Opinion: It only took a few days of testimony for the FTC’s case against Qualcomm to fall apart – Part 1

Two years ago, when the FTC first filed its case against Qualcomm in US District Court, outgoing FTC Commissioner Maureen Ohlhausen took the extraordinary step of drafting a dissent letter that outlined just how unjustified and ill-advised the FTC’s case against Qualcomm was. She wasn’t wrong, and the FTC should have heeded her warning. Following the almost comical unraveling of one of the FTC’s key “expert” witnesses’ arguments during testimony earlier this week (we will dive into that in Part 3), the FTC’s already questionable case against the US chipmaker appears to be unraveling right before our eyes. Some highlights, from my perspective:

  • The “monopolistic, anticompetitive” and “harmful” behaviors that the FTC alleges don’t appear to exist.
  • The FTC’s argument that Qualcomm’s licensing fees are “unreasonable” (read: unreasonably high) falls apart the moment those fees are revealed to only amount to a few dollars per phone.
  • Time and time again, the FTC manages to inexplicably present evidence that contradicts its own case. (A spectacular feat unto itself.)
  • Not only does the FTC’s case struggle to make the slightest bit of sense, it ultimately fails to meet even the most basic burdens of proof with regard to any of its accusations.
  • No one seems to understand why the FTC is asking for injunctive relief when no evidence exists that the behaviors it alleges have ever occurred, or are occurring now, or that any harm was ever caused, is being caused now, or might reasonably be caused in the future.

The FTC’s entire case seems to be equal parts fantasy, unsubstantiated claims, and a soup of contradictions that no self-respecting first-year law student would get tangled up in. In short, as one industry colleague also following the case (but who prefers to remain anonymous) put it to me yesterday, the FTC’s case is “basically a mind-numbing clusterf**k.” I would tend to agree.

No one should be all that surprised by this. Anyone with even a cursory understanding of the law, technology licensing, or the mobile industry in general (to say nothing of the mobile chip market) should have been able to poke holes in the FTC’s case long before the start of opening arguments. It was all right there, lying in plain sight in the FTC’s pretrial brief. One almost feels bad for the unfortunate “expert witnesses” that the FTC basically threw to the wolves with somewhat less than a full leg between them to collectively stand on. The prospect that their combined contributions to the FTC’s case might fall somewhere south of effective was predictable enough, but in hindsight, having read through the transcripts of their testimony as the FTC’s case began to come apart around them, they now seem like little more than a sad, sweaty layer of frosting clinging to a crumbling half-baked cake. How this case wasn’t thrown out on principle before it was even allowed to waste taxpayer money is beyond me. To add insult to injury, one of the FTC’s key witnesses, upon whose dubious (and easily debunked) theories about patent valuation much of the FTC’s case rests, failed the neutrality test when it was revealed in court that his firm not only worked for Huawei (a Qualcomm rival that could definitely stand to gain from a ruling against Qualcomm), but that he himself had represented Huawei in negotiations against Qualcomm. (#Facepalm) You couldn’t make this up if you tried.

Before we get to what happened in court with the FTC’s witnesses, let me start this short series by highlighting a just few of what, in my view, are some of the dumbest and most egregiously incorrect elements of the FTC’s case. It is going to take a few articles just to get through the Top 10, but bear with me. If nothing else, this short series will help illustrate just how doomed this self-defeating expedition to nowhere should have been to everyone from the start; but more importantly, you will also learn how this case, should the FTC somehow manage to prevail in Judge Koh’s courtroom, could ultimately take a wrecking ball to R&D investments in the United States, help China achieve global technology hegemony at the expense of the United States, and weaken US national security for decades to come.

Let’s begin.

1. In order to lay the groundwork for its theory that Qualcomm engages in monopolistic behaviors, the FTC alleges that Qualcomm enjoys a monopoly in the premium mobile chip market… by inventing an imaginary market.

For starters, there is no such thing as a “premium” chip market. There is a mobile chip market, which encompasses LTE, CDMA, and broad swath of modems and chipsets with different uses and levels of performance, and naturally, as with all products, some of those chips are better and worse than others. The notion that Qualcomm has somehow created a “premium” mobile chip market, separate from the overall mobile chip market, is like arguing that Tesla has created a premium automotive market, separate from the rest of the auto industry, and that this amounts to some kind of monopoly. This theory would fall apart the moment Qualcomm (and Tesla) rivals introduced comparable alternatives in the market… which is of course precisely what took place.

