Archives For FTC v Qualcomm Series

Qualcomm is currently in the midst of a high-profile antitrust case against the FTC. At the heart of these proceedings lies Qualcomm’s so-called “No License, No Chips” (NLNC) policy, whereby it purportedly refuses to sell chips to OEMs that have not concluded a license agreement covering its underlying intellectual property. According to the FTC and Qualcomm’s opponents, this ultimately thwarts competition in the chipset market.

Against this backdrop, Mark Lemley, Douglas Melamed, and Steven Salop penned a high-profile amicus brief supporting the FTC’s stance. 

We responded to their brief in a Truth on the Market blog post, and this led to a series of blog exchanges between the amici and ourselves. 

This post summarizes these exchanges.

1. Amicus brief supporting the FTC’s stance, and ICLE brief in support of Qualcomm’s position

The starting point of this blog exchange was an Amicus brief written by Mark Lemley, Douglas Melamed, and Steven Salop (“the amici”) , and signed by 40 law and economics scholars. 

The amici made two key normative claims:

  • Qualcomm’s no license, no chips policy is unlawful under well-established antitrust principles: 
    Qualcomm uses the NLNC policy to make it more expensive for OEMs to purchase competitors’ chipsets, and thereby disadvantages rivals and creates artificial barriers to entry and competition in the chipset markets.”
  • Qualcomm’s refusal to license chip-set rivals reinforces the no license, no chips policy and violates the antitrust laws:
    Qualcomm’s refusal to license chipmakers is also unlawful, in part because it bolsters the NLNC policy.16 In addition, Qualcomm’s refusal to license chipmakers increases the costs of using rival chipsets, excludes rivals, and raises barriers to entry even if NLNC is not itself illegal.

It is important to note that ICLE also filed an amicus brief in these proceedings. Contrary to the amici, ICLE’s scholars concluded that Qualcomm’s behavior did not raise any antitrust concerns and was ultimately a matter of contract law and .

2. ICLE response to the Lemley, Melamed and Salop Amicus brief.

We responded to the amici in a first blog post

The post argued that the amici failed to convincingly show that Qualcomm’s NLNC policy was exclusionary. We notably highlighted two important factors.

  • First, Qualcomm could not use its chipset position and NLNC policy to avert the threat of FRAND litigation, thus extracting supracompetitve royalties:
    Qualcomm will be unable to charge a total price that is significantly above the price of rivals’ chips, plus the FRAND rate for its IP (and expected litigation costs).”
  • Second, Qualcomm’s behavior did not appear to fall within standard patterns of strategic behavior:
    The amici attempt to overcome this weakness by implicitly framing their argument in terms of exclusivity, strategic entry deterrence, and tying […]. But none of these arguments totally overcomes the flaw in their reasoning.” 

3. Amici’s counterargument 

The amici wrote a thoughtful response to our post. Their piece rested on two main arguments:

  • The Amici underlined that their theory of anticompetitive harm did not imply any form of profit sacrifice on Qualcomm’s part (in the chip segment):
    Manne and Auer seem to think that the concern with the no license/no chips policy is that it enables inflated patent royalties to subsidize a profit sacrifice in chip sales, as if the issue were predatory pricing in chips.  But there is no such sacrifice.
  • The deleterious effects of Qualcomm’s behavior were merely a function of its NLNC policy and strong chipset position. In conjunction, these two factors deterred OEMs from pursuing FRAND litigation:
    Qualcomm is able to charge more than $2 for the license only because it uses the power of its chip monopoly to coerce the OEMs to give up the option of negotiating in light of the otherwise applicable constraints on the royalties it can charge.

4. ICLE rebuttal

We then responded to the amici with the following points:

  • We agreed that it would be a problem if Qualcomm could prevent OEMs from negotiating license agreements in the shadow of FRAND litigation:
    The critical question is whether there is a realistic threat of litigation to constrain the royalties commanded by Qualcomm (we believe that Lemley et al. agree with us on this point).”
  • However, Qualcomm’s behavior did not preclude OEMs from pursuing this type of strategy:
    We believe the following facts support our assertion:
    OEMs have pursued various litigation strategies in order to obtain lower rates on Qualcomm’s IP. […]
    For the most part, Qualcomm’s threats to cut off chip supplies were just that: threats. […]
    OEMs also wield powerful threats. […]
    Qualcomm’s chipsets might no longer be “must-buys” in the future.”

 5. Amici’s surrebuttal

The amici sent us a final response (reproduced here in full) :

In their original post, Manne and Auer argued that the antitrust argument against Qualcomm’s no license/no chips policy was based on bad economics and bad law.  They now seem to have abandoned that argument and claim instead – contrary to the extensive factual findings of the district court – that, while Qualcomm threatened to cut off chips, it was a paper tiger that OEMs could, and knew they could, ignore.  The implication is that the Ninth Circuit should affirm the district court on the no license/ no chips issue unless it sets aside the court’s fact findings.  That seems like agreement with the position of our amicus brief.

We will not in this post review the huge factual record.  We do note, however, that Manne and Auer cite in support of their factual argument only that 3 industry giants brought and then settled litigation against Qualcomm.  But all 3 brought antitrust litigation; their doing so hardly proves that contract litigation or what Manne and Auer call “holdout” were viable options for anyone, much less for smaller OEMs.  The fact that Qualcomm found it necessary to actually cut off only one OEM – and then it only took the OEM only 7 days to capitulate – certainly does not prove that Qualcomm’s threats lacked credibility.   Notably, Manne and Auer do not claim that any OEMs bought chips from competitors of Qualcomm (although Apple bought some chips from Intel for a short while). No license/no chips appears to have been a successful, coercive policy, not an easily ignored threat.                                                                                                                                              

6. Concluding remarks

First and foremost, we would like to thank the Amici for thoughtfully engaging with us. This is what the law & economics tradition is all about: moving the ball forward by taking part in vigorous, multidisciplinary, debates.

With that said, we do feel compelled to leave readers with two short remarks. 

First, contrary to what the amici claim, we believe that our position has remained the same throughout these debates. 

Second, and more importantly, we think that everyone agrees that the critical question is whether OEMs were prevented from negotiating licenses in the shadow of FRAND litigation. 

We leave it up to Truth on the Market readers to judge which side of this debate is correct.

[This guest post is authored by Mark A. Lemley, Professor of Law and the Director of Program in Law, Science & Technology at Stanford Law School; A. Douglas Melamed, Professor of the Practice of Law at Stanford Law School and Former Senior Vice President and General Counsel of Intel from 2009 to 2014; and Steven Salop, Professor of Economics and Law at Georgetown Law School. It is part of an ongoing debate between the authors, on one side, and Geoffrey Manne and Dirk Auer, on the other, and has been integrated into our ongoing series on the FTC v. Qualcomm case, where all of the posts in this exchange are collected.]

In their original post, Manne and Auer argued that the antitrust argument against Qualcomm’s no license/no chips policy was based on bad economics and bad law. They now seem to have abandoned that argument and claim instead – contrary to the extensive factual findings of the district court – that, while Qualcomm threatened to cut off chips, it was a paper tiger that OEMs could, and knew they could, ignore. The implication is that the Ninth Circuit should affirm the district court on the no license/ no chips issue unless it sets aside the court’s fact findings. That seems like agreement with the position of our amicus brief.

We will not in this post review the huge factual record. We do note, however, that Manne and Auer cite in support of their factual argument only that 3 industry giants brought and then settled litigation against Qualcomm. But all 3 brought antitrust litigation; their doing so hardly proves that contract litigation or what Manne and Auer call “holdout” were viable options for anyone, much less for smaller OEMs. The fact that Qualcomm found it necessary to actually cut off only one OEM – and then it only took the OEM only 7 days to capitulate – certainly does not prove that Qualcomm’s threats lacked credibility. Notably, Manne and Auer do not claim that any OEMs bought chips from competitors of Qualcomm (although Apple bought some chips from Intel for a short while). No license/no chips appears to have been a successful, coercive policy, not an easily ignored threat.

Last week, we posted a piece on TOTM, criticizing the amicus brief written by Mark Lemley, Douglas Melamed and Steven Salop in the ongoing Qualcomm litigation. The authors prepared a thoughtful response to our piece, which we published today on TOTM. 

In this post, we highlight the points where we agree with the amici (or at least we think so), as well as those where we differ.

Negotiating in the shadow of FRAND litigation

Let us imagine a hypothetical world, where an OEM must source one chipset from Qualcomm (i.e. this segment of the market is non-contestable) and one chipset from either Qualcomm or its  rivals (i.e. this segment is contestable). For both of these chipsets, the OEM must also reach a license agreement with Qualcomm.

