Qualcomm’s dominance hit by changing demands
The leading chipmaker is caught in a bitter licensing issue with Apple, and that is not the only one as it faces antitrust scrutiny from regulators worldwide
teven Mollenkopf, the chief executive of the chipmaker Qualcomm, views the company’s recent patent dispute with Apple and antitrust scrutiny from regulators worldwide as elaborate price negotiations.
His company, he says, invented fundamental technology that animates modern cellphones and deserves to be well paid for its innovation. But, Mollenkopf observed at a “Fortune” conference in July, “people want to pay less”. When asked about the bitter conflict with Apple, which has battered Qualcomm’s profits, Mollenkopf said his company’s position was simple: There is a contract in place.
“That contract has been in existence for a long time,” he said. “There’s not really anything new going on.”
But a lot about the cellphone industry has changed since that contract was signed nearly a decade ago. Those shifts, including the companies that dominate the industry, help explain the challenges Qualcomm faces from big customers like Apple and Samsung and anti-trust watchdogs around the globe.
They also explain why Qualcomm, once so powerful and profitable, has become vulnerable so quickly — and why Broadcom, another big chipmaker, is pouncing with a $105 billion (Dh386 billion) takeover bid.
Changing smartphones
Several forces are working against Qualcomm, including the rise of China as both the dominant smartphone manufacturer and a huge consumer market, and the growing clout of the Apple and Samsung brands. But perhaps as much as anything, the smartphone inventions that attract consumers today are not provided by Qualcomm.
In earlier generations of products, faster wireless connections sold new phones. Today, people walk into stores looking for an Apple iPhone or a Samsung Galaxy and ask about features like the size of the screen, the camera, and its memory and storage capacity.
“All these technologies have little or nothing to do with Qualcomm,” said Romit Shah, an analyst at Nomura Instinet. “The landscape, the environment has changed.”
These technologies have enriched the smartphone experience and driven up the price, especially for top-of-the-line iPhones and Galaxy models. But what has generally not changed is Qualcomm’s licensing formula — typically charging fees of about 5 per cent of the wholesale price of a phone, analysts say, even though its technology accounts for less of the value of many smartphone models.
That position has increasingly irritated big customers like Apple and Samsung and contract manufacturers like Foxconn, which is Apple’s major supplier. (The contract manufacturers are usually the ones that directly pay fees to Qualcomm and receive passthrough payments from Apple and others.)
Antitrust concerns
The other Qualcomm practice that has prompted scrutiny from various anti-trust investigators is charging smartphone-makers license fees whether or not they use Qualcomm chips, because of the strength of its patents. Qualcomm contends that its licensing practices are fair, simple and efficient — allowing new entrants, especially start-ups in Asia, to enter the smartphone market.
But after an anti-trust investigation in China, Qualcomm paid a fine of $975 million in 2015. As part of the settlement, Qualcomm agreed to license some of its patents to Chinese handset makers at lower rates. Analysts estimate that Qualcomm’s overall royalty rates in China were cut by as much as half, to about 2.5 per cent.
The settlement allowed Qualcomm to keep operating in the vast Chinese market and smoothed relations with government officials there. In other antitrust cases, Qualcomm paid South Korea $853 million in December and Taiwan $773 million last month.
In the US, an investigation by the Federal Trade Commission is underway. Shortly after the commission’s move in January, Apple sued Qualcomm, claiming unfair patent-licensing practices.
Apple declined to comment on its chip plans or how a Broadcom acquisition might affect its patent suit against Qualcomm. Analysts say Apple has already been exploring whether to work with other chipmakers or design its own chips.
Already, though, Apple is not making passthrough payments to its contract manufacturers for Qualcomm royalty payments. In turn, those payments — an estimated $2.5 billion a year — are not made to Qualcomm.
Qualcomm has said another major company, which it has not named, has stopped paying license fees of $1 billion a year. In the fiscal year ended in September, the company reported net income of $2.5 billion, less than half the $5.7 billion in the previous year.
“Things went off the cliff pretty quickly, mainly because of Apple,” said Stacy Rasgon, an analyst at Bernstein Research. Mollenkopf has worked at Qualcomm for more than two decades, starting as a bench engineer. He is the first chief executive of Qualcomm who was not part of the founding family. Irwin Jacobs co-founded Qualcomm in 1985 and headed the company until 2005, when his son Paul became chief executive. Paul Jacobs is executive chairman today.
Mollenkopf was elevated to the top job in 2014, after his name surfaced as a candidate to succeed Steven Ballmer as chief executive of Microsoft. Analysts say he has been a champion of Qualcomm’s efforts to build a third large business alongside patent licensing and chips.
“He really understands that Qualcomm’s future depends on its ability to diversify beyond its core smartphone heartland,” said Geoff Blaber, an analyst at CCS Insight, a technology research firm.
Past efforts faltered. For example, Qualcomm invested hundreds of millions of dollars in a unit called MediaFlo, which tried to develop a content delivery service for smartphones. It folded that business, but did sell much of the unit’s assets and technology to AT&T for $1.9 billion in 2010.
Qualcomm’s big bet for the future is 5G technology. The next generation of wireless communications technology holds the potential to connect billions of devices to the internet, from cars to sensor-filled clothes.
A pending $47 billion purchase of NXP, whose specialised chips with beefed-up security are used in some cars and mobile payment systems, would be a big step toward that hoped-for third leg. The deal has been slowed by regulatory reviews.
5G future
In a conference call with analysts, Mollenkopf pointed to the 5G future, declaring that Qualcomm was “leading the industry”. The 5G story is likely to play a prominent role in Qualcomm’s effort to stay independent or at least drive up the price Broadcom eventually pays.
“Its strongest hand is the promise of 5G and that its leadership position will lead to an explosion of demand for its technology,” said David Yoffie, a professor at the Harvard Business School, who has written case studies on Qualcomm. Still, 5G devices are not expected to reach the market in volume until 2019 — and the patience of Qualcomm’s shareholders is uncertain.