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Qualcomm’s Business Model Is on Trial Over a $7.50 Fee

Ian King, Mark Gurman and Kartikay Mehrotra
Qualcomm’s Business Model Is on Trial Over a $7.50 Fee

(Bloomberg) -- Apple Inc. didn’t mind paying a modest technology fee to Qualcomm Inc. when it first launched the iPhone, but times have changed.

Testimony in the U.S. Federal Trade Commission’s antitrust case against Qualcomm reveals that Steve Jobs gladly agreed to the San Diego-based chipmaker’s request for a licensing royalty in 2007 when Apple’s chief executive needed chips for his company’s nascent smartphone.

On Monday, Apple’s current second-in-command took the witness stand to denounce the $7.50-a-phone fee as an unfair business practice. The regulatory agency called Apple Chief Operating Officer Jeff Williams as a witness to help show that Qualcomm has abused its global dominance in the smartphone market.

“That may not sound like a lot, but we’re selling hundreds of millions of phones,” and that’s “a billion dollars a year," Williams told U.S. District Judge Lucy Koh Monday as the non-jury trial moved into its second week in San Jose, California. “We had a gun to our head.”

Apple has come a long way since Jobs made his deal with Qualcomm -- and that helps to explain why the Silicon Valley giant now views the fee as a ransom. Twelve years ago, Apple was late to enter the mobile phone market and was desperate for technology. Today, it defines a market that sells more than a billion devices worldwide a year.

Qualcomm Faces FTC Trial Threatening Smartphone Dominance

Qualcomm’s fees are at the heart of the government regulator’s case against it. Fees provide the company with the majority of its profit, enabling it to fund technology development that helps cement its position as the leading chipmaker in the industry.

The FTC and Qualcomm’s customers accuse the company of exacting too high a price for only one part of what makes smartphones so attractive to consumers -- and doing so by illegally bullying its customers into paying up.

Qualcomm counters that the fees are relatively small for technology that’s so fundamental to phones and claims that the patents it owns underpin how modern, high-speed-data networks work. Its technology determines how handsets are able to efficiently access high-speed data -- without which the iPhone would be just an expensive iPod, the chipmaker has said. Qualcomm maintains that it continues to contribute technology to other areas of the industry and its practices follow industry norms.

A $7.50 fee is a drop in the bucket considering that iPhones sell, on average, for $793 each. But it adds up. Qualcomm’s licensing revenue peaked in 2015 at $7.9 billion. In its most recent financial year, Qualcomm had revenue of $5.16 billion from its licensing division, even in a year when Apple had stopped paying fees. Apple sold 217 million iPhones in its most recent fiscal year.

Apple Claims ‘Mounting Evidence’ Against Qualcomm’s Business

Apple didn’t use Qualcomm modems in its devices until 2011, but it still owed the company royalties due to its patents. For the initial iPhone models, Apple used modems from Infineon, which was acquired by Intel Corp. in 2010.

The licensing fight soured the relationship between the world’s leader in semiconductor technology and the iPhone maker, leading Apple to sue Qualcomm in 2017. Williams testified Monday that the legal battle prompted Qualcomm to refuse to provide chips for the 2018 iPhones, despite his efforts to negotiate a deal.

Williams said the chipmaker left Cupertino, California-based Apple no choice but to use Intel modems exclusively in the iPhone XS, iPhone XS Max, and iPhone XR released in September and October.

Qualcomm said in October 2017 that it had already “tested and released to Apple” modems that could be used in the new iPhones and that it was committed to working as a supplier for Apple.

Other Apple executives testified earlier Monday that the company prefers to source components from multiple providers. Dual-sourcing chips allows Apple to drive down costs, but also provides a contingency plan if there’s an issue with one of the suppliers.

Qualcomm President Cristiano Amon told Koh last week that the company is still trying to get new business from Apple.

The case is Federal Trade Commission v. Qualcomm Inc., 17-cv-00220, U.S. District Court, Northern District of California (San Jose).

(Corrrects scope of smartphone sales in fifth paragraph.)

To contact the reporters on this story: Ian King in San Francisco at ianking@bloomberg.net;Mark Gurman in San Francisco at mgurman1@bloomberg.net;Kartikay Mehrotra in San Francisco at kmehrotra2@bloomberg.net

To contact the editors responsible for this story: Elizabeth Wollman at ewollman@bloomberg.net, ;Jillian Ward at jward56@bloomberg.net, Peter Blumberg, Steve Stroth

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