Nokia and several other cell phone companies are fighting Qualcomm over royalties for next-generation technology.
Like two superpowers that cooperate for mutual benefit while eyeing each other warily, Nokia Corp. and Qualcomm Inc. have forged an uneasy alliance. Since the early 1990s, Qualcomm has reigned over the cell phone industry, licensing out the basic patents underlying the two main industry standards, GSM and CDMA. As the world's leading cell phone manufacturer, with $50 billion in annual revenue, Nokia is one of Qualcomm's most important licensees. The Finnish company has paid Qualcomm billions of dollars for the rights to so-called second-generation cell phone technology.
Now this fragile détente has reached a breaking point. In April the patent cross-license between the two giants is set to expire. The terms of that pact are confidential, but it is widely believed that Qualcomm collects an average of 5 percent from licensees of its CDMA cell phone technology. Nokia wants a better deal -- and it's not alone.
The time is ripe for renegotiation. The cell phone industry marks its progress in terms of three generations of technology. The first generation, which relied on analog signals, came into its own in the 1980s. The second, benefiting from advances in digital systems, has thrived since the early 1990s. Qualcomm has thrived along with it. About a third of the company's $7 billion revenue comes from patent royalties, which account for about 60 percent of profits. The third generation, or 3G, may not be so lucrative for Qualcomm. Powered by a high-speed digital format, 3G offers whiz-bang features like Web surfing, music downloads and streaming TV clips. While Qualcomm has patents covering 3G technologies, Nokia contends that Qualcomm doesn't have the same kind of death grip as it did on the second generation. In patent and antitrust cases filed across the United States and in Europe, Nokia is pressuring Qualcomm to lower its licensing fees in accordance with the value of its IP contribution to 3G technology. William Plummer, Nokia's vice president of external affairs, sums up the company's grievance this way: "Qualcomm is trying to project its current business model into the future in an uneconomical, irrational way."
A list of household names in the cell phone industry have filed similar complaints in various venues in the United States, Europe and South Korea -- including Ericsson, Texas Instruments Inc. and Broadcom Corp. Qualcomm has countered by filing a string of patent suits against Nokia, Texas Instruments and Broadcom. One investment research firm in London terms the great maze of legal disputes a "holy war." Fighting the crusade are some of the best-known litigators in the U.S. Qualcomm has brought in Evan Chesler, the deputy presiding partner at Cravath, Swaine & Moore and his partner Richard Stark. Broadcom has hired David Boies of Boies Schiller & Flexner as well as George Cary of Cleary Gottlieb, Steen & Hamilton, and William Lee and Michael Esch of Wilmer Cutler Pickering Hale and Dorr. Texas Instruments and Nokia are both represented by Quinn Emanuel Urquhart Oliver & Hedges. Partner Stephen Neuwirth represents T.I. and name partner A. William Urquhart is lead counsel for Nokia.
The stakes in the game contain a dizzying number of zeroes. Worldwide revenue from handsets over the next five years will likely exceed half a trillion dollars, most of it from the sale of 3G devices, according to Marina Amoroso, a wireless industry analyst for the Yankee Group, the Boston-based high-tech research firm. Qualcomm's licensing fees are pegged to handset sales. If the company were forced to accept a lesser royalty rate for 3G, its bottom line would take a hit. "A few points of royalty are likely to amount to many, many millions of dollars over many years," notes Louis Lupin, general counsel and a senior vice president at Qualcomm. "Companies are motivated to fight about it."
The battle is taking place in court, but its roots lie within the arcane world of standard-setting bodies, the nonprofit industry associations that decide what patents are relevant to a given technology and mandate that members license those patents on fair and reasonable terms. What constitutes "fair and reasonable," as the language of many standard-setting agreements requires, is at the heart of the complaints against Qualcomm. As the fight over royalty fees proceeds, it could result in far-reaching rulings by courts or regulatory bodies that would redefine how parties to standard-setting agreements must deal with one another.
National and regional standard-setting bodies helped decide the fate of the second-generation cell phone standards. The GSM standard got its big boost in 1990, when the European Telecommunications Standards Institute picked the technology -- developed largely by European companies -- as the sole cell phone standard for the European market. Standard-setting bodies in the U.S. and Japan designated both CDMA and GSM as their countries' standards. Both second-generation standards solve the technical problem of many people trying to talk at the same time on the same frequency, but they do so in different ways -- CDMA encodes wireless signals, and GSM divides signals into minifractions of a second among multiple users. The split among the world's 2.5 billion cell phone users stands at about 75-25, with GSM in the lead, according to the Yankee Group.
A few years ago, another standard, CDMA 2000, began supplanting CDMA. Groups like the Telecommunications Industry Association in North America and the Telecommunication Technology Committee (Japan) have endorsed some of the CDMA 2000 technology. Meanwhile, GSM has morphed into WCDMA (the "W" stands for wideband). The European standards group has endorsed all of the WCDMA standards, and other groups in Japan, China, South Korea and North America have signed on to some of those technologies.
Qualcomm holds patents in both standards, and it says that about 135 companies have taken a license to one or more of its 3G technologies. Nokia, Broadcom and the other companies suing Qualcomm allege that it's asking too much for these licenses. As a party to several standard-setting protocols, Qualcomm is obligated to license out patents according to fair, reasonable and nondiscriminatory terms. The standard-setting organizations leave it to participating companies to hash out whether an offer satisfies these obligations.