We use the same number as the amici: 

  • The OEM has a reserve price of $20 for each chip/license combination. 
  • Rivals can produce chips at a cost of $11. 
  • The hypothetical FRAND benchmark is $2 per chip. 

With these numbers in mind, the critical question is whether there is a realistic threat of litigation to constrain the royalties commanded by Qualcomm (we believe that Lemley et al. agree with us on this point). The following table shows the prices that a hypothetical OEM would be willing to pay in both of these scenarios:

Blue cells are segments where QC can increase its profits if the threat of litigation is removed.

When the threat of litigation is present, Qualcomm obtains a total of $20 for the combination of non-contestable chips and IP. Qualcomm can use its chipset position to evade FRAND and charges the combined monopoly price of $20. At a chipset cost of $11, it would thus make $9 worth of profits. However, it earns only $13 for contestable chips ($2 in profits). This is because competition brings the price of chips down to $11 and Qualcomm does not have a chipset advantage to earn more than the FRAND rate for its IP.

When the threat of litigation is taken off the table, all chipsets effectively become non-contestable. Qualcomm still earns $20 for its previously non-contestable chips. But it can now raise its IP rate above the FRAND benchmark in the previously contestable segment (for example, by charging $10 for the IP). This squeezes its chipset competitors.

If our understanding of the amici’s response is correct, they argue that the combination of Qualcomm’s strong chipset position and its “No License, No Chips” policy (“NLNC”) effectively nullifies the threat of litigation:

Qualcomm is able to charge more than $2 for the license only because it uses the power of its chip monopoly to coerce the OEMs to give up the option of negotiating in light of the otherwise applicable constraints on the royalties it can charge. 

According to the amici, the market thus moves from a state of imperfect competition (where OEMs would pay $33 for two chips and QC’s license) to a world of monopoly (where they pay the full $40).

We beg to differ. 

Our points of disagreement

From an economic standpoint, the critical question is the extent to which Qualcomm’s chipset position and its NLNC policy deter OEMs from obtaining closer-to-FRAND rates.

While the case record is mixed and contains some ambiguities, we think it strongly suggests that Qualcomm’s chipset position and its NLNC policy do not preclude OEMs from using litigation to obtain rates that are close to the FRAND benchmark. There is thus no reason to believe that it can exclude its chipset rivals.

We believe the following facts support our assertion:

  • OEMs have pursued various litigation strategies in order to obtain lower rates on Qualcomm’s IP. As we mentioned in our previous post, this was notably the case for Apple, Samsung and LG. All three companies ultimately reached settlements with Qualcomm (and these settlements were concluded in the shadow of litigation proceedings — indeed, in Apple’s case, on the second day of trial). If anything, this suggests that court proceedings are an integral part of negotiations between Qualcomm and its OEMs.
  • For the most part, Qualcomm’s threats to cut off chip supplies were just that: threats. In any negotiation, parties will try to convince their counterpart that they have a strong outside option. Qualcomm may have done so by posturing that it would not sell chips to OEMs before they concluded a license agreement. 

    However, it seems that only once did Qualcomm apparently follow through with its threats to withhold chips (against Sony). And even then, the supply cutoff lasted only seven days.

    And while many OEMs did take Qualcomm to court in order to obtain more favorable license terms, this never resulted in Qualcomm cutting off their chipset supplies. Other OEMs thus had no reason to believe that litigation would entail disruptions to their chipset supplies.
  • OEMs also wield powerful threats. These include patent holdout, litigation, vertical integration, and purchasing chips from Qualcomm’s rivals. And of course they have aggressively pursued the bringing of this and other litigation around the world by antitrust authorities — even quite possibly manipulating the record to bolster their cases. Here’s how one observer sums up Apple’s activity in this regard:

    “Although we really only managed to get a small glimpse of Qualcomm’s evidence demonstrating the extent of Apple’s coordinated strategy to manipulate the FRAND license rate, that glimpse was particularly enlightening. It demonstrated a decade-long coordinated effort within Apple to systematically engage in what can only fairly be described as manipulation (if not creation of evidence) and classic holdout.

    Qualcomm showed during opening arguments that, dating back to at least 2009, Apple had been laying the foundation for challenging its longstanding relationship with Qualcomm.” (Emphasis added)

    Moreover, the holdout and litigation paths have been strengthened by the eBay case, which significantly reduced the financial risks involved in pursuing a holdout and/or litigation strategy. Given all of this, it is far from obvious that it is Qualcomm who enjoys the stronger bargaining position here.
  • Qualcomm’s chipsets might no longer be “must-buys” in the future. Rivals have gained increasing traction over the past couple of years. And with 5G just around the corner, this momentum could conceivably accelerate. Whether or not one believes that this will ultimately be the case, the trend surely places additional constraints on Qualcomm’s conduct. Aggressive behavior today may spur disgruntled rivals to enter the chipset market or switch suppliers tomorrow.

To summarize, as we understand their response, the delta between supracompetitive and competitive prices is entirely a function of Qualcomm’s ability to charge supra-FRAND prices for its licenses. On this we agree. But, unlike Lemley et al., we do not agree that Qualcomm is in a position to evade its FRAND pledges by using its strong position in the chipset market and its NLNC policy.

Finally, it must be said again: To the extent that that is the problem — the charging of supra-FRAND prices for licenses — the issue is manifestly a contract issue, not an antitrust one. All of the complexity of the case would fall away, and the litigation would be straightforward. But the opponents of Qualcomm’s practices do not really want to ensure that Qualcomm lowers its royalties by this delta; if they did, they would be bringing/supporting FRAND litigation. What the amici and Qualcomm’s contracting partners appear to want is to use antitrust litigation to force Qualcomm to license its technology at even lower rates — to force Qualcomm into a different business model in order to reset the baseline from which FRAND prices are determined (i.e., at the chip level, rather than at the device level). That may be an intelligible business strategy from the perspective of Qualcomm’s competitors, but it certainly isn’t sensible antitrust policy.

[This guest post is authored by Mark A. Lemley, Professor of Law and the Director of Program in Law, Science & Technology at Stanford Law School; A. Douglas Melamed, Professor of the Practice of Law at Stanford Law School and Former Senior Vice President and General Counsel of Intel from 2009 to 2014; and Steven Salop, Professor of Economics and Law at Georgetown Law School. It is a response to the post, “Exclusionary Pricing Without the Exclusion: Unpacking Qualcomm’s No License, No Chips Policy,” by Geoffrey Manne and Dirk Auer, which is itself a response to Lemley, Melamed, and Salop’s amicus brief in FTC v. Qualcomm.]

Geoffrey Manne and Dirk Auer’s defense of Qualcomm’s no license/no chips policy is based on a fundamental misunderstanding of how that policy harms competition.  The harm is straightforward in light of facts proven at trial. In a nutshell, OEMs must buy some chips from Qualcomm or else exit the handset business, even if they would also like to buy additional chips from other suppliers. OEMs must also buy a license to Qualcomm’s standard essential patents, whether they use Qualcomm’s chips or other chips implementing the same industry standards. There is a monopoly price for the package of Qualcomm’s chips plus patent license. Assume that the monopoly price is $20. Assume further that, if Qualcomm’s patents were licensed in a standalone transaction, as they would be if they were owned by a firm that did not also make chips, the market price for the patent license would be $2. In that event, the monopoly price for the chip would be $18, and a chip competitor could undersell Qualcomm if Qualcomm charged the monopoly price of $18 and the competitor could profitably sell chips for a lower price. If the competitor’s cost of producing and selling chips was $11, for example, it could easily undersell Qualcomm and force Qualcomm to lower its chip prices below $18, thereby reducing the price for the package to a level below $20.

However, the no license/no chips policy enables Qualcomm to allocate the package price of $20 any way it wishes. Because the OEMs must buy some chips from Qualcomm, Qualcomm is able to coerce the OEMs to accept any such allocation by threatening not to sell them chips if they do not agree to a license at the specified terms. The prices could thus be $18 and $2; or, for example, they could be $10 for the chips and $10 for the license. If Qualcomm sets the license price at $10 and a chip price of $10, it would continue to realize the monopoly package price of $20. But in that case, a competitor could profitably undersell Qualcomm only if its chip cost were less than 10. A competitor with a cost of $11 would then not be able to successfully enter the market, and Qualcomm would not need to lower its chip prices. That is how the no license/no chip policy blocks entry of chip competitors and maintains Qualcomm’s chip monopoly. 

