Er…not quite.
For, while 2016 might have been a pretty good year for Qualcomm but 2017 has started on a bad note with the company facing accusations of indulging in anti-competitive activities from FTC, KFTC and Apple. Sounds complex? Let me try and provide a clearer picture of what’s happening with Qualcomm and why.
More than just chips: Qualcomm’s business model
Let’s begin with a brief overview of Qualcomm’s business model. Most people know Qualcomm as a “chipmaker” in very informal terms. That is right to some extent, but Qualcomm’s business is a little more sophisticated than that and can be classified into three categories. Qualcomm has a sort of 25-75 business model. Even though patent licensing makes up just 25 percent or so of Qualcomm’s revenues, they make roughly 75 percent of their profits from patent licensing. Similarly, even though modems and processors make up close to 75 percent of Qualcomm’s revenues, they contribute just 25 percent of Qualcomm’s profits. It is important to note that the 25-75 split is a rough estimate I am giving since the figures keep changing every quarter but remain in the same ballpark.
Patents, Standards and being FRAND-ly
Now that I have given a rough idea of Qualcomm’s business model we can proceed to the dispute with Apple, FTC and KFTC. First off, what are SEPs and how are they formed? SEPs stand for Standard Essential Patents. In order to ensure interoperability between devices and to achieve mass scale so as to make technologies as affordable as possible, standards are required. Various forms of standards exist in the space of technology and telecommunications but for the scope of this article, we will limit our discussion to the kind of standards Qualcomm makes. Qualcomm is involved in the business of creating telecom standards. The reason why your smartphone works in the US just like it works in India is because organizations known as Standard Setting Organisations (SSO) work together to create a set of standards on the basis of which smartphone manufacturers, network equipment manufacturers, etc., work. Network technologies such as GSM/CDMA for 2G, EVDO/WCDMA for 3G and LTE for 4G are all standards. A new telecom generation arrives roughly once every ten years. 3G came around 2000; 4G around 2010 and now 5G is expected to come by the end of 2017. During the ten-year gap between every new telecom generation, various companies work with standard-setting organizations to create standards that will meet the criteria set out for various generations. For example, GSM and CDMA are telecom standards that meet the criteria needed to be classified as 2G; similarly, LTE is a telecom standard that meets the criteria needed for 4G. Companies such as Ericsson, Huawei, Nokia, Qualcomm, and Samsung, among others, contribute significant resources in creating technologies which they hope Standard Setting Organisations (SS0) will incorporate in their standards. Qualcomm has invested heavily too and holds a number of technologies related to CDMA and LTE. Considering the millions and sometimes billions of Dollars companies pour in to create technologies that get incorporated in telecom standards, they patent those technologies and charge a fee for it. If your technology is part of a standard, as in the case of Qualcomm where its patents are part of the CDMA telecom standard and LTE telecom standard, then it’s governed by the laws of “Standard Essential Patents” and needs to be licensed under “FRAND” terms. What this means is that Qualcomm is required to license its patents on Fair, Reasonable and non-discriminatory terms to every licensee that’s interested.
For a few percent more – Apple bites!
Qualcomm holds a monopoly in the case of CDMA. Apart from Qualcomm, hardly anyone else can provide a CDMA modem and Qualcomm also holds a number of patents in the LTE standard as well. Being SEPs, Qualcomm is supposed to license them to all interested parties. However, that is what Qualcomm is not doing to support its other businesses. As I said above, Qualcomm also supplies modems and SoCs, so it makes strategic sense for Qualcomm to not license its CDMA and LTE patents to competing SoC modem manufacturers so that Qualcomm alone is the sole supplier of modems and SoCs in the case of CDMA and high-end LTE modems.
