After years of "forced" exclusivity, Apple finally added another baseband supplier in the iPhone 7. Image source: Apple.
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Just days after the Federal Trade Commission sued Qualcomm (NASDAQ: QCOM) for antitrust concerns, Apple (NASDAQ: AAPL) took an unprecedented step of similarly filling suit against one of its most important suppliers. The complaints are largely the same, but Apple felt compelled to file its own lawsuit in part to get nearly $1 billion that it says it is owed. According to the complaint, Qualcomm gives Apple rebates that effectively serve as royalty relief, but in exchange Apple has agreed to buy baseband processors exclusively from the company for the past five years. It's these rebates that Qualcomm is now withholding since Apple has cooperated with antitrust regulators around the world.
AppleInsider's Mikey Campbell unearthed the entire 104-page complaint and posted it on Scribd. I'd encourage Apple investors to give it a look, but for those that aren't inclined to spend their weekends reading legal complaints, I've read through it in full and here are the most damning things that Qualcomm is being accused of. (All bold emphasis added by me.)
Qualcomm tried to get Apple to change its testimony
The Korea Fair Trade Commission (KFTC) fined Qualcomm $853 million just last month, based in part on Apple's testimony to the KFTC. When Qualcomm learned that Apple would be cooperating with the investigation, it tried to use the royalty rebates as leverage:
There's little enforcement of whether patents are actually essential
When patents are deemed standards-essential by standard-setting organizations (SSOs), they become incredibly powerful. But companies are able to declare their patents as essential, and SSOs do not validate these claims:
Apple is challenging the validity of some of Qualcomm's standards-essential patents (SEPs).
Qualcomm has violated its FRAND commitments
Companies that have SEP portfolios are required to license those patents to rivals at fair, reasonable, and non-discriminatory (FRAND) rates. Qualcomm is egregiously refusing to offer FRAND licensing:
Rivals never had a chance
Many companies have exited the baseband processor market over the past decade. It wasn't just intense competition, either -- they never had a chance because Qualcomm cornered the market by leveraging its patent portfolio:
Apple's contract manufacturers are partially responsible
Apple doesn't license Qualcomm's patents directly, and not for a lack of trying. Instead, its contract manufacturers ink licensing deals, and subsequently pass along the royalty costs in full to Apple. The contract manufacturers like Foxconn don't bother negotiating, since Apple foots the bill. These agreements are confidential, and Qualcomm won't even let Apple see them:
Apple pays more for less
Qualcomm is but one of many companies that hold SEPs and contribute to cellular standards. Apple has to pay Qualcomm more than everyone else combined:
Qualcomm used Apple to kill WiMAX
Once upon a time, WiMAX was a competing 4G standard. Apple never released a WiMAX iPhone, which helped contribute to the standard's loss to LTE, which has emerged as the dominant 4G technology:
This has been going on for nearly a decade
The iPhone is now 10 years old, and as such Apple has been seeking a direct license ever since.
Qualcomm makes money when you upgrade storage
Since Qualcomm's royalty structure is calculated as a percentage of the device's price, the company collects more for more expensive phones:
Compared to a $100 Kyocera LTE smartphone, Apple estimates that its royalty payment for a $400 iPhone SE is "four to nine times more than Kyocera's royalty for its smartphone." That also means Qualcomm collects more when customers pay as much as $200 more for increased storage capacity, a feature that has nothing to do with cellular connectivity.
Apple has wanted to bring on competing basebands suppliers for years
It goes without saying that Apple considers a wide range of suppliers for nearly all of its components, considering the significant benefits of dual-sourcing (reduced supply risk, increased leverage in pricing negotiations, etc.). But it couldn't:
There's more where that came from
These are the most interesting snippets within the filing, but there is a lot of other information about Apple's contentious relationship with Qualcomm over the years. This case is going to be a big storyline for the two companies in 2017, and the legal process could even potentially drag on for years unless Apple and Qualcomm settle.
If the pair make it to trial, investors can expect even more juicy details to finally see the light of day.
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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Qualcomm. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy.