Chinese Smartphone Makers, Qualcomm in Battle Royale over Patent Payments

03.24.2014 19:44

Chinese Smartphone Makers, Qualcomm in Battle Royale over Patent Payments

Country’s device manufacturers take complaints over high rates for chipmaker’s royalties to top economic planner, which is investigating

By staff reporter Qin Min

(Beijing) – As the country moves into the next generation of wireless networks, handset vendors hope an anti-trust probe into computer chip giant Qualcomm Inc. will put an end to what they see as discriminatory patent fees.

The country’s top economic planner, the National Development and Reform Commission (NDRC), began investigating the U.S. semiconductor company in November. The probe coincides with the launch of the fourth generation (4G) wireless network in the country, raising questions over whether the top economic planner is targeting Qualcomm to lower the cost of patents for Chinese companies.

Equipment suppliers have become increasingly dissatisfied with Qualcomm’s high patent charges, and hope the move by NDRC will give them some bargaining power, a source from the industry said.

The allegations against Qualcomm come as China’s telecoms firms start offering 4G services, but NDRC denies its probe is connected to that. “We received complaints from industry associations and companies. It has nothing to do with 3G or 4G,” Xu Kunlin, director general of the NDRC’s anti-monopoly bureau, said.

The CEO of a medium-sized mobile phone maker said the complaints came from an industry association in Beijing. “It is not a top-down initiative but certainly regulators also see this is the perfect timing for an anti-trust probe,” the CEO said.

For every device sold, Chinese handset makers pay about 5 percent of the device’s price to Qualcomm for its 3G patents, experts say. Qualcomm said its royalty on devices that only support 4G will be lower than that for 3G.

However, an expert said this is an empty promise.

“The problem is that most mobile phones will be compatible with 2G, 3G and 4G, so they still need to pay the package royalty rate it currently charges,” an expert in intellectual property issues at the Ministry of Industry and Information Technology (MIIT) said. “The 3.5 percent rate for 4G-only devices is impossible to obtain.”

Many vendors see the country’s big push into the next generation of wireless technology as a window of opportunity to renegotiate with Qualcomm for lower rates.

“Most equipment suppliers have not signed 4G contracts with Qualcomm this year because they’re counting the days for the results of the probe to come out,” a source from the industry said.

Qualcomm has 110 authorized 3G mobile phone vendors but only about 50 providers of 4G handsets have signed licensing agreements so far, data from the company shows.

Tough Nut

Qualcomm has more than 30 percent of the global mobile phone chip market and an even higher share in China, an executive at a company that makes devices said.

Because Qualcomm owns so many patented technologies approved by the International Telecom Union (ITU), which sets telecom standards worldwide, “almost no mobile phone maker in the business can completely bypass Qualcomm,” said Wang Yanhui, general secretary of the Mobile Phone China League.

The latter is an industry association representing most domestic handset makers, including ZTE Corp. and Coolpad Group Ltd. The association spent several weeks visiting more than 20 member companies and submitted a report to the NDRC on Qualcomm’s “unfair business practice,” he said, indicating it was the reason for the NDRC’s inquiry.

Chinese handset vendors have little bargaining room because they don’t have much Qualcomm wants besides money, he said.

And suing Qualcomm is difficult. Small handset manufacturers often lack the resources for such a lawsuit, and large companies worry about damaging their ties with Qualcomm. Potential problems could be delivery delays and limits on shipments.

The industry therefore turned to the government’s anti-trust watchdog.

“What people take the most issue with is the large differences in Qualcomm’s royalty rate between different vendors,” the CEO of a medium-sized phone maker said. “For the same patents, Qualcomm’s royalty rate for Huawei and ZTE is about 2.5 percent of the device’s retail price and 4.5 percent for us, so for a phone that sells for 2,000 yuan we have to pay 90 yuan whereas Huawei and ZTE only pay 50 yuan.”

But labeling Qualcomm a monopoly requires a lot of evidence, said You Yunting, a property rights lawyer at Shanghai Debund Law Offices. Although Qualcomm has a large market share, it still faces competition from Chinese chipset makers.

“Monopolistic behavior is the abuse of a dominant market position,” he said. The anti-trust law does not apply unless the government finds evidence that Qualcomm raised royalties for clients who buy from its competitors or used its large number of standard patents to force unreasonable agreements, You said.

Qualcomm also said it is unaware of any anti-trust law violations. The royalty for its CDMA standard patents, a major type of cellular technology approved by the ITU, has remained flat since the 1990s, it said.

“The values of our patents are rising, but the average patent fees for each CDMA device has decreased,” Qualcomm said in a statement it gave Caixin.

The specific royalty rate is determined in negotiations with each mobile phone maker. “Qualcomm does not make a distinction on whether the client is from China or other countries,” the statement said.

You said it is very hard to determine what counts as discriminatory or excessive pricing, and Qualcomm can say it charges different royalties based on its assessment of a vendor’s size, reputation and growth prospects.

Government intervention usually carries great weight in China. When the NDRC launched an anti-trust inquiry into the broadband services offered by China Mobile and China Telecom in 2011, in less than a month the two sought to stop the investigation and promised to make changes.

A source close to Qualcomm said the investigation is similar to ones it has faced before, and “there will not be much surprise.” In 2009, South Korea’s anti-trust agency fined Qualcomm US$ 208 million for abusing its dominant position and discriminating against clients who used rivals’ products. Qualcomm was also under anti-trust investigation in Europe that year due to complaints from European Union companies, but regulators dropped the case after Qualcomm and the firms reached a deal.

New Deal

Handsets vendors also want to change the way Qualcomm charges, Wang said. Unlike Microsoft, which charges a set royalty for a device regardless of its price, Qualcomm usually extracts a royalty as a percentage of the retail price of a device.

It only negotiates one rate with each vendor, without making distinctions for the different standards or models of the handsets the vendor produces. In other words, a company would face much higher payments on a high-end device than it would for a low-end version.

Wang said this is unfair because some models command higher prices considering they have features that have nothing to do with Qualcomm’s patents.

A better way, he says, is to charge by how many parts in a device use Qualcomm technology. If a low-end model uses fewer of its patents, the vendor should be able to pay lower royalties, Wang said.

Qualcomm argues its charging method follows industry standards and is more efficient than calculating which parts involve its patents. Also, the 3G and 4G wireless technology support other functions on the phone, the company said, basically arguing its technology is the most important part of a device.

The expert from MIIT said that as the smartphones develop more features, they will rely less on hardware. For example, an easy operating system and a large screen are the most attractive features of smartphones designed for the elderly.

“The proportion of its patents used in a device continues to decline, so extracting royalties based on the final price is in fact squeezing the value of other patents used in the device,” he said.

Royalties are a major source of income for Qualcomm, making up of nearly two-thirds of its net profit in 2013, the firm’s financial report shows.

The tension between Qualcomm and device manufacturers has heightened in the past year. Phone makers are reluctant to accept its patent licensing approach given the increasingly slim profit margins they face, Wang said.

For example, Coolpad’s revenue from its 3G smartphone model in 2012 was HK$ 13.1 billion. Given the 4.5 percent royalty rate, it had to pay HK$ 589 million to Qualcomm, which is more than its net profit of HK$ 330 million.

The most effective solution, Wang said, is for Chinese companies to develop more patented technologies.