This is why the iPhone 7 despite having an Intel modem onboard, still uses Qualcomm modems for Sprint and Verizon. While other CDMA patent holders such VIA technologies do exist, the depth of their patents simply is not enough and someone building a modem by licensing through VIA technologies will end up having the risk of being sued by Qualcomm. Qualcomm has a business model where it extracts licensing fees/patents fees by charging a particular percentage of the device’s overall price. This obviously makes Apple one of Qualcomm’s highest paying clients as cellular iPads and iPhones have some of the highest ASPs in their respective industries. For all the advances in telecom, CDMA is still used by Verizon and Sprint in America which happens to be one of Apple’s biggest markets. Qualcomm is not licensing its CDMA and LTE patents to any competing modem maker such as Intel and apart from Qualcomm, the others simply do not hold enough patents in the CDMA sector. So Apple or rather any manufacturer has no choice but to use Qualcomm’s modems and bend to Qualcomm’s terms and conditions. While Apple has to deal with Qualcomm’s onerous terms for its CDMA+LTE modems, Apple’s iPhones are slowing in growth and margins are under pressure. A part of the dispute here is that according to Apple, Qualcomm charging Apple a percentage of the entire device’s price is unfair as apart from the modem, Qualcomm is not helping in making the iPhone any more innovative. Meanwhile, Qualcomm, in its defense, says that without the Qualcomm modem, the entire device is useless and thereby it makes sense to charge a percentage of the price of the entire device. It must be noted that Qualcomm does not directly charge Apple – it charges Apple’s contract manufacturers such as Foxconn which pass on the cost to Apple in full.
Apple is in a precarious position here; the iPhone maker has already moved its SoC division in-house and relies on Qualcomm for the modem alone. Qualcomm has a near-monopoly in the modem division as apart from Intel there is no real competitor. If Apple is able to make Qualcomm license its CDMA and LTE patents or reduce its royalty rates, then Apple benefits. Making Qualcomm license its CDMA and LTE patents to competitors would mean that companies like Intel and Samsung (Shannon) also would be able to create CDMA modems and fight for a place in the next A-series processor as the modem provider. Considering Apple’s scale of operations, it is very necessary for the Cupertino giant to maintain competition in its supply chain. On the other hand, a reduction in Qualcomm royalty rates would directly improve Apple’s profits as the royalty rates are a percentage of the overall device cost. Considering the drop in iPhone’s growth and no new growth avenues available, it becomes clear why Apple has finally decided to train its legal guns on Qualcomm as any gains here would help Apple at least maintain or improve its profits, even if revenue remains stagnant or falls.
A boon for Davids, a bane for Goliaths!
Considering that Qualcomm’s licensing revenue depends on a percentage of the entire device’s cost, Qualcomm has been doing all it can to make itself as indispensable as possible and that has benefited small manufacturers who have little or no R&D budgets. First of all, by virtue of being a SoC manufacturer itself, Qualcomm takes care of one of the most important components of the smartphone. In a PC, the CPU is supplied by Intel, GPU maybe by NVIDIA and the Wi-Fi/LAN component by someone else. Qualcomm integrates all of this into one SoC which contains the CPU, GPU, ISP, DSP, modem and even the radios for Wi-Fi, Bluetooth and NFC.
Qualcomm has long been providing reference designs which smartphone manufacturers can build on top of. Recently, Qualcomm also introduced Snapdragon Sense ID and has even introduced camera modules that provide a bokeh-like effect like the iPhone 7 Plus. All this work that Qualcomm does helps small-scale local manufacturers a lot as they save a lot of R&D money and get Lego-like pieces which they can simply join together and ship as a smartphone. While Qualcomm’s work helps small-scale manufacturers a lot, it is of no use to giants like Apple and Samsung. Apple is very unlikely to ever refer to a Qualcomm reference design for its next design. The company has close to 200 people working on the iPhone’s camera, has its own Touch ID and even has its own custom application processor. The only place where Apple needs Qualcomm is the modem. It is, therefore, becoming easy to see why Apple is annoyed. Qualcomm’s work like Snapdragon Sense ID, reference designs and camera modules help small manufacturers the most and these manufacturers have a very low ASP, of say USD 200. Assuming Qualcomm charges 2 percent as the royalty fee, then the small manufacturer just needs to pay Qualcomm $4 per unit and gets a host of benefits in return. On the other hand, Apple’s ASP is somewhere around $600-$700 and 2 percent of that means USD 12 which ends up being a pretty big amount considering that millions of iPhones are shipped every quarter. Apple does not even benefit from Qualcomm’s extra work and needs to pay USD12 to Qualcomm just because it is using its modem. On the other hand, the small manufacturer benefits from all of Qualcomm’s work and in all probability uses Qualcomm’s Snapdragon SoC. It is important to note that licensing fees are paid over and above what Qualcomm charges for its modems and Snapdragon line of chipsets. It does not matter if you are buying a Snapdragon 820 or Snapdragon 410 or just the modem, the licensing fee will be levied on the cost of the overall device and needs to be paid separately apart from whatever Qualcomm charges for its chipsets or modems. It is important to note that even though Qualcomm charges a licensing fee separately, the licensing fee is not uniform. Chinese manufacturers are known to pay Qualcomm lesser than their Indian and US counterparts.
Qualcomm’s Licence to Make a Killing
Currently, Qualcomm is not licensing its CDMA or LTE patents to any of its SoC or modem competitors and makes sure that if someone wants a modem or chipset for a CDMA or advanced LTE phone, then Qualcomm is their only choice. However, Qualcomm’s investors have long been clamoring for Qualcomm to spin off its licensing division and other businesses. As I said earlier, Qualcomm makes close to 75 per cent of its profits by licensing alone and investors feel that if Qualcomm starts licensing its CDMA and LTE standards to not just manufacturers that use its products but also competitors like MediaTek and Intel then the licensing revenues and thereby profits, can increase significantly. However, if Qualcomm starts licensing its CDMA and LTE standards to competitors then Qualcomm’s modem and SoC business will take a loss. One of the prime reasons why companies like Samsung use Qualcomm SoCs in the North American market is because of CDMA networks and Qualcomm having a monopoly over them. If you want to serve CDMA customers, then a Qualcomm modem is a must and Samsung prefers to use Qualcomm’s SoC in markets/networks where Qualcomm’s modem is the only option, and its own Exynos SoC and Shannon modems in other markets. The only exception was Qualcomm’s disastrous Snapdragon 810 which Samsung did not use anywhere. Otherwise, Samsung has used Snapdragon 820 in quite a few Samsung models. If Qualcomm starts licensing its CDMA and LTE standards to competitors, then Samsung can very well just use its own Exynos SoC everywhere and Intel can finally start supplying a much bigger part of iPhone modems or maybe even all the iPhone modems. Considering the complaints by FTC, KFTC and Apple and investor pressure, it is very well possible that Qualcomm might delink its licensing and other businesses.
Next up from Apple: iModem?
Of all tech companies, Apple has built a very strong silicon team thanks to its acquisition of PA Semi. But the one space where Apple still has not managed to get a strong foothold is the modem. Modems are very integral to the smartphone experience and something that Apple might want to integrate into the Apple Watch or other devices going forward. However building a good modem is anything but easy. Qualcomm has spent years mastering the art of building high-quality modems and absolutely no one matches its quality. A test conducted showed how the Intel modem in the iPhone 7 was much worse off than the Qualcomm modem. Qualcomm is known to spend millions or billions of Dollars on R&D in the telecom community to make sure it stay a step ahead and its technologies become a part of the next major standard of the next generation. Apple, by comparison, is known to have upset the same telecom community by removing the control carriers had on users. Building modems is not easy especially when so much of it depends on maintaining a great relationship with the telecom community and having some of the best RF engineers working under you. But if there’s one company that can pull it off, well, it is Apple. It has the resources, the scale and the incentive to get it done. After all, the A7 was nothing less than a shock to Qualcomm and the chipset community. Do not be too surprised then if Apple pulls off something similar with modems. An iModem? You read it first here.
