The smartphone industry could completely change after Qualcomm’s disastrous ruling

The most important technology company most people have never heard of just got a disastrous court ruling that could upend the way the smartphone industry does business.

Qualcomm, the world’s largest maker of smartphone chips and modems, has acted illegally for years by charging exorbitant fees to phone makers that license and use its technology, a federal judge ruled Tuesday. The ruling could drastically reduce the amount of money phone makers pay for their smartphones to perform basic functions, including placing calls and connecting to the internet.

Qualcomm’s technology is ubiquitous in smartphones, and the company has ambitions to become the leader in 5G connectivity. The San Diego company makes computers and modems for smartphones, but it makes most of its money from licensing technology it patented years ago that allows phones to connect to cell phone towers. Qualcomm makes tens of billions of dollars every year on licensing, because phone makers pay Qualcomm a percentage of the total value of each phone they sell, up to $400.

But in a case brought to court in 2017 by the US Federal Trade Commission, District Court Judge Lucy Koh ruled Tuesday that Qualcomm’s licensing practices are illegal.

“Qualcomm’s licensing practices have strangled competition … for years, and harmed rivals, [equipment manufacturers] and end consumers in the process,” she wrote in the findings of fact. She found that its business practices are an “unreasonable restraint of trade” under the nation’s antitrust law.

Qualcomm said it disagrees with the decision and will appeal.

Changes to Qualcomm’s business model

Koh ruled Qualcomm should not receive a percentage of sales of each phone a company sells; instead, it should receive a much smaller amount based on what Qualcomm technology exists inside the phone. The ruling would limit the fees based on the $15 to $20 cost of the modem chips itself, rather than the entire cost of the phone.

“It is generally required that royalties be based not on the entire product, but instead on the smallest salable … unit,” Judge Koh wrote in her findings.

The ruling doesn’t cap what Qualcomm can charge for future royalties, but it removes much of the leverage it used to get top dollar from equipment manufacturers, said Florian Mueller, an intellectual property expert who studies patent litigation.

“The conversation has to be what percentage of that chip price is justified,” Mueller said. “What the ruling makes clear is that what they have charged is outrageous.”

Koh also ordered Qualcomm to negotiate or renegotiate license terms with customers in good faith. For example, Qualcomm can no longer threaten to cut off phone makers’ access to the company’s chips. It also can no longer enter exclusivity agreements with phone makers, preventing smartphone companies from putting rivals’ chips in their phones.

Qualcomm must also license its patents to rival chipmakers, which Qualcomm has been hesitant to do in the past.

The company’s practices have made smartphone makers think twice about putting Qualcomm rivals’ technologies in their phones. And it was easier to do business with Qualcomm, because they were already writing licensing checks to the company in the first place. Intel last month said it would exit the 5G modem business because it didn’t believe that business would ever turn a profit.

Pushing back

Qualcomm said it intends to file an expedited appeal of the decision. It will also seek a stay to stop it from taking effect.

“We strongly disagree with the judge’s conclusions, her interpretation of the facts and her application of the law,” said Don Rosenberg, the company’s general counsel, in a statement.

The Trump administration had fought to protect Qualcomm from the ruling. The United States wants to lead the world in 5G technology, as it remains embroiled in a bitter trade war with China, another 5G leader. The Trump administration believes Qualcomm is a crucial piece of that puzzle.

The FTC, which brought the case, is an independent federal agency charged with protecting the interest of consumers. The Justice Department filed arguments in the case that seemed to undercut the FTC’s position. Even if Qualcomm were found guilty of violating the antitrust law, the Justice Department argued the court should not impose any penalties or conditions without additional hearings and arguments.

But Koh rejected that argument.

Growing antitrust sentiment

Her ruling comes five weeks after Qualcomm reached a settlement in a similar but separate antitrust case brought by Apple. That agreement included an unspecified payment from Apple to Qualcomm, and the two companies announced a six-year license contract under which Apple will continue to buy Qualcomm chips. The deal was reached on the eve of that case going to trial.

Qualcomm’s stock had soared 35% following the agreement. But Qualcomm’s stock tumbled 10% in early trading Wednesday.

Although the case specifically applies to Qualcomm and its business practices, critics question the power of the world’s tech giants. Many have called for them to be reined in or even broken up.

The Supreme Court ruled earlier this month that a group of iPhone owners could sue Apple in an antitrust case charging that its App Store is a monopoly. The European Union recently hit Google with a $1.7 billion fine for violating antitrust rules. Critics have accused Facebook and Amazon of having monopoly power.