Tuesday, April 10, 2007

All Quiet on the Western Front

For nearly century (ca. 1840-1920), the dominant form of warfare between major powers was massed armies, supported by artillery. Long-distance barrages of cannon, mortar and artillery would “soften up” the opponent, particularly during the U.S. Civil War and the Western Front during the Great War (the war to end all wars). In such a context, an unexpected nighttime pause in shelling (I’m told) could be an unnerving event — suggesting either the opponent was either reloading for a major barrage, or moving forces forward for a full frontal attack.

Today (Tuesday), the lack of news on the bitter Nokia-Qualcomm IPR fight is eerie. By most calculations, April 9 (yesterday) was the last day that Nokia’s 2001 CDMA patent license with Qualcomm was valid, and thus any Nokia W-CDMA product shipments today would potentially be in violation of Qualcomm’s patents.

The stakes are high. Based on numbers given by Qualcomm CEO Paul Jacobs at the annual meeting, I estimated that the annualized (post-tax) value of Nokia royalties to Qualcomm’s bottom line was $250-400 million/year, consistent with the $450 million to $500 million (pretax) annual top line estimate made by stock analysts. However, since Nokia is still shipping some GSM phones without UMTS, the proportion is only going to increase as UMTS (W-CDMA) becomes dominant in Europe and starts to be deployed in the US.

This is really the second battle of a war that began nearly 10 years ago. In 1998, Qualcomm held the dominant IPR in the 2G IS-95 (later cdmaOne) but essentially none in GSM (from the EU) or IS-54/IS-136 (the Western Hemisphere D-AMPS). The GSM group (led by Nokia and Ericsson) and the Japanese had agreed to combine a GSM network with a Japanese W-CDMA air interface to create a 3G standard before the Americans could get their act together. The hope of the group (by then called 3GPP) was that they would not need a license to Qualcomm’s CDMA technology, or that Qualcomm could be forced to cross-license its patents (and thus cancel out royalties) as the EU manufacturer cartel had done with GSM. (These patents formed an entry barrier well-documented by the research of my colleague Rudi Bekkers.)

The last battle was when Ericsson gambled that it could ship UMTS phones without a Qualcomm license. The IPR fight threatened to become a EU-US trade war, until in March 1999 the two sides announced a deal. Qualcomm dumped its money-losing infrastructure business and got Ericsson to sign a patent license: despite hand-wringing at the time, it was a clear victory for Qualcomm. Ericsson has since closed the CDMA infrastructure division in San Diego (for which it paid a reported $250 million), leaving that market to Lucent and Nortel.

The speculation now is rampant: both sides must dig in, and both sides must settle. The world’s largest cell phone maker has a business model based on selling phones. Thus, they have been pushing for years to change the rules for UMTS royalties in two ways. First, they want value to be determined by their patent counting proposal (rejected by Qualcomm) that argues that Qualcomm’s patent royalties should be proportionate to its share of the UMTS IPR. Second, they want total royalties should be capped at 5% so more buyer money ends up in the hands of cell phone makers. (Nokia claims its total UMTS IPR costs are less than 3%, but — as with all cell phone IPR royalties — the real figures are not public).

The world’s largest cell phone IPR holder has sought to stick to a business model that says “use one patent, use them all, the price is the same” — a price that (with the notable exception of a one-time deal in China) is around 4-5%. If Qualcomm cuts royalties for Nokia, it will have to cut royalties for almost everyone else, and its IPR royalties (1/3 of revenues but 2/3 of profits) will fall across the board. So this is a pile of money to Nokia but Qualcomm’s entire future.

Conversely, both sides have weaknesses. Nokia’s offer of a token $20 million royalty payment has been suggested to be an attempt to avoid treble damages if they lose the patent lawsuit they plan on winning. Meanwhile, this is the first real test of leadership for Jacobs fils, while Jacobs père in his long career has created two companies, fought the long uphill war to establish CDMA, and of course won the aforementioned skirmish with Ericsson.

To me, the most unremarked development last week was Qualcomm’s demand for arbitration. Unremarked, perhaps, because journalists (Bob Metcalfe aside) haven’t run a business. In normal circumstances, arbitration is a win-win — get a quicker, cheaper resolution without spending piles of money on lawyers. While I don’t know the specific clause in the agreement, Qualcomm’s move implies that they think they have a stronger hand before a neutral third party — absent some new legal theories of IPR royalties of the sort Nokia is trying to establish. In 2003, Nokia requested binding arbitration with InterDigital in 2003 and lost, so perhaps they don’t want to try that route again soon.

But the reality is that (as elsewhere in the U.S.) the only short-term winners are the lawyers. As the UT’s Kathryn Balint reported in an nugget-filled story Monday, Qualcomm’s legal spending has ballooned from $50 million to $200 million a year. Of course, Qualcomm is waging a war on many fronts as its rivals seek to rein in (or end) its business model. Still, Nokia’s lawyers aren’t working for free (and it still has litigation with InterDigital) so its legal spending has also ballooned recently (I’m guessing to approach $100 million/years).

Even if Qualcomm were to win this battle, its legal fights are far from over. As Rob Black of Seeking Alpha blog notes, the next major decision is due May 8 in the ongoing fight with Broadcom.

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