This article was co-authored by Senior Analyst Olivier Blanchard
The clinical distance we enjoy as analysts allows us to be somewhat more objective than the average pundit, fan boy (or fan girl), or critic. As a result of both our focus and access, we often find ourselves on the front lines of not only emerging technologies and exciting disruption, but emerging problems that arise in the tech sector. As front-line observers of these problems, it occasionally falls on us to sound the alarm and provide expert analysis when one comes across our radar. This is such a moment.
This might be a good place to point out that we are generally fans of Apple, and have been for quite some time. Most of us here use Apple devices, and like many technology and design enthusiasts around the world, look forward to whatever Apple has in store for the market next. But just because we like a company doesn’t mean we get to turn a blind eye to behaviors or actions we find troubling. Case in point: Just a few days ago, on April 28, Apple announced that it would be withholding payments to its contract manufacturers for royalties they owe under licenses with Qualcomm for sales in the quarter ending March 31, 2017. This announcement, according to Apple, pertains to an ongoing legal dispute with Qualcomm regarding said royalty payments. The long and short of that initial dispute is a topic for another day, and one that we will dive into over the course of the next several weeks and months. For now, make a mental note of the following points:
1.) Conspicuous Timing, Questionable Ethics: Apple’s announcement came less than a week before its May 2 quarterly earnings call, during which we learned that iPhone and iPad sales were down from this quarter last year. On a more positive note for Apple, its overall sales for the March quarter, driven by a strong push into services, rose from $50.6 billion a year ago to $52.9 billion.
Given Apple’s contract manufacturers’ already thin margins, relatively inexistent bargaining position, and relative neutrality in the Apple vs. Qualcomm licensing dispute, Apple withholding payment from its contract manufacturers (Read: business partners) does not strike us as particularly ethical. Did Apple even warn their contract manufacturers in advance, or set a start date to give them the opportunity to adjust, or did Apple simply announce that it would be withholding payments retroactively, leaving their partners holding the bag? Based upon Qualcomm’s restated guidance last week, they don’t appear to have received any advance-warning.
Secondly, and adding insult to injury, Apple decided to suspend royalty payments owed to contract manufacturers mere days before announcing soaring revenues for the previous quarter ($2.3 billion more than last year’s Q2), and the return of over $10 billion to investors. Given these numbers, which Apple had to have been aware of on April 28th, the announcement’s timing seems especially self-serving.
2.) Punishing Partners and Stifling Innovation: By unloading a significant portion of costs that it should be responsible for onto contract manufacturers, Apple is unfairly forcing the ecosystem to carry weight it shouldn’t have to, and ultimately making it difficult for core innovators like Qualcomm – without whom the kind of structural innovation that mobility, the cloud, and the IoT depend on cannot advance – to invest in crucial research and innovation.
Qualcomm, for its part, has strategically spent billions of dollars on wireless technology innovation that Apple has utilized to deliver their most successful products. Comparatively, Apple has spent very little on wireless innovation, depending instead on partners like Qualcomm to handle most of the ground work – partners, it should be said, whom Apple is now battling in court to lessen the value of their R&D investments.
3.) Are Earnings Being Artificially Inflated? The impact of Apple’s decision to withhold royalties, relative to Apple’s latest financial disclosures, should not be glossed over or ignored. We consider it to be a fairly prominent caveat in Apple’s financials since they are proclaiming to be accruing against royalties due, but not disclosing at what rate. Any amount below the normal agreed-upon rate would theoretically have been reflected as quarterly profit. It is important not to forget that, whether Apple acknowledges it or not, and whether or not royalty payments have been made or remain on hold, a significant portion of Apple’s quarterly results will be based upon earnings from sales of devices that included Qualcomm Intellectual Property.
In short, we aren’t exactly impressed with Apple’s decision to use their supremacy in the market as a bully whip to not only get out of paying their share of licensing and royalty fees to artificially enhance their bottom-line, but to do so in such a way that a) contract manufacturers who depend on high volume Apple contracts are made to bear the brunt of a dispute they have no part in, and b) Qualcomm, which Apple appears to also be attempting to bend to its will, now finds itself in the uncomfortable position of having to either weather the temporary loss of revenue from Apple’s “decision,” or lean on contract manufacturers whom they know will suffer if they do.
Despite how little press the ongoing and potentially growing dispute between Apple and Qualcomm has garnered in recent weeks, it is a very big deal – much bigger than the business press has made it out to be so far, and more dangerous to the tech ecosystem than any previous dispute between top tier tech companies. Apple’s May 2 earnings call felt to us like the next red flag in a succession of red flags that we need to shed some light on before things get too far out of hand.
The type of aggression we are seeing from Apple, especially since it seems both unnecessary and harmful to the tech ecosystem, worries us. If a large enough company decides to singlehandedly bully its way out of agreements, potentially abuse the courts to simultaneously stifle innovation and trivialize massive R&D investments, and throw the entire ecosystem out of balance for its own ends, the consequences could be disastrous. Not to mention, this type of action could result in severely limiting consumer choice when it comes to device selection. We are surprised to see a company like Apple, which has, in the past, fiercely defended its patents and intellectual property, now appearing to show little regard for the patents and intellectual property of others. Combined with the seemingly callous decision to leave contract manufacturers in a lurch, Apple’s behavior lately is disappointing.
This isn’t just about disappointment and the erosion of trust, however. It is also about the kind of damage and ripple effects this sort of behavior could cause across the technology sector: Supply chains could find themselves severely affected, as could investment channels, innovation projects, indispensable partnerships, and so on, because every single one of these channels is increasingly dependent on wireless technology. Speaking of ripple effects, what would be the impact on the rest of us, who are also becoming more and more dependent on wireless? We don’t just mean consumers and investors but doctors, researchers, engineers, designers, marketers, and everyone who depends on a healthy, well-balanced technology ecosystem to continue to deliver a steady stream of mobile, cloud, and IoT innovation? By taking a wrecking ball to the tech sector’s natural equilibrium, a company of Apple’s stature could cause a great deal of harm, some of it irreparable, to an ecosystem that depends on diversity and strong partnerships to thrive.
Expect more in-depth coverage of this dispute. Until then, consider today’s insight an early alarm bell.
Disclosure: Futurum Research, like all research and analyst firms, provides or has provided research, analysis, advising, and/or consulting to many high-tech companies in the tech and digital industries. The firm does not hold any equity positions with any other companies cited in this column.
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