China NDRC’s decision on Qualcomm could send message on intervention in IT patent practices

4 November 2014. By MLex Staff.

China's antitrust watchdog is set to announce soon a package of remedies in its high profile investigation into Qualcomm, a move that could send a message on how it defines antitrust infringement and applies antitrust rules to intervene in the patent licensing practices of technology companies.

While exact details of the package remain unclear, the National Development and Reform Commission may levy some fines on Qualcomm, but the amount is likely to be lower than the speculation that has appeared in some media reports, MLex has learned.

Chinese media reported earlier that Qualcomm could face a hefty penalty up to 10 percent of its previous year's sales revenue, confiscation of illegal gains, and also be required to pay back some patent fees.

The NDRC is likely to impose a series of conditions, such as lowering patent licensing fees for certain products and revising its grant-back provisions.

Among other corrective measures, the US chip maker may also agree to license its standard essential patents on fair, reasonable and non-discriminatory, or Frand, terms.

The San Diego-based technology firm has counted on China's booming smartphone sales to fuel its growth. It recorded $12.3 billion in revenue from chip sales and licensing fees in China for the year ended in September, accounting for 49 percent of its total revenue.

"The remedies would be difficult for Qualcomm in any way, depending on what sort of prohibition or settlement measures [are taken], and whether they would affect their business model," one Beijing-based antitrust lawyer said.

The crucial question centers on whether the NDRC will intervene in Qualcomm's business model and require it to change its basis for charging licensing and royalty fees from the whole device into single chips.

Chinese smartphone makers have accused Qualcomm of unfairly high pricing because it charges royalty fees for WCDMA, LTE and other standard-essential patents, or SEPs, of around 5 percent of the whole cellphone device, while Chinese handset makers suffer from very low profit margins due to intense competition.

In addition, the NDRC's investigation focuses on other issues such as bundled sales of SEPs, and non-SEPs; requiring licensees to grant back for free; charging for expired patents; bundled sales of patents and chips; refusal to license patents to chip manufacturers; and imposing unreasonable trading conditions on the sale of patents and chips, according to a statement by the NDRC on July 11.

In its resolution of the Qualcomm case, the regulator is likely to send an important signal to other multinational technology companies that may have similar problems.

Currently, the NDRC is also investigating audio technology company Dolby Lab and electronics product licensing agent HDMI Licensing for alleged abuse of dominance.

Low profit and excessive pricing

China is currently the world's largest smartphone market. There are hundreds of downstream smartphone makers in China, which generally have very low profit margins, and the steep licensing fees are cutting into their profitability.

The NDRC's aggressive approach to the use of excessive pricing law to tackle patent pricing has raised concerns that the policy may be an attempt to lower royalty payments in order to benefit Chinese companies.

A senior antitrust adviser warned last week that the Chinese regulator should exercise caution and adopt the rule-of-reason principle and professional analysis when attempting to use suspicions of excessive pricing to intervene in the high-tech market. But Wang Xiaoye, an adviser to the State Council's Antimonopoly Commission, said

Qualcomm's sales practices violate Frand obligations and are noticeably "unfair and unreasonable," because the company expanded the calculation scope, and also charged for other non-essential patents in devices.

The high fees have put many Chinese handset manufacturers on the verge of losses, whereas a reasonable licensing rate would take into consideration reasonable returns for manufacturers, Wang said in July.

An executive at a Shenzhen-based smartphone company also said Qualcomm's royalties are too high and should be prohibited.

Most Chinese smartphone players have operating profit margins of less than 10 percent, compared with 23 percent for Samsung and around 40 percent for Apple in 2013, according to a recent research note by Bank of America Merrill Lynch.

In the same year, Chinese phone maker Lenovo had a profit margin of 1 percent; TCL had a margin in the low single digits; while ZTE was still facing losses. In contrast, Xiaomi, the most profitable company, had a margin of around 10 percent.

"Looking at the industry going forward, there are more essential patents for 4G and 5G wireless standards, which could be tens of thousands. A 5 percent or 2 percent charge based on the price of the final product may make the IP costs more expensive than the sales price of the whole product [if all holders of essential patents charged handset makers similar fees]," an antitrust lawyer said.