Manne and Auer’s defense of the no license/no chips policy is deeply flawed. In the first place, Manne and Auer mischaracterize the problem as one in which “Qualcomm undercuts [chipset rivals] on chip prices and recoups its losses by charging supracompetitive royalty rates on its IP.” On the basis of this description of the issue, they argue that, if Qualcomm cannot charge more than $2 for the license, it cannot use license revenues to offset the chip price reduction. And if Qualcomm can charge more than $2 for the license, it does not need a chip monopoly in order to make supracompetitive licensing profits. This argument is wrong both factually and conceptually.  

As a factual matter, there are constraints on Qualcomm’s ability to charge more than $2 for the license if the license is sold by itself. If sold by itself, the license would be negotiated in the shadow of infringement litigation and the royalty would be constrained by the value of the technology claimed by the patent, the risk that the patent would be found to be invalid or not infringed, the “reasonable royalty” contemplated by the patent laws, and the contractual commitment to license on FRAND terms. But Qualcomm is able to circumvent those constraints by coercing OEMs to pay a higher price or else lose access to essential Qualcomm chips. In other words, Qualcomm’s ability to charge more than $2 for the license is not exogenous. Qualcomm is able to charge more than $2 for the license only because it uses the power of its chip monopoly to coerce the OEMs to give up the option of negotiating in light of the otherwise applicable constraints on the royalties it can charge. It is a simple story of bundling with simultaneous recoupment.  

As a conceptual matter, Manne and Auer seem to think that the concern with the no license/no chips policy is that it enables inflated patent royalties to subsidize a profit sacrifice in chip sales, as if the issue were predatory pricing in chips.  But there is no such sacrifice. Money is fungible, and Manne and Auer have it backwards. The problem is that the no license/no chips policy enables Qualcomm to make purely nominal changes by allocating some of its monopoly chip price to the license price. Qualcomm offsets that nominal license price increase when the OEM buys chips from it by lowering the chip price by that amount in order to maintain the package price at the monopoly price.  There is no profit sacrifice for Qualcomm because the lower chip price simply offsets the higher license price. Qualcomm offers no such offset when the OEM buys chips from other suppliers. To the contrary, by using its chip monopoly to increase the license price, it increases the cost to OEMs of using competitors’ chips and is thus able to perpetuate its chip monopoly and maintain its monopoly chip prices and profits. Absent this policy, OEMs would buy more chips from third parties; Qualcomm’s prices and profits would fall; and consumers would benefit.

At the end of the day, Manne and Auer rely on the old “single monopoly profit” or “double counting” idea that a monopolist cannot both charge a monopoly price and extract additional consideration as well. But, again, they have it backwards. Manne and Auer describe the issue as whether Qualcomm can leverage its patent position in the technology markets to increase its market power in chips. But that is not the issue. Qualcomm is not trying to increase profits by leveraging monopoly power from one market into a different market in order to gain additional monopoly profits in the second market. Instead, it is using its existing monopoly power in chips to maintain that monopoly power in the first place. Assuming Qualcomm has a chip monopoly, it is true that it earns the same revenue from OEMs regardless of how it allocates the all-in price of $20 to its chips versus its patents. But by allocating more of the all-in price to the patents (i.e., in our example, $10 instead of $2), Qualcomm is able to maintain its monopoly by preventing rival chipmakers from undercutting the $20 monopoly price of the package. That is how competition and consumers are harmed.

Qualcomm is currently in the midst of a high-profile antitrust case against the FTC. At the heart of these proceedings lies Qualcomm’s so-called “No License, No Chips” (NLNC) policy, whereby it purportedly refuses to sell chips to OEMs that have not concluded a license agreement covering its underlying intellectual property. According to the FTC and Qualcomm’s opponents, this ultimately thwarts competition in the chipset market.

But Qualcomm’s critics fail to convincingly explain how NLNC averts competition — a failing that is particularly evident in the short hypothetical put forward in the amicus brief penned by Mark Lemley, Douglas Melamed, and Steven Salop. This blog post responds to their brief. 

The amici’s hypothetical

In order to highlight the most salient features of the case against Qualcomm, the brief’s authors offer the following stylized example:

A hypothetical example can illustrate how Qualcomm’s strategy increases the royalties it is able to charge OEMs. Suppose that the reasonable royalty Qualcomm could charge OEMs if it licensed the patents separately from its chipsets is $2, and that the monopoly price of Qualcomm’s chips is $18 for an all-in monopoly cost to OEMs of $20. Suppose that a new chipmaker entrant is able to manufacture chipsets of comparable quality at a cost of $11 each. In that case, the rival chipmaker entrant could sell its chips to OEMs for slightly more than $11. An OEM’s all-in cost of buying from the new entrant would be slightly above $13 (i.e., the Qualcomm reasonable license royalty of $2 plus the entrant chipmaker’s price of slightly more than $11). This entry into the chipset market would induce price competition for chips. Qualcomm would still be entitled to its patent royalties of $2, but it would no longer be able to charge the monopoly all-in price of $20. The competition would force Qualcomm to reduce its chipset prices from $18 down to something closer to $11 and its all-in price from $20 down to something closer to $13.

Qualcomm’s NLNC policy prevents this competition. To illustrate, suppose instead that Qualcomm implements the NLNC policy, raising its patent royalty to $10 and cutting the chip price to $10. The all-in cost to an OEM that buys Qualcomm chips will be maintained at the monopoly level of $20. But the OEM’s cost of using the rival entrant’s chipsets now will increase to a level above $21 (i.e., the slightly higher than $11 price for the entrant’s chipset plus the $10 royalty that the OEM pays to Qualcomm of $10). Because the cost of using the entrant’s chipsets will exceed Qualcomm’s all-in monopoly price, Qualcomm will face no competitive pressure to reduce its chipset or all-in prices.

A close inspection reveals that this hypothetical is deeply flawed

There appear to be five steps in the amici’s reasoning:

  1. Chips and IP are complementary goods that are bought in fixed proportions. So buyers have a single reserve price for both; 
  2. Because of its FRAND pledges, Qualcomm is unable to directly charge a monopoly price for its IP;
  3. But, according to the amici, Qualcomm can obtain these monopoly profits by keeping competitors out of the chipset market [this would give Qualcomm a chipset monopoly and, theoretically at least, enable it to charge the combined (IP + chips) monopoly price for its chips alone, thus effectively evading its FRAND pledges]; 
  4. To keep rivals out of the chipset market, Qualcomm undercuts them on chip prices and recoups its losses by charging supracompetitive royalty rates on its IP.
  5. This is allegedly made possible by the “No License, No Chips” policy, which forces firms to obtain a license from Qualcomm, even when they purchase chips from rivals.

While points 1 and 3 of the amici’s reasoning are uncontroversial, points 2 and 4 are mutually exclusive. This flaw ultimately undermines their entire argument, notably point 5. 

The contradiction between points 2 and 4 is evident. The amici argue (using hypothetical but representative numbers) that its FRAND pledges should prevent Qualcomm from charging more than $2 in royalties per chip (“the reasonable royalty Qualcomm could charge OEMs if it licensed the patents separately from its chipsets is $2”), and that Qualcomm deters entry in the chip market by charging $10 in royalties per chip sold (“raising its patent royalty to $10 and cutting the chip price to $10”).

But these statements cannot both be true. Qualcomm either can or it cannot charge more than $2 in royalties per chip. 

There is, however, one important exception (discussed below): parties can mutually agree to depart from FRAND pricing. But let us momentarily ignore this limitation, and discuss two baseline scenarios: One where Qualcomm can evade its FRAND pledges and one where it cannot. Comparing these two settings reveals that Qualcomm cannot magically increase its profits by shifting revenue from chips to IP.

For a start, if Qualcomm cannot raise the price of its IP beyond the hypothetical FRAND benchmark ($2, in the amici’s hypo), then it cannot use its standard essential technology to compensate for foregone revenue in the chipset market. Any supracompetitive profits that it earns must thus result from its competitive position in the chipset market.

Conversely, if it can raise its IP revenue above the $2 benchmark, then it does not require a strong chipset position to earn supracompetitive profits. 

It is worth unpacking this second point. If Qualcomm can indeed evade its FRAND pledges and charge royalties of $10 per chip, then it need not exclude chipset rivals to obtain supracompetitive profits. 

Take the amici’s hypothetical numbers and assume further that Qualcomm has the same cost as its chipsets rivals (i.e. $11), and that there are 100 potential buyers with a uniform reserve price of $20 (the reserve price assumed by the amici). 