According to a complaint filed by Nokia on Aug. 8 in Delaware Chancery Court, Qualcomm has about 80 percent of the patents in the second-generation CDMA standard. Nokia alleges that Qualcomm's percentages in both 3G standards are much lower. Qualcomm has "less than" 50 percent of the CDMA 2000 patents, and "at most" 20 percent of WCDMA, Nokia writes in the complaint. (Qualcomm's Lupin disputes the numbers but declined to say what the company believes the ratios are.)
Nokia claims that Qualcomm's royalty rates should be lowered in proportion to the lower percentages. The company is asking the Delaware court to devise a test that standard-setting bodies can use to determine a fair and reasonable royalty rate. Nokia wants the court to look at the number of patents that Qualcomm holds. Nokia also wants the court to consider: the cumulative royalty charged by all holders of WCDMA patents; the existence of noninfringing alternatives to Qualcomm's WCDMA patents at the time the standard was adopted; and the extent to which Qualcomm might have exploited its WCDMA patents had they not been included in the standard. A trial is scheduled for March 6.
Few, if any, courts or regulatory agencies have specified a yardstick of that sort, says Lupin. Nor in his view should they do so, because, he says, "It's not what the standards bodies have intended, and that's not how it has worked." He adds that "there's a generally understood meaning within the industry. People know more or less what's required, but the concept is flexible to allow the parties to craft something that works well for their individual situation." As for Nokia's "patent-counting exercise," as Lupin calls its proposed test, he insists that Qualcomm would meet it because, he says, the company has been a "key contributor" to "all CDMA approaches," including WCDMA.
While Nokia has been dogging Qualcomm in Delaware, other companies, especially Broadcom, have been moving against it on several fronts. With $3.5 billion in annual revenue, Irvine, Calif.-based Broadcom ranks among the world's top 20 chip makers. Only within the past two years, however, has the company started supplying chips for cell phones. In an effort to clear the way on patent rights, Broadcom negotiated with Qualcomm during several months last year. But, as in Nokia's case, the negotiations stalled. What Qualcomm offered was "fundamentally onerous," says David Rosmann, Broadcom's vice president for IP litigation.
On May 19, 2005, Broadcom brought a complaint before the International Trade Commission claiming that chips imported by Qualcomm into the United States infringe its patents. (Qualcomm lodged a similar ITC complaint against Nokia in June.) Since then, the dispute has widened. Broadcom filed an antitrust complaint in July 2005 in federal district court in Trenton, N.J., claiming that Qualcomm's "abuses" of its 3G patent power pose the "dangerous probability" of excluding Broadcom and other competitors from the WCDMA chip market. And in federal courts in San Diego and Santa Ana, Calif., the companies have hurled patent infringement claims against each other. Qualcomm claims that Broadcom has infringed 18 patents; Broadcom says that Qualcomm has infringed 12.
Broadcom was one of six companies -- along with Nokia, Texas Instruments, Ericsson, NEC and Panasonic Mobile Communications -- that filed simultaneous unfair trade claims against Qualcomm with the European Union on Oct. 28, 2005. The claims rest on what several lawyers in the case say is a novel theory: that Qualcomm's alleged failure to offer WCDMA licenses on fair and reasonable terms violates EU competition law.
Like Nokia in Delaware, the claimants in the EU argue that the royalties Qualcomm demands on its WCDMA patents are "excessive and disproportionate." The EU claimants go further, however, claiming that Qualcomm's alleged practice of offering lower royalty rates to customers who buy its chips exclusively undermines competition among chip makers. This June, acting alone, Texas Instruments lodged a comparable claim against Qualcomm with South Korea's Fair Trade Commission. Qualcomm denies all these claims. Indeed, company chairman Irwin Jacobs insists that Qualcomm has actually spurred competition among handset producers, making its patents available to new and innovative companies and thus challenging "entrenched" competitors, according to the published text of a speech he made in August at a business policy conference in Aspen, Colo.
The legal disputes have a long way to go before there is any kind of resolution, though some preliminary results are in. On Aug. 30, U.S. District Court Judge Mary Cooper issued a 47-page opinion in the New Jersey case concluding that Broadcom's antitrust allegations, even if true, did not state a viable antitrust claim. Broadcom is appealing the decision to the 3rd U.S. Circuit Court of Appeals.
Also in October, an ITC administrative law judge ruled that Qualcomm's chips infringe a Broadcom patent, but stopped short of recommending that cell phones containing the chips be barred from the U.S. market. A decision by the full commission, which is expected in early 2007, would be subject to appeal. But the looming threat of an injunction may pressure Qualcomm into sweetening the patent terms it is offering its legal adversaries. Conversely, rulings in favor of Qualcomm might stiffen its backbone in negotiations.
In an extraordinary step to expedite a settlement between Broadcom and Qualcomm in the case in San Diego federal court, Magistrate Anthony Battaglia ordered an October meeting between the chairmen of both companies -- Jacobs of Qualcomm and Henry Samueli of Broadcom -- to discuss a "global resolution" of their disputes. But the closed-door meeting did not produce a settlement.
Patent licensing cases typically settle out of court. But this is no garden-variety patent spat. The outcome will not only divide a huge pot of third-generation cell phone royalties, but could also shape the cell phone industry's IP leadership for generations to come.