Qualcomm's hardball tactics skewed power balance in licensing negotiations, judge hears

During the first day of trial in the Federal Trade Commission's antitrust case against mobile chipmaker Qualcomm, a federal judge heard from the company's licensees about how Qualcomm's unique business model allowed it to extract anticompetitive royalties on its patented technology standards.

The trial kicked off today in San Jose, California, with the two sides giving US District Judge Lucy Koh competing visions of Qualcomm’s role in the mobile device industry, and its leverage over devicemakers that rely on wireless communications standards like LTE and the forthcoming 5G.

Throughout the day, Koh heard testimony — mostly via deposition videos — from several current and former Qualcomm executives, as well as senior employees at Lenovo and Huawei, about the company's practice of withholding chip supplies from device makers until patent licenses are signed, and how it uses that strategy to coerce companies into signing contracts they don't feel are fair.

Negotiations between Qualcomm and its licensees are central to the FTC's theory that Qualcomm abused the standard-setting process by extracting anticompetitive royalties for its widely adopted technology.

Those licensees are some of the most well-known mobile device makers around the world: Apple, Samsung, Huawei, Lenovo, and many others.

Eric Reifschneider, former senior vice president of Qualcomm's licensing business, said it was his understanding "that we had a practice of not selling modem chips to a company that was not licensed under the patent portfolio for the kind of product that chip would go into"

Reifschneider said he was not aware of any other chipmaker with that same practice.

Today's testimony focused on the "no license, no chips" policy that Reifschneider described. The FTC is also challenging Qualcomm's refusal to license its patents to rival chipmakers, and exclusivity deals, including those with Apple, that it says cut key customers off from Qualcomm's competitors.

The patents at issue in the trial are used in wireless communication standards, specifically those governing cellular connectivity. These so-called standard-essential patents require Qualcomm to offer licenses on fair, reasonable and non-discriminatory terms. The FTC says the company has broken that promise.

Lenovo's vice president of intellectual property, Ira Blumberg, told the court he didn't feel his company had much negotiating power over Qualcomm.

Qualcomm, meanwhile, maintains that its customers are sophisticated, global companies that don't easily fold in negotiations.

Blumberg, though, said his company had little choice in signing on to royalty rates he maintains to this day are too high. “We don’t know if Qualcomm would follow through on their threat to cut off supply, but we can’t take that risk.”

Qualcomm was the only company making chips that would satisfy purchasers of expensive, high-end mobile phones, Blumberg said. It threatened to look elsewhere, but only Qualcomm had what it needed, he said.

Huawei's senior patent counsel, Nancy Yu, told a similar story. She said the company wasn’t happy with the high royalty rates it was paying Qualcomm, but felt it had “no choice” but to sign an extension or lose access to Qualcomm’s modem chipsets, and it had no other option for modem chips for its high-end smartphones.

“If you don’t have the license agreement, they will just cut off the chipset supply,” Yu testified in a taped deposition. Eric Reifschneider of Qualcomm "made it very clear we had to sign a license agreement. We didn’t see there was any other way to avoid the chipset disruption.”

Reifschneider told Huawei that “if we do not extend the CDMA license agreement, they would stop the supply of the chipsets to us, and it would be a disruption of Huawei’s business,” Yu said.

A portion of today's testimony focused on internal Qualcomm deliberations about the possibility of splitting the company between its chip-manufacturing and patent-licensing businesses. The bulk of the company's revenue is derived from chip sales, but most of the profit comes from licensing.

First in 2008, and again in 2015, Qualcomm weighed splitting up the company, with current senior finance vice president David Wise and former CEO Paul Jacobs describing the discussions. Wise was the only witness to testify live today.

In his deposition, Jacobs admitted the company passed on the plan — known as Project Berlin in 2008 — after determining that licensees would have more leverage in negotiations without a connected chip business.

But Jacobs insisted the decision wasn't made to extract above-market rates. Rather, he said the combined business was a better "partner" for its customers. "It turned out I was right," he said of not splitting the company. Qualcomm settled longstanding litigation with Nokia, and ultimately doubled in value, he said.

The company revisited the discussion in 2015 — known as Project Phoenix — when faced with an invasive antitrust investigation by Chinese regulators leading to a nearly $1 billion fine, and increased in-house chip development at Huawei and Samsung for use in their own devices, Wise told the court.

Under examination by FTC attorney Dan Matheson, Wise described a report from Boston Consulting Group that recommended against the split to avoid losing licensing leverage. Wise said that report was used to confirm the company's decision not to break apart.

The trial is scheduled to last through Jan. 28. On Monday, former Qualcomm executives Derek Aberle and Steve Altman are expected to testify, along with a Blackberry executive who will testify under seal about that company's negotiations with Qualcomm.

A related trial between Qualcomm and Apple — one of the chief complainants to the FTC — is expected to start in April. Qualcomm has been trying to settle with the FTC for several months, and discussions are understood to be ongoing.

The trial is also taking place under the spectre of an ongoing government shutdown. Koh said at the end of the day that while the federal courts expect to run out of money Jan. 11, "I think we should assume that we’re going to continue." But she doesn't have confirmation yet that will happen.