As the amici point out, Qualcomm can earn the full monopoly profits by charging $10 for IP and $10 for chips. Qualcomm would thus pocket a total of $900 in profits ((10+10-11)*100). What the amici brief fails to acknowledge is that Qualcomm could also earn the exact same profits by staying out of the chipset market. Qualcomm could let its rivals charge $11 per chip (their cost), and demand $9 for its IP. It would thus earn the same $900 of profits (9*100). 

In this hypothetical, the only reason for Qualcomm to enter the chip market is if it is a more efficient chipset producer than its chipset rivals, or if it can out-compete them with better chipsets. For instance, if Qualcomm’s costs are only $10 per chip, Qualcomm could earn a total of $1000 in profits by driving out these rivals ((10+10-10)*100). Or, if it can produce better chips, though at higher cost and price (say, $12 per chip), it could earn the same $1000 in profits ((10+12-12)*100). Both of the situations would benefit purchasers, of course. Conversely, at a higher production cost of $12 per chip, but without any quality improvement, Qualcomm would earn only $800 in profits ((10+10-12)*100) and would thus do better to exit the chipset market.

Let us recap:

  • If Qualcomm can easily evade its FRAND pledges, then it need not enter the chipset market to earn supracompetitive profits; 
  • If it cannot evade these FRAND obligations, then it will be hard-pressed to leverage its IP bottleneck so as to dominate chipsets. 

The upshot is that Qualcomm would need to benefit from exceptional circumstances in order to improperly leverage its FRAND-encumbered IP and impose anticompetitive harm by excluding its rivals in the chipset market

The NLNC policy

According to the amici, that exceptional circumstance is the NLNC policy. In their own words:

The competitive harm is a result of the royalty being higher than it would be absent the NLNC policy.

This is best understood by adding an important caveat to our previous hypothetical: The $2 FRAND benchmark of the amici’s hypothetical is only a fallback option that can be obtained via litigation. Parties are thus free to agree upon a higher rate, for instance $10. This could, notably, be the case if Qualcomm offsetted the IP increase by reducing its chipset price, such that OEMs who purchase both chipsets and IP from Qualcomm were indifferent between contracts with either of the two royalty rates.

At first sight, this caveat may appear to significantly improve the FTC’s case against Qualcomm — it raises the specter of Qualcomm charging predatory prices on its chips and then recouping its losses on IP. But further examination suggests that this is an unlikely scenario.

Though firms may nominally be paying $10 for Qualcomm’s IP and $10 for its chips, there is no escaping the fact that buyers have an outside option in both the IP and chip segments (respectively, litigation to obtain FRAND rates, and buying chips from rivals). As a result, Qualcomm will be unable to charge a total price that is significantly above the price of rivals’ chips, plus the FRAND rate for its IP (and expected litigation costs).

This is where the amici’s hypothetical is most flawed. 

It is one thing to argue that Qualcomm can charge $10 per chipset and $10 per license to firms that purchase all of their chips and IP from it (or, as the amici point out, charge a single price of $20 for the bundle). It is another matter entirely to argue — as the amici do — that Qualcomm can charge $10 for its IP to firms that receive little or no offset in the chip market because they purchase few or no chips from Qualcomm, and who have the option of suing Qualcomm, thus obtaining a license at $2 per chip (if that is, indeed, the maximum FRAND rate). Firms would have to be foolish to ignore this possibility and to acquiesce to contracts at substantially higher rates. 

Indeed, two of the largest and most powerful OEMs — Apple and Samsung — have entered into such contracts with Qualcomm. Given their ability (and, indeed, willingness) to sue for FRAND violations and to produce their own chips or assist other manufacturers in doing so, it is difficult to conclude that they have assented to supracompetitive terms. (The fact that they would prefer even lower rates, and have supported this and other antitrust suits against Qualcomm doesn’t, change this conclusion; it just means they see antitrust as a tool to reduce their costs. And the fact that Apple settled its own FRAND and antitrust suit against Qualcomm (and paid Qualcomm $4.5 billion and entered into a global licensing agreement with it) after just one day of trial further supports this conclusion).

Double counting

The amici attempt to overcome this weakness by implicitly framing their argument in terms of exclusivity, strategic entry deterrence, and tying:

An OEM cannot respond to Qualcomm’s NLNC policy by purchasing chipsets only from a rival chipset manufacturer and obtaining a license at the reasonable royalty level (i.e., $2 in the example). As the district court found, OEMs needed to procure at least some 3G CDMA and 4G LTE chipsets from Qualcomm.

* * *

The surcharge burdens rivals, leads to anticompetitive effects in the chipset markets, deters entry, and impedes follow-on innovation. 

* * *

As an economic matter, Qualcomm’s NLNC policy is analogous to the use of a tying arrangement to maintain monopoly power in the market for the tying product (here, chipsets).

But none of these arguments totally overcomes the flaw in their reasoning. Indeed, as Aldous Huxley once pointed out, “several excuses are always less convincing than one”.

For a start, the amici argue that Qualcomm uses its strong chipset position to force buyers into accepting its supracompetitive IP rates, even in those instances where they purchase chipsets from rivals. 

In making this point, the amici fall prey to the “double counting fallacy” that Robert Bork famously warned about in The Antitrust Paradox: Monopolists cannot simultaneously charge a monopoly price AND purchase exclusivity (or other contractual restrictions) from their buyers/suppliers.

The amici fail to recognize the important sacrifices that Qualcomm would have to make in order for the above strategy to be viable. In simple terms, Qualcomm would have to offset every dollar it charges above the FRAND benchmark in the IP segment with an equivalent price reduction in the chipset segment.

This has important ramifications for the FTC’s case.

Qualcomm would have to charge lower — not higher — IP fees to OEMs who purchased a large share of their chips from third party chipmakers. Otherwise, there would be no carrot to offset its greater-than-FRAND license fees, and these OEMs would have significant incentives to sue (especially in a post-eBay world where the threat of injunctions is reduced if they happen to lose). 

And yet, this is the exact opposite of what the FTC alleged:

Qualcomm sometimes expressly charged higher royalties on phones that used rivals’ chips. And even when it did not, its provision of incentive funds to offset its license fees when OEMs bought its chips effectively resulted in a discriminatory surcharge. (emphasis added)

The infeasibility of alternative explanations

One theoretical workaround would be for Qualcomm to purchase exclusivity from its OEMs, in an attempt to foreclose chipset rivals. 

Once again, Bork’s double counting argument suggests that this would be particularly onerous. By accepting exclusivity-type requirements, OEMs would not only be reducing potential competition in the chipset market, they would also be contributing to an outcome where Qualcomm could evade its FRAND pledges in the IP segment of the market. This is particularly true for pivotal OEMs (such as Apple and Samsung), who may single-handedly affect the market’s long-term trajectory. 

The amici completely overlook this possibility, while the FTC argues that this may explain the rebates that Qulacomm gave to Apple. 

But even if the rebates Qualcomm gave Apple amounted to de facto exclusivity, there are still important objections. Authorities would notably need to prove that Qualcomm could recoup its initial losses (i.e. that the rebate maximized Qualcomm’s long-term profits). If this was not the case, then the rebates may simply be due to either efficiency considerations or Apple’s significant bargaining power (Apple is routinely cited as a potential source of patent holdout; see, e.g., here and here). 

Another alternative would be for Qualcomm to evict its chipset rivals through strategic entry deterrence or limit pricing (see here and here, respectively). But while the economic literature suggests that incumbents may indeed forgo short-term profits in order to deter rivals from entering the market, these theories generally rest on assumptions of imperfect information and/or strategic commitments. Neither of these factors was alleged in the case at hand.

In particular, there is no sense that Qualcomm’s purported decision to shift royalties from chips to IP somehow harms its short-term profits, or that it is merely a strategic device used to deter the entry of rivals. As the amici themselves seem to acknowledge, the pricing structure maximizes Qualcomm’s short term revenue (even ignoring potential efficiency considerations). 

Note that this is not just a matter of economic policy. The case law relating to unilateral conduct infringements — be it Brooke Group, Alcoa, or Aspen Skiing — almost systematically requires some form of profit sacrifice on the part of the monopolist. (For a legal analysis of this issue in the Qualcomm case, see ICLE’s Amicus brief, and yesterday’s blog post on the topic).

The amici are thus left with the argument that Qualcomm could structure its prices differently, so as to maximize the profits of its rivals. Why it would choose to do so, or should indeed be forced to, is a whole other matter.

Finally, the amici refer to the strategic tying literature (here), typically associated with the Microsoft case and the so-called “platform threat”. But this analogy is highly problematic. 

