastructure companies). The standards have evolved over time, as is represented by the notation that technology is 2G, 3G, or 4G (second, third, or fourth generation).

The standards rely on technology, much of which is patented. The SSOs will not incorporate patented technology into a standard unless the patent holder agrees to license the technology to other companies on fair, reasonable, and nondiscriminatory terms. That agreement is known as a FRAND commitment. Patent holders have an incentive to make that commitment because sales of cellphone technology multiply exponentially when that technology is incorporated into SSO standards.

Qualcomm Technology Licenses

Qualcomm is the world’s largest manufacturer of the modem chips that allow cellphones to connect to wireless networks. Qualcomm made a FRAND commitment to SSOs that required it to license its modem chip technology.

In recent years, Qualcomm has been charging a royalty on the sale of mobile phones in exchange for licensing the right to use various Qualcomm patents associated with modem chips. The royalty is generally 3% to 5% of the phone’s selling price, up to a maximum selling price of $400.

Qualcomm charges less in China because of an antitrust investigation that it settled on favorable terms. Qualcomm obtained those terms after making a $150 million “contribution” to the Chinese government.

Qualcomm makes more that $7 billion each year from licensing its technology. About two-thirds of the company’s value comes of its licensing operation. It also sells modem chips that enable mobile phones to communicate with a network. Qualcomm contracts with manufacturers to produce the chips that it sells. Several competing companies also sell modem chips, although they typically use technology that they have licensed from Qualcomm.

FTC Charges

The FTC contended that Qualcomm violated federal law in two ways: first, by making agreements that caused an unreasonable restraint of trade; second, by gaining monopoly power in the modem chip industry by controlling prices and excluding competitors from the market.

A restraint of trade occurs when a company makes agreements that significantly impair competition. While restraint of trade requires proof of anticompetitive agreements, a company can acquire monopoly power by its independent actions.

A company unlawfully excludes competitors to acquire monopoly power when its conduct harms the competitive process. A company might acquire a large market share by making a better product or marketing it more wisely than competitors, but competing effectively is not unlawful.

Court’s Conclusions

The court concluded that Qualcomm had monopoly power with regard to CDMA modem chips, the kinds that are required to connect to certain 2G and 3G networks, including Verizon’s. Qualcomm has historically controlled more than 90% of the market for CDMA chips, and as much as 96% or 97% in some years, although its market share dropped a bit after MediaTek introduced a CDMA multimode chip.

The court noted that Qualcomm was able to add $4 per chip to the cost of CDMA chips, as opposed to the other modem chips it marketed that had similar production costs, because it enjoyed monopoly power. The cost of developing a new chip from scratch prevented other companies from introducing competing CDMA chips into the market to drive down that premium price.

Mobile phone manufacturers were therefore forced to accept Qualcomm’s monopoly pricing or lose the ability to sell phones that would connect to networks that require a CDMA chip. Representatives of Motorola and Samsung testified that they would not have been able to sell phones without buying Qualcomm’s CDMA chip.

The court arrived at the same conclusion regarding Qualcomm’s LTE chip, required for connection to 4G networks. Sellers of premium ($400+) phones need LTE chips. Qualcomm dominates the LTE chip market, particularly for cellphones not manufactured by Samsung, which has developed its own modem chip division.

The court also concluded that Qualcomm engaged in anticompetitive behavior by refusing to sell modem chips to cellphone manufacturers that did not sign its patent license agreement. Qualcomm is the only company in the industry that imposes that requirement. The court noted that television buyers do not license patents and pay royalties on patented components of the television. Qualcomm imposes that requirement on cellphone manufacturers because it has monopoly power, not because patent licensing is customary in the industry.

Qualcomm’s other anticompetitive actions include refusing to provide sample chips, withholding technical support, and delaying delivery of software or threatening to require the return of software until manufacturers sign Qualcomm’s patent license agreements. The court determined that Qualcomm’s anticompetitive practices “sustain Qualcomm’s unreasonably high royalty rates.”

Relief Granted

According to the court, “Qualcomm not only knows that its royalty rates violate FRAND and are sustained by Qualcomm’s modem chip share, but Qualcomm has also intended to harm competition via its practices.” The court was satisfied that the FTC proved both that Qualcomm unlawfully restrained trade and that it unlawfully gained and exploited monopoly power to increase modem chip prices.

The court ordered Qualcomm to stop misbehaving. More specifically, it ordered Qualcomm to stop conditioning the supply of modem chips on a customer’s willingness to sign a licensing agreement and to negotiate or renegotiate those agreements without threatening to cut off chip supplies, technical support, or access to software.

Qualcomm must also make patent licenses available on FRAND terms and agree to neutral dispute resolution when those terms cannot be agreed upon. Nor can it enter into agreements to be the exclusive supplier of chips to any cellphone manufacturer.

Qualcomm’s Credibility

It isn’t often that large companies lose antitrust cases. In this case, the court found the evidence to be compelling. The court’s view of the evidence was driven in part by its conclusion that Qualcomm’s witnesses were not credible.

Qualcomm relied large on the testimony of its executives in defending against the FTC’s charges. To say that the judge was unimpressed with their testimony would be an understatement.

The judge placed great reliance on the documents that Qualcomm created in the past several years — documents that Qualcomm’s witnesses, including its expert witnesses, largely ignored. The judge noted that the “executives’ trial testimony was contradicted by these witnesses’ own contemporaneous emails, handwritten notes, and recorded statements.”

For example, Qualcomm’s president testified that he was never informed that Qualcomm had threated to cut off the supply of chips to customers, when his notes indicated his awareness that Qualcomm was “constantly” threatening to cut off chip supply to Motorola. Other documents established that the president expressly approved a plan to cut off the chip supply to Chinese manufacturers who refused Qualcomm’s royalty demands.

Qualcomm’s CEO also testified that he was unaware of Qualcomm ever cutting off chip supply in response to a licensing dispute. Yet documents established that the CEO knew that Qualcomm stopped shipping chips to Sony because of licensing issues and failed to put an end to the practice.

The court cited many additional examples of executive testimony that the court considered to be less than credible. Remarkably, documents proved that a division president even emphasized the importance of finding a strategy to cut off chip supply that would minimize Qualcomm’s risk of being sued for antitrust violations. The court faulted a former Qualcomm president who claimed in a deposition that he did not understand a PowerPoint presentation of that strategy for devising a seemingly innocent explanation by the time of trial.

The judge did not buy the sudden improvement of the former president’s memory. In the end, the judge gave more weight to the documents that were prepared during the course of business than the “trial testimony prepared specifically for this litigation.”

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