The U.S. Court of Appeals for the Ninth Circuit in San Francisco will decide America’s 5G future when it considers Qualcomm’s appeal of an antitrust remedy urged by the Federal Trade Commission (FTC).
The FTC’s economically dubious victory against the American standard bearer in mobile phone technologies has resulted, in my view, in a myopic and improvident lower-court order apt to disincent technology development and create confusion in the mobile phone technology marketplace. The Ninth Circuit, which has issued a stay on District Judge Lucy Koh’s injunction pending appeal, should ultimately overturn the decision lest it hurt competition and transfer American leadership in 5G wireless technology to Huawei.
A wider view of the public interest must be countenanced, expressed by the Department of Justice (DOJ) in its Statements of Interest filed before both courts: an unbounded antitrust remedy can endanger innovation and even national security.
The whole wireless technology ecosystem is fragile. It requires that those contributing the technology agree to license in exchange for adequate reward on fair, reasonable, and nondiscriminatory (FRAND) terms. But patents are not self-enforcing. Technology users are not obliged to seek a license. Ultimately technology contributors must assert their patents, sometimes through expensive litigation. Judge Koh’s decision does not provide adequate, fair, and structurally sound compensation for Qualcomm’s technology within the open-innovation FRAND licensing regime established by ETSI (European Telecommunications Standards Institute, the leading wireless standards development organization).
Qualcomm makes two main products: wireless communications technology, often incorporated into standards, that proximately benefits chip manufacturers and handset manufacturers, and industry-leading chipsets for sale to those handset manufacturers. To avoid exhaustion of its patent portfolio by licensing at multiple levels of the value chain, Qualcomm has customarily licensed only handset manufacturers (and not chipset manufacturers). To purchase Qualcomm’s chipsets, those handset manufacturers tend to license the underlying patents. Capturing value through a reasonable royalty is a concern for a business seeking to profit from its risky investment in breakthrough technology.
The court discounted the testimony of Qualcomm’s executives (and testifying experts) in order to find Qualcomm’s licensing practices anti-competitive. Ironically, and surprisingly given concerns raised elsewhere by governments and the private sector, the judge found Huawei’s witnesses credible enough to rely upon and cite, repeatedly. But the judge did not even dare to name the FTC’s economic expert whose “bargaining leverage” theory she tacitly adopted despite its rejection by District Judge Richard J. Leon in last year’s AT&T-TimeWarner ruling for its lack of “reliability and factual credibility.”
Judge Koh’s first main conclusion was that Qualcomm had monopolized two carefully tailored modem chip markets, seemingly only through the force of licensing practices she deemed anti-competitive. That Qualcomm produced a superior product found no place in the court’s decision. Her finding that “Qualcomm had two decades head start on Intel” seems to me to demonstrate Qualcomm’s technological leadership rather than support for the anti-competitive behavior the judge believed she had found. Qualcomm’s success was acknowledged by an Apple executive in 2015: “iPhone cellular: we’ve been using QCOM, and engineering-wise, they have been the best.” Judge Koh did not merely decline to acknowledge this explanation but struck it from the record in the court’s post-trial denial of stay pending appeal.
The judge’s second main conclusion held that this alleged monopoly power was leveraged to obtain patent royalty rates that were not just high, but unreasonably high. Qualcomm’s expert testimony analyzing rivals’ decisions was dismissed as “not reliable” for the reason that it did not analyze Qualcomm’s behavior, thereby failing to reject her null hypothesis that Qualcomm’s licensing was anti-competitive. “Guilty until proven innocent” is a novel approach in antitrust law and not consistent with American jurisprudence. This approach enabled the judge to slide easily from the uniqueness of Qualcomm’s licensing practice to its unreasonableness (hence illegality). Qualcomm’s business model is rather unique because it relies on the licensing of intangible assets much more than it relies on the sale of products.
Did the judge’s ruling fail to follow the law? Perhaps, if the harm to consumers (not just competitors) needs to be shown. Indeed, it does not appear that any evidence of actual (end-user) consumer harm came before the judge.
Judge Koh’s ruling requires Qualcomm to license its IP for standardized cellular technology to chipmakers as well as handset makers, rather than solely to handset makers (as is the industry norm). If Judge Koh heard any evidence that chip-level licensing was better for innovation, efficiency, or competition, she makes no mention of it. The soundness of split-level regulation of the industry has not been supported by evidence, such as would have emerged from the remedy hearing the DOJ sought. But the judge declined DOJ’s recommendation.
The implications of Judge Koh’s decision are significant. Licensees may stop paying royalties right away. A Qualcomm executive declared to the judge in June that Huawei had stopped paying royalties on an active license agreement, resulting in significant lost royalty revenue. Despite Qualcomm’s strong balance sheet and cash reserves, this interruption writ large would be traumatic and could lead to the layoff of thousands of engineers, mostly in the United States. Harm would be inflicted on the American economy, with no benefit for consumers. Harming of the very competition the FTC should be promoting is the natural corollary. If the ruling stands, American leadership in cell phone technology will be the loser, and Huawei will be the clear winner.
I’ve spent much of my career trying to help policymakers and executives of pioneering companies figure out how to capture a fair and reasonable share of the rewards from innovation. Their battle is almost always uphill, unless they have compelling network externalities on their side — which Qualcomm does not.
I’ve rarely seen such a poorly supported FTC antitrust case coupled with an erroneous court decision (so confidently put forward), contrary to caution from a sister government agency and scholarship, that at minimum scopes the complexities of the issues and signals that only “fools rush in where angels fear to tread.”
David J. Teece is a professor at the University of California, Berkeley, and chairman of the Berkeley Research Group.
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