Unlike Microsoft and its Internet Explorer browser, Qualcomm’s IP is de facto — and necessarily — tied to the chips that practice its technology. This is not a bug, it is a feature of the patent system. Qualcomm is entitled to royalties, whether it manufactures chips itself or leaves that task to rival manufacturers. In other words, there is no counterfactual world where OEMs could obtain Qualcomm-based chips without entering into some form of license agreement (whether directly or indirectly) with Qualcomm. The fact that OEMs must acquire a license that covers Qualcomm’s IP — even when they purchase chips from rivals — is part and parcel of the IP system.

In any case, there is little reason to believe that Qualcomm’s decision to license its IP at the OEM level is somehow exclusionary. The gist of the strategic tying literature is that incumbents may use their market power in a primary market to thwart entry in the market for a complementary good (and ultimately prevent rivals from using their newfound position in the complementary market in order to overthrow the incumbent in the primary market; Carlton & Waldman, 2002). But this is not the case here.

Qualcomm does not appear to be using what little power it might have in the IP segment in order to dominate its rivals in the chip market. As has already been explained above, doing so would imply some profit sacrifice in the IP segment in order to encourage OEMs to accept its IP/chipset bundle, rather than rivals’ offerings. This is the exact opposite of what the FTC and amici allege in the case at hand. The facts thus cut against a conjecture of strategic tying.

Conclusion

So where does this leave the amici and their brief? 

Absent further evidence, their conclusion that Qualcomm injured competition is untenable. There is no evidence that Qualcomm’s pricing structure — enacted through the NLNC policy — significantly harmed competition to the detriment of consumers. 

When all is done and dusted, the amici’s brief ultimately amounts to an assertion that Qualcomm should be made to license its intellectual property at a rate that — in their estimation — is closer to the FRAND benchmark. That judgment is a matter of contract law, not antitrust.

On November 22, the FTC filed its answering brief in the FTC v. Qualcomm litigation. As we’ve noted before, it has always seemed a little odd that the current FTC is so vigorously pursuing this case, given some of the precedents it might set and the Commission majority’s apparent views on such issues. But this may also help explain why the FTC has now opted to eschew the district court’s decision and pursue a novel, but ultimately baseless, legal theory in its brief.

The FTC’s decision to abandon the district court’s reasoning constitutes an important admission: contrary to the district court’s finding, there is no legal basis to find an antitrust duty to deal in this case. As Qualcomm stated in its reply brief (p. 12), “the FTC disclaims huge portions of the decision.” In its effort to try to salvage its case, however, the FTC reveals just how bad its arguments have been from the start, and why the case should be tossed out on its ear.

What the FTC now argues

The FTC’s new theory is that SEP holders that fail to honor their FRAND licensing commitments should be held liable under “traditional Section 2 standards,” even though they do not have an antitrust duty to deal with rivals who are members of the same standard-setting organizations (SSOs) under the “heightened” standard laid out by the Supreme Court in Aspen and Trinko:  

To be clear, the FTC does not contend that any breach of a FRAND commitment is a Sherman Act violation. But Section 2 liability is appropriate when, as here, a monopolist SEP holder commits to license its rivals on FRAND terms, and then implements a blanket policy of refusing to license those rivals on any terms, with the effect of substantially contributing to the acquisition or maintenance of monopoly power in the relevant market…. 

The FTC does not argue that Qualcomm had a duty to deal with its rivals under the Aspen/Trinko standard. But that heightened standard does not apply here, because—unlike the defendants in Aspen, Trinko, and the other duty-to-deal precedents on which it relies—Qualcomm entered into a voluntary contractual commitment to deal with its rivals as part of the SSO process, which is itself a derogation from normal market competition. And although the district court applied a different approach, this Court “may affirm on any ground finding support in the record.” Cigna Prop. & Cas. Ins. Co. v. Polaris Pictures Corp., 159 F.3d 412, 418-19 (9th Cir. 1998) (internal quotation marks omitted) (emphasis added) (pp.69-70).

In other words, according to the FTC, because Qualcomm engaged in the SSO process—which is itself “a derogation from normal market competition”—its evasion of the constraints of that process (i.e., the obligation to deal with all comers on FRAND terms) is “anticompetitive under traditional Section 2 standards.”

The most significant problem with this new standard is not that it deviates from the basis upon which the district court found Qualcomm liable; it’s that it is entirely made up and has no basis in law.

Absent an antitrust duty to deal, patent law grants patentees the right to exclude rivals from using patented technology

Part of the bundle of rights connected with the property right in patents is the right to exclude, and along with it, the right of a patent holder to decide whether, and on what terms, to sell licenses to rivals. The law curbs that right only in select circumstances. Under antitrust law, such a duty to deal, in the words of the Supreme Court in Trinko, “is at or near the outer boundary of §2 liability.” The district court’s ruling, however, is based on the presumption of harm arising from a SEP holder’s refusal to license, rather than an actual finding of anticompetitive effect under §2. The duty to deal it finds imposes upon patent holders an antitrust obligation to license their patents to competitors. (While, of course, participation in an SSO may contractually obligate an SEP-holder to license its patents to competitors, that is an entirely different issue than whether it operates under a mandatory requirement to do so as a matter of public policy).  

The right of patentees to exclude is well-established, and injunctions enforcing that right are regularly issued by courts. Although the rate of permanent injunctions has decreased since the Supreme Court’s eBay decision, research has found that federal district courts still grant them over 70% of the time after a patent holder prevails on the merits. And for patent litigation involving competitors, the same research finds that injunctions are granted 85% of the time.  In principle, even SEP holders can receive injunctions when infringers do not act in good faith in FRAND negotiations. See Microsoft Corp. v. Motorola, Inc., 795 F.3d 1024, 1049 n.19 (9th Cir. 2015):

We agree with the Federal Circuit that a RAND commitment does not always preclude an injunctive action to enforce the SEP. For example, if an infringer refused to accept an offer on RAND terms, seeking injunctive relief could be consistent with the RAND agreement, even where the commitment limits recourse to litigation. See Apple Inc., 757 F.3d at 1331–32

Aside from the FTC, federal agencies largely agree with this approach to the protection of intellectual property. For instance, the Department of Justice, the US Patent and Trademark Office, and the National Institute for Standards and Technology recently released their 2019 Joint Policy Statement on Remedies for Standards-Essential Patents Subject to Voluntary F/RAND Commitments, which clarifies that:

All remedies available under national law, including injunctive relief and adequate damages, should be available for infringement of standards-essential patents subject to a F/RAND commitment, if the facts of a given case warrant them. Consistent with the prevailing law and depending on the facts and forum, the remedies that may apply in a given patent case include injunctive relief, reasonable royalties, lost profits, enhanced damages for willful infringement, and exclusion orders issued by the U.S. International Trade Commission. These remedies are equally available in patent litigation involving standards-essential patents. While the existence of F/RAND or similar commitments, and conduct of the parties, are relevant and may inform the determination of appropriate remedies, the general framework for deciding these issues remains the same as in other patent cases. (emphasis added).

By broadening the antitrust duty to deal well beyond the bounds set by the Supreme Court, the district court opinion (and the FTC’s preferred approach, as well) eviscerates the right to exclude inherent in patent rights. In the words of retired Federal Circuit Judge Paul Michel in an amicus brief in the case: 

finding antitrust liability premised on the exercise of valid patent rights will fundamentally abrogate the patent system and its critical means for promoting and protecting important innovation.

And as we’ve noted elsewhere, this approach would seriously threaten consumer welfare:

Of course Qualcomm conditions the purchase of its chips on the licensing of its intellectual property; how could it be any other way? The alternative would require Qualcomm to actually facilitate the violation of its property rights by forcing it to sell its chips to device makers even if they refuse its patent license terms. In that world, what device maker would ever agree to pay more than a pittance for a patent license? The likely outcome is that Qualcomm charges more for its chips to compensate (or simply stops making them). Great, the FTC says; then competitors can fill the gap and — voila: the market is more competitive, prices will actually fall, and consumers will reap the benefits.

Except it doesn’t work that way. As many economists, including both the current [now former] and a prominent former chief economist of the FTC, have demonstrated, forcing royalty rates lower in such situations is at least as likely to harm competition as to benefit it. There is no sound theoretical or empirical basis for concluding that using antitrust to move royalty rates closer to some theoretical ideal will actually increase consumer welfare. All it does for certain is undermine patent holders’ property rights, virtually ensuring there will be less innovation.