What actually happened with Qualcomm (and the same could be said of Tesla) is that its ability to innovate enabled it to develop the next generation of high performance products ahead of competitors, and in so doing, initially enjoyed a first-mover advantage in that market. That’s it. Period. Last I checked, the ability to outpace your competitors’ R&D and come out with better products first isn’t anticompetitive behavior, nor is it monopolistic. 

To that point, consider this: Whether we are talking about Qualcomm’s mobile chipsets or Tesla’s smart cars, what the FTC argues is a separate “premium” product category today is really just product evolution driven by a normal, competition-driven innovation lifecycle: When this year’s modem is better than last year’s modem, the new modem isn’t a new “premium” tier. It is just the newest iteration of a constantly evolving product. This should not be rocket science.

Moreover, the FTC’s case, which focuses on the time period roughly between 2008 and 2016, fails to take into account that Qualcomm’s so-called “premium modem-chips” (they aren’t) now have plenty of competition in the market from other chipmakers – ranging from (currently) in-house vendors like Huawei to merchant vendors like Intel. That is just how innovation and competition work in a healthy, competitive market. The FTC’s notion that there a separate market for “premium chips” in the mobile industry existed between 2008 and 2016 is a fantasy. It has no merit in the real world. 

 

2. The FTC’s theory that Qualcomm enjoys a monopoly in the mobile chip market (“premium” or not), is also a complete fantasy.

For starters, if Qualcomm enjoys a monopoly in the mobile chip market, that will certainly be news to Intel (Apple’s sole supplier of LTE modems for its current generation of iPhones), Samsung, Huawei, MediaTek, and other Qualcomm rivals.

If that notion isn’t absurd enough, the FTC inexplicably goes to the additional effort of invalidating its own argument by presenting evidence about Qualcomm’s market share from 2011 to 2016 that clearly shows that Qualcomm does not, in fact, have a monopoly on mobile chipsets. Per the FTC’s pretrial brief:

“Evidence at trial will show that Qualcomm possessed monopoly power in the market for CDMA modem chips in the period from 2006 to 2016. Professor Shapiro [one of the FTC’s expert witnesses] will testify that Qualcomm maintained a share exceeding 90% of the market for CDMA modem chips in each year from 2008 through 2014 and exceeding 80% in 2015, on both unit and revenue basis; in 2016, Professor Shapiro will testify that Qualcomm’s share exceeded 60% on a unit basis and 74% on revenue basis.”

Oh?

Observation number one: Even in the period between 2008 and 2014, when Qualcomm’s market share of CDMA chips was at its highest point, Qualcomm enjoyed a dominant market position, NOT a monopoly.

In case this particular point is in any way unclear: A dominant market position is not a monopoly.

Note: For Qualcomm to be a monopoly, two standards have to be met: 1) Qualcomm must have “the power to fix prices and exclude competitors within the relevant market,” and 2) Qualcomm must also be demonstrably guilty of “the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen or historical accident”. In addition to all of this, the FTC must be able to prove that Qualcomm abused its position AND caused harm, which must not only be proven but quantified. (We will circle back to the FTC’s burden of proof later in the series to discuss the extent to which the FTC’s case fails to meet said burdens.)

Observation number two: Per the FTC’s own admission, Qualcomm’s dominant position in the CDMA chip market steadily eroded from 90% to 80% to 60% in the span of just three years. (Based on this trend, I would assume that Qualcomm’s market share is now below 50%.) The question practically asks itself: How does one argue with a straight face that Qualcomm enjoys a monopoly in the CDMA chip market when the numbers used to support that assertion signal the exact opposite? The ineptitude on display here is egregious enough to give even the most patient observer a stress migrane.

Observation number three: Causality is important here. Was Qualcomm’s high market share in CDMA chips the result of other vendors deliberately choosing not to invest in CDMA and pursuing other markets (WCDMA, LTE), of rivals wrestling with technical hurdles in their pursuit of  CDMA chip development, or the result of anti-competitive behavior? Hint: Cross-examination of several witnesses pointed to the first two factors rather than the third.

Additionally, with regard to possible monopolistic behaviors…

Did Qualcomm “fix” prices? I see no evidence of that. Qualcomm’s competitors set their own pricing and obviously manage to offer competitive pricing for their chipsets, as evidenced by their success against Qualcomm in recent years.

Did Qualcomm exclude competitors within the relevant market? Qualcomm clearly did no such thing. In that time period, the number of Qualcomm competitors entering the market actually increased, and Qualcomm subsequently lost market share – the result of a normal, healthy competitive market, and the opposite of what would have happened had Qualcomm enjoyed a monopoly or engaged in anticompetitive behaviors.

Where is the FTC’s basis for its reasoning? Your guess is as good as mine.

PS: The data presented by the FTC also supports my earlier assertion that first-mover advantage is temporary and in no way anticompetitive. (Quite the contrary, it is fuel to competition as innovation almost always motivates competitors to innovate as well, which drives markets forward and helps them grow.)

 

3. The FTC alleges that Qualcomm’s no-license, no-chip business policy is somehow anticompetitive. That is painfully incorrect.

As I understand it, here’s how the “no-license, no-chip” policy works, in a nutshell:

Say you want to build a phone, and you are looking for a modem to put inside of it. You shop around, and you decide that you want to use Qualcomm’s modem. On the one hand, the modem itself (the chip) is going to cost you $x. You’re buying hardware at this point. You’re buying chips.

With me so far? Okay, good.

Next comes the issue of software and IP licensing, because guess what: A chip isn’t just hardware. It’s also software. A lot of IP (intellectual property / patented innovation) goes into chips and other mobile device components. Some of it has to do with wireless connectivity but a lot of it also has to do with power management, user functionality, system compatibility, over-the-air algorithms, end-to-end software techniques and methodologies, etc. This means that, in addition to buying the chip, you also need to become a licensee of that IP in order to have the right to use the chip. This is not unlike having to sign a licensing agreement for apps and the productivity software that we all download to our phones and laptops.

Now, Qualcomm could decide, if it wanted to, to make all of its software licenses available to all for free. It is within Qualcomm’s rights to do that. But because Qualcomm isn’t a nonprofit, and the company has a fiduciary duty to its investors (and to itself) not to give away the fruits of the tens of billions of dollars already invested in the development of said IP, Qualcomm charges a small fee that gives licensees access to various parts of its vast IP portfolio, and the right to build products and features around those patents, however they see fit.

There is therefore nothing anticompetitive, illegal, unethical, or otherwise shady about Qualcomm’s “no-license, no-chip” policy. It makes sense. Without the licensing element, purchasers of Qualcomm chips would not be able to actually use the chips other than for decoration without exposing themselves to patent infringement challenges. Licensing gives them legal access to the chips’ functionality as per the licensing agreement, gives them the right to actually use the IP built into the chips, and also gives them access to IP they will need to activate a plethora of adjacent mobile functionality without which their phone will be mostly useless.

The FTC has zero cause to attack this model, and I cannot fathom why they would. The only explanation I can come up with is that somewhere along the way, the FTC somehow managed to confuse “no-license, no chip” with its exact opposite: “no-chip, no license,” which would be an example of anticompetitive behavior. (“No-chip, no-license” would be a scheme by which a company forces handset makers to purchase its chips in order to have access to its portfolio of standard essential patents / SEPs. It doesn’t take a legal expert to glimpse how that kind of practice would run afoul of antitrust and FRAND frameworks. No argument there.) The problem though, at least for the FTC, is that Qualcomm does no engage in a “no-chip, no-license” model. Qualcomm’s business model is the precise opposite.  Is the FTC confused on this point? Your guess is as good as mine. Nothing about its line of thinking on this point makes any sense. And we’re just getting started.

Stay tuned for more, and definitely be on the lookout for Part 3, where I will share some insights into how this case, should the FTC prevail, could, by weakening IP protections and disincentivizing R&D investments, ultimately undermine both national security and the future of US innovation.

To be continued.

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Olivier Blanchard

Senior Analyst at Futurum Research
Olivier Blanchard has extensive experience managing product innovation, technology adoption, digital integration, and change management for industry leaders in the B2B, B2C, B2G sectors, and the IT channel. His passion is helping decision-makers and their organizations understand the many risks and opportunities of technology-driven disruption, and leverage innovation to build stronger, better, more competitive companies. A trusted source of analysis and insights on digital business and digital innovation, Olivier also travels the globe speaking about business technology, Disruption as a Model (DaaM), and the impact of innovation on markets and culture. He is also the best-selling author of Social Media RIO: Managing and Measuring Social Media Efforts in Your Organization, and co-author of Building Dragons: Digital Transformation in the Experience Economy. Blanchard is based in Greenville, South Carolina.
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