The FTC realizes the district court doesn’t have the evidence to support its duty to deal analysis

Antitrust law does not abrogate the right of a patent holder to exclude and to choose when and how to deal with rivals, unless there is a proper finding of a duty to deal. In order to find a duty to deal, there must be a harm to competition, not just a competitor, which, under the Supreme Court’s Aspen and Trinko cases can be inferred in the duty-to-deal context only where the challenged conduct leads to a “profit sacrifice.” But the record does not support such a finding. As we wrote in our amicus brief:

[T]he Supreme Court has identified only a single scenario from which it may plausibly be inferred that defendant’s refusal to deal with rivals harms consumers: The existence of a prior, profitable course of dealing, and the termination and replacement of that arrangement with an alternative that not only harms rivals, but also is less profitable for defendant. 

A monopolist’s willingness to forego (short-term) profits plausibly permits an inference that conduct is not procompetitive, because harm to a rival caused by an increase in efficiency should lead to higher—not lower—profits for defendant. And “[i]f a firm has been ‘attempting to exclude rivals on some basis other than efficiency,’ it’s fair to characterize its behavior as predatory.” Aspen Skiing, 472 U.S. at 605 (quoting Robert Bork, The Antitrust Paradox 138 (1978)).

In an effort to satisfy this standard, the district court states that “because Qualcomm previously licensed its rivals, but voluntarily stopped licensing rivals even though doing so was profitable, Qualcomm terminated a voluntary and profitable course of dealing.” Slip op. at 137. 

But it is not enough merely that the prior arrangement was profitable. Rather, Trinko and Aspen Skiing hold that when a monopolist ends a profitable relationship with a rival, anticompetitive exclusion may be inferred only when it also refuses to engage in an ongoing arrangement that, in the short run, is more profitable than no relationship at all. The key is the relative value to the monopolist of the current options on offer, not the value to the monopolist of the terminated arrangement. See Trinko, 540 U.S. at 409 (“a willingness to forsake short-term profits”); Aspen Skiing, 472 U.S. at 610–11 (“it was willing to sacrifice short-run benefits”)…

The record here uniformly indicates Qualcomm expected to maximize its royalties by dealing with OEMs rather than rival chip makers; it neither anticipated nor endured short-term loss. As the district court itself concluded, Qualcomm’s licensing practices avoided patent exhaustion and earned it “humongously more lucrative” royalties. Slip op. at 1243–254. That Qualcomm anticipated greater profits from its conduct precludes an inference of anticompetitive harm.

Moreover, Qualcomm didn’t refuse to allow rivals to use its patents; it simply didn’t sell them explicit licenses to do so. As discussed in several places by the district court:

According to Andrew Hong (Legal Counsel at Samsung Intellectual Property Center), during license negotiations, Qualcomm made it clear to Samsung that “Qualcomm’s standard business practice was not to provide licenses to chip manufacturers.” Hong Depo. 161:16-19. Instead, Qualcomm had an “unwritten policy of not going after chip manufacturers.” Id. at 161:24-25… (p.123)

* * *

Alex Rogers (QTL President) testified at trial that as part of the 2018 Settlement Agreement between Samsung and Qualcomm, Qualcomm did not license Samsung, but instead promised only that Qualcomm would offer Samsung a FRAND license before suing Samsung: “Qualcomm gave Samsung an assurance that should Qualcomm ever seek to assert its cellular SEPs against that component business, against those components, we would first make Samsung an offer on fair, reasonable, and non-discriminatory terms.” Tr. at 1989:5-10. (p.124)

This is an important distinction. Qualcomm allows rivals to use its patented technology by not asserting its patent rights against them—which is to say: instead of licensing its technology for a fee, Qualcomm allows rivals to use its technology to develop their own chips royalty-free (and recoups its investment by licensing the technology to OEMs that choose to implement the technology in their devices). 

The irony of this analysis, of course, is that the district court effectively suggests that Qualcomm must charge rivals a positive, explicit price in exchange for a license in order to facilitate competition, while allowing rivals to use its patented technology for free (or at the “cost” of some small reduction in legal certainty, perhaps) is anticompetitive.

Nonetheless, the district court’s factual finding that Qualcomm’s licensing scheme was “humongously” profitable shows there was no profit sacrifice as required for a duty to deal finding. The general presumption that patent holders can exclude rivals is not subject to an antitrust duty to deal where there is no profit sacrifice by the patent holder. Here, however, Qualcomm did not sacrifice profits by adopting the challenged licensing scheme. 

It is perhaps unsurprising that the FTC chose not to support the district court’s duty-to-deal argument, even though its holding was in the FTC’s favor. But, while the FTC was correct not to countenance the district court’s flawed arguments, the FTC’s alternative argument in its reply brief is even worse.

The FTC’s novel theory of harm is unsupported and weak

As noted, the FTC’s alternative theory is that Qualcomm violated Section 2 simply by failing to live up to its contractual SSO obligations. For the FTC, because Qualcomm joined an SSO, it is no longer in a position to refuse to deal legally. Moreover, there is no need to engage in an Aspen/Trinko analysis in order to find liability. Instead, according to the FTC’s brief, liability arises because the evasion of an exogenous pricing constraint (such as an SSO’s FRAND obligation) constitutes an antitrust harm:

Of course, a breach of contract, “standing alone,” does not “give rise to antitrust liability.” City of Vernon v. S. Cal. Edison Co., 955 F.2d 1361, 1368 (9th Cir. 1992); cf. Br. 52 n.6. Instead, a monopolist’s conduct that breaches such a contractual commitment is anticompetitive only when it satisfies traditional Section 2 standards—that is, only when it “tends to impair the opportunities of rivals and either does not further competition on the merits or does so in an unnecessarily restrictive way.” Cascade Health, 515 F.3d at 894. The district court’s factual findings demonstrate that Qualcomm’s breach of its SSO commitments satisfies both elements of that traditional test. (emphasis added)

To begin, it must be noted that the operative language quoted by the FTC from Cascade Health is attributed in Cascade Health to Aspen Skiing. In other words, even Cascade Health recognizes that Aspen Skiing represents the Supreme Court’s interpretation of that language in the duty-to-deal context. And in that case—in contrast to the FTC’s argument in its brief—the Court required demonstration of such a standard to mean that a defendant “was not motivated by efficiency concerns and that it was willing to sacrifice short-run benefits and consumer goodwill in exchange for a perceived long-run impact on its… rival.” (Aspen Skiing at 610-11) (emphasis added).

The language quoted by the FTC cannot simultaneously justify an appeal to an entirely different legal standard separate from that laid out in Aspen Skiing. As such, rather than dispensing with the duty to deal requirements laid out in that case, Cascade Health actually reinforces them.

Second, to support its argument the FTC points to Broadcom v. Qualcomm, 501 F.3d 297 (3rd Cir. 2007) as an example of a court upholding an antitrust claim based on a defendant’s violation of FRAND terms. 

In Broadcom, relying on the FTC’s enforcement action against Rambus before it was overturned by the D.C. Circuit, the Third Circuit found that there was an actionable issue when Qualcomm deceived other members of an SSO by promising to

include its proprietary technology in the… standard by falsely agreeing to abide by the [FRAND policies], but then breached those agreements by licensing its technology on non-FRAND terms. The intentional acquisition of monopoly power through deception… violates antitrust law. (emphasis added)

Even assuming Broadcom were good law post-Rambus, the case is inapposite. In Broadcom the court found that Qualcomm could be held to violate antitrust law by deceiving the SSO (by falsely promising to abide by FRAND terms) in order to induce it to accept Qualcomm’s patent in the standard. The court’s concern was that, by falsely inducing the SSO to adopt its technology, Qualcomm deceptively acquired monopoly power and limited access to competing technology:

When a patented technology is incorporated in a standard, adoption of the standard eliminates alternatives to the patented technology…. Firms may become locked in to a standard requiring the use of a competitor’s patented technology. 

Key to the court’s finding was that the alleged deception induced the SSO to adopt the technology in its standard:

We hold that (1) in a consensus-oriented private standard-setting environment, (2) a patent holder’s intentionally false promise to license essential proprietary technology on FRAND terms, (3) coupled with an SDO’s reliance on that promise when including the technology in a standard, and (4) the patent holder’s subsequent breach of that promise, is actionable conduct. (emphasis added)

Here, the claim is different. There is no allegation that Qualcomm engaged in deceptive conduct that affected the incorporation of its technology into the relevant standard. Indeed, there is no allegation that Qualcomm’s alleged monopoly power arises from its challenged practices; only that it abused its lawful monopoly power to extract supracompetitive prices. Even if an SEP holder may be found liable for falsely promising not to evade a commitment to deal with rivals in order to acquire monopoly power from its inclusion in a technological standard under Broadcom, that does not mean that it can be held liable for evading a commitment to deal with rivals unrelated to its inclusion in a standard, nor that such a refusal to deal should be evaluated under any standard other than that laid out in Aspen Skiing.

Moreover, the FTC nowhere mentions the DC Circuit’s subsequent Rambus decision overturning the FTC and calling the holding in Broadcom into question, nor does it discuss the Supreme Court’s NYNEX decision in any depth. Yet these cases stand clearly for the opposite proposition: a court cannot infer competitive harm from a company’s evasion of a FRAND pricing constraint. As we wrote in our amicus brief

In Rambus Inc. v. FTC, 522 F.3d 456 (D.C. Cir. 2008), the D.C. Circuit, citing NYNEX, rejected the FTC’s contention that it may infer anticompetitive effect from defendant’s evasion of a constraint on its monopoly power in an analogous SEP-licensing case: “But again, as in NYNEX, an otherwise lawful monopolist’s end-run around price constraints, even when deceptive or fraudulent, does not alone present a harm to competition.” Id. at 466 (citation omitted). NYNEX and Rambus reinforce the Court’s repeated holding that an inference is permissible only where it points clearly to anticompetitive effect—and, bad as they may be, evading obligations under other laws or violating norms of “business morality” do not permit a court to undermine “[t]he freedom to switch suppliers [which] lies close to the heart of the competitive process that the antitrust laws seek to encourage. . . . Thus, this Court has refused to apply per se reasoning in cases involving that kind of activity.” NYNEX, 525 U.S. at 137 (citations omitted).

Essentially, the FTC’s brief alleges that Qualcomm’s conduct amounts to an evasion of the constraint imposed by FRAND terms—without which the SSO process itself is presumptively anticompetitive. Indeed, according to the FTC, it is only the FRAND obligation that saves the SSO agreement from being inherently anticompetitive. 

In fact, when a firm has made FRAND commitments to an SSO, requiring the firm to comply with its commitments mitigates the risk that the collaborative standard-setting process will harm competition. Product standards—implicit “agreement[s] not to manufacture, distribute, or purchase certain types of products”—“have a serious potential for anticompetitive harm.” Allied Tube, 486 U.S. at 500 (citation and footnote omitted). Accordingly, private SSOs “have traditionally been objects of antitrust scrutiny,” and the antitrust laws tolerate private standard-setting “only on the understanding that it will be conducted in a nonpartisan manner offering procompetitive benefits,” and in the presence of “meaningful safeguards” that prevent the standard-setting process from falling prey to “members with economic interests in stifling product competition.” Id. at 500- 01, 506-07; see Broadcom, 501 F.3d at 310, 314-15 (collecting cases). 

FRAND commitments are among the “meaningful safeguards” that SSOs have adopted to mitigate this serious risk to competition…. 

Courts have therefore recognized that conduct that breaches or otherwise “side-steps” these safeguards is appropriately subject to conventional Sherman Act scrutiny, not the heightened Aspen/Trinko standard… (p.83-84)

In defense of the proposition that courts apply “traditional antitrust standards to breaches of voluntary commitments made to mitigate antitrust concerns,” the FTC’s brief cites not only Broadcom, but also two other cases:

While this Court has long afforded firms latitude to “deal or refuse to deal with whomever [they] please[] without fear of violating the antitrust laws,” FountWip, Inc. v. Reddi-Wip, Inc., 568 F.2d 1296, 1300 (9th Cir. 1978) (citing Colgate, 250 U.S. at 307), it, too, has applied traditional antitrust standards to breaches of voluntary commitments made to mitigate antitrust concerns. In Mount Hood Stages, Inc. v. Greyhound Corp., 555 F.2d 687 (9th Cir. 1977), this Court upheld a judgment holding that Greyhound violated Section 2 by refusing to interchange bus traffic with a competing bus line after voluntarily committing to do so in order to secure antitrust approval from the Interstate Commerce Commission for proposed acquisitions. Id. at 69723; see also, e.g., Biovail Corp. Int’l v. Hoechst Aktiengesellschaft, 49 F. Supp. 2d 750, 759 (D.N.J. 1999) (breach of commitment to deal in violation of FTC merger consent decree exclusionary under Section 2). (p.85-86)

The cases the FTC cites to justify the proposition all deal with companies sidestepping obligations in order to falsely acquire monopoly power. The two cases cited above both involve companies making promises to government agencies to win merger approval and then failing to follow through. And, as noted, Broadcom deals with the acquisition of monopoly power by making false promises to an SSO to induce the choice of proprietary technology in a standard. While such conduct in the acquisition of monopoly power may be actionable under Broadcom (though this is highly dubious post-Rambus), none of these cases supports the FTC’s claim that an SEP holder violates antitrust law any time it evades an SSO obligation to license its technology to rivals. 

Conclusion

Put simply, the district court’s opinion in FTC v. Qualcomm runs headlong into the Supreme Court’s Aspen decision and founders there. This is why the FTC is trying to avoid analyzing the case under Aspen and subsequent duty-to-deal jurisprudence (including Trinko, the 9th Circuit’s MetroNet decision, and the 10th Circuit’s Novell decision): because it knows that if the appellate court applies those standards, the district court’s duty-to-deal analysis will fail. The FTC’s basis for applying a different standard is unsupportable, however. And even if its logic for applying a different standard were valid, the FTC’s proffered alternative theory is groundless in light of Rambus and NYNEX. The Ninth Circuit should vacate the district court’s finding of liability. 

FTC v. Qualcomm

Last week the International Center for Law & Economics (ICLE) and twelve noted law and economics scholars filed an amicus brief in the Ninth Circuit in FTC v. Qualcomm, in support of appellant (Qualcomm) and urging reversal of the district court’s decision. The brief was authored by Geoffrey A. Manne, President & founder of ICLE, and Ben Sperry, Associate Director, Legal Research of ICLE. Jarod M. Bona and Aaron R. Gott of Bona Law PC collaborated in drafting the brief and they and their team provided invaluable pro bono legal assistance, for which we are enormously grateful. Signatories on the brief are listed at the end of this post.

We’ve written about the case several times on Truth on the Market, as have a number of guest bloggers, in our ongoing blog series on the case here.   

The ICLE amicus brief focuses on the ways that the district court exceeded the “error cost” guardrails erected by the Supreme Court to minimize the risk and cost of mistaken antitrust decisions, particularly those that wrongly condemn procompetitive behavior. As the brief notes at the outset:

The district court’s decision is disconnected from the underlying economics of the case. It improperly applied antitrust doctrine to the facts, and the result subverts the economic rationale guiding monopolization jurisprudence. The decision—if it stands—will undercut the competitive values antitrust law was designed to protect.  

The antitrust error cost framework was most famously elaborated by Frank Easterbrook in his seminal article, The Limits of Antitrust (1984). It has since been squarely adopted by the Supreme Court—most significantly in Brooke Group (1986), Trinko (2003), and linkLine (2009).  

In essence, the Court’s monopolization case law implements the error cost framework by (among other things) obliging courts to operate under certain decision rules that limit the use of inferences about the consequences of a defendant’s conduct except when the circumstances create what game theorists call a “separating equilibrium.” A separating equilibrium is a 

solution to a game in which players of different types adopt different strategies and thereby allow an uninformed player to draw inferences about an informed player’s type from that player’s actions.

Baird, Gertner & Picker, Game Theory and the Law

The key problem in antitrust is that while the consequence of complained-of conduct for competition (i.e., consumers) is often ambiguous, its deleterious effect on competitors is typically quite evident—whether it is actually anticompetitive or not. The question is whether (and when) it is appropriate to infer anticompetitive effect from discernible harm to competitors. 

Except in the narrowly circumscribed (by Trinko) instance of a unilateral refusal to deal, anticompetitive harm under the rule of reason must be proven. It may not be inferred from harm to competitors, because such an inference is too likely to be mistaken—and “mistaken inferences are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” (Brooke Group (quoting yet another key Supreme Court antitrust error cost case, Matsushita (1986)). 

Yet, as the brief discusses, in finding Qualcomm liable the district court did not demand or find proof of harm to competition. Instead, the court’s opinion relies on impermissible inferences from ambiguous evidence to find that Qualcomm had (and violated) an antitrust duty to deal with rival chip makers and that its conduct resulted in anticompetitive foreclosure of competition. 

We urge you to read the brief (it’s pretty short—maybe the length of three blogs posts) to get the whole argument. Below we draw attention to a few points we make in the brief that are especially significant. 

The district court bases its approach entirely on Microsoft — which it misinterprets in clear contravention of Supreme Court case law

The district court doesn’t stay within the strictures of the Supreme Court’s monopolization case law. In fact, although it obligingly recites some of the error cost language from Trinko, it quickly moves away from Supreme Court precedent and bases its approach entirely on its reading of the D.C. Circuit’s Microsoft (2001) decision. 

Unfortunately, the district court’s reading of Microsoft is mistaken and impermissible under Supreme Court precedent. Indeed, both the Supreme Court and the D.C. Circuit make clear that a finding of illegal monopolization may not rest on an inference of anticompetitive harm.

The district court cites Microsoft for the proposition that

Where a government agency seeks injunctive relief, the Court need only conclude that Qualcomm’s conduct made a “significant contribution” to Qualcomm’s maintenance of monopoly power. The plaintiff is not required to “present direct proof that a defendant’s continued monopoly power is precisely attributable to its anticompetitive conduct.”

It’s true Microsoft held that, in government actions seeking injunctions, “courts [may] infer ‘causation’ from the fact that a defendant has engaged in anticompetitive conduct that ‘reasonably appears capable of making a significant contribution to maintaining monopoly power.’” (Emphasis added). 

But Microsoft never suggested that anticompetitiveness itself may be inferred.

“Causation” and “anticompetitive effect” are not the same thing. Indeed, Microsoft addresses “anticompetitive conduct” and “causation” in separate sections of its decision. And whereas Microsoft allows that courts may infer “causation” in certain government actions, it makes no such allowance with respect to “anticompetitive effect.” In fact, it explicitly rules it out:

[T]he plaintiff… must demonstrate that the monopolist’s conduct indeed has the requisite anticompetitive effect…; no less in a case brought by the Government, it must demonstrate that the monopolist’s conduct harmed competition, not just a competitor.”

The D.C. Circuit subsequently reinforced this clear conclusion of its holding in Microsoft in Rambus

Deceptive conduct—like any other kind—must have an anticompetitive effect in order to form the basis of a monopolization claim…. In Microsoft… [t]he focus of our antitrust scrutiny was properly placed on the resulting harms to competition.

Finding causation entails connecting evidentiary dots, while finding anticompetitive effect requires an economic assessment. Without such analysis it’s impossible to distinguish procompetitive from anticompetitive conduct, and basing liability on such an inference effectively writes “anticompetitive” out of the law.

Thus, the district court is correct when it holds that it “need not conclude that Qualcomm’s conduct is the sole reason for its rivals’ exits or impaired status.” But it is simply wrong to hold—in the same sentence—that it can thus “conclude that Qualcomm’s practices harmed competition and consumers.” The former claim is consistent with Microsoft; the latter is emphatically not.

Under Trinko and Aspen Skiing the district court’s finding of an antitrust duty to deal is impermissible 

Because finding that a company operates under a duty to deal essentially permits a court to infer anticompetitive harm without proof, such a finding “comes dangerously close to being a form of ‘no-fault’ monopolization,” as Herbert Hovenkamp has written. It is also thus seriously disfavored by the Court’s error cost jurisprudence.

In Trinko the Supreme Court interprets its holding in Aspen Skiing to identify essentially a single scenario from which it may plausibly be inferred that a monopolist’s refusal to deal with rivals harms consumers: the existence of a prior, profitable course of dealing, and the termination and replacement of that arrangement with an alternative that not only harms rivals, but also is less profitable for the monopolist.

In an effort to satisfy this standard, the district court states that “because Qualcomm previously licensed its rivals, but voluntarily stopped licensing rivals even though doing so was profitable, Qualcomm terminated a voluntary and profitable course of dealing.”

But it’s not enough merely that the prior arrangement was profitable. Rather, Trinko and Aspen Skiing hold that when a monopolist ends a profitable relationship with a rival, anticompetitive exclusion may be inferred only when it also refuses to engage in an ongoing arrangement that, in the short run, is more profitable than no relationship at all. The key is the relative value to the monopolist of the current options on offer, not the value to the monopolist of the terminated arrangement. In a word, what the Court requires is that the defendant exhibit behavior that, but-for the expectation of future, anticompetitive returns, is irrational.

It should be noted, as John Lopatka (here) and Alan Meese (here) (both of whom joined the amicus brief) have written, that even the Supreme Court’s approach is likely insufficient to permit a court to distinguish between procompetitive and anticompetitive conduct. 

But what is certain is that the district court’s approach in no way permits such an inference.

“Evasion of a competitive constraint” is not an antitrust-relevant refusal to deal

In order to infer anticompetitive effect, it’s not enough that a firm may have a “duty” to deal, as that term is colloquially used, based on some obligation other than an antitrust duty, because it can in no way be inferred from the evasion of that obligation that conduct is anticompetitive.

The district court bases its determination that Qualcomm’s conduct is anticompetitive on the fact that it enables the company to avoid patent exhaustion, FRAND commitments, and thus price competition in the chip market. But this conclusion is directly precluded by the Supreme Court’s holding in NYNEX

Indeed, in Rambus, the D.C. Circuit, citing NYNEX, rejected the FTC’s contention that it may infer anticompetitive effect from defendant’s evasion of a constraint on its monopoly power in an analogous SEP-licensing case: “But again, as in NYNEX, an otherwise lawful monopolist’s end-run around price constraints, even when deceptive or fraudulent, does not alone present a harm to competition.”

As Josh Wright has noted:

[T]he objection to the “evasion” of any constraint approach is… that it opens the door to enforcement actions applied to business conduct that is not likely to harm competition and might be welfare increasing.

Thus NYNEX and Rambus (and linkLine) reinforce the Court’s repeated holding that an inference of harm to competition is permissible only where conduct points clearly to anticompetitive effect—and, bad as they may be, evading obligations under other laws or violating norms of “business morality” do not suffice.

The district court’s elaborate theory of harm rests fundamentally on the claim that Qualcomm injures rivals—and the record is devoid of evidence demonstrating actual harm to competition. Instead, the court infers it from what it labels “unreasonably high” royalty rates, enabled by Qualcomm’s evasion of competition from rivals. In turn, the court finds that that evasion of competition can be the source of liability if what Qualcomm evaded was an antitrust duty to deal. And, in impermissibly circular fashion, the court finds that Qualcomm indeed evaded an antitrust duty to deal—because its conduct allowed it to sustain “unreasonably high” prices. 

The Court’s antitrust error cost jurisprudence—from Brooke Group to NYNEX to Trinko & linkLine—stands for the proposition that no such circular inferences are permitted.

The district court’s foreclosure analysis also improperly relies on inferences in lieu of economic evidence

Because the district court doesn’t perform a competitive effects analysis, it fails to demonstrate the requisite “substantial” foreclosure of competition required to sustain a claim of anticompetitive exclusion. Instead the court once again infers anticompetitive harm from harm to competitors. 

The district court makes no effort to establish the quantity of competition foreclosed as required by the Supreme Court. Nor does the court demonstrate that the alleged foreclosure harms competition, as opposed to just rivals. Foreclosure per se is not impermissible and may be perfectly consistent with procompetitive conduct.

Again citing Microsoft, the district court asserts that a quantitative finding is not required. Yet, as the court’s citation to Microsoft should have made clear, in its stead a court must find actual anticompetitive effect; it may not simply assert it. As Microsoft held: 

It is clear that in all cases the plaintiff must… prove the degree of foreclosure. This is a prudential requirement; exclusivity provisions in contracts may serve many useful purposes. 

The court essentially infers substantiality from the fact that Qualcomm entered into exclusive deals with Apple (actually, volume discounts), from which the court concludes that Qualcomm foreclosed rivals’ access to a key customer. But its inference that this led to substantial foreclosure is based on internal business statements—so-called “hot docs”—characterizing the importance of Apple as a customer. Yet, as Geoffrey Manne and Marc Williamson explain, such documentary evidence is unreliable as a guide to economic significance or legal effect: 

Business people will often characterize information from a business perspective, and these characterizations may seem to have economic implications. However, business actors are subject to numerous forces that influence the rhetoric they use and the conclusions they draw….

There are perfectly good reasons to expect to see “bad” documents in business settings when there is no antitrust violation lurking behind them.

Assuming such language has the requisite economic or legal significance is unsupportable—especially when, as here, the requisite standard demands a particular quantitative significance.

Moreover, the court’s “surcharge” theory of exclusionary harm rests on assumptions regarding the mechanism by which the alleged surcharge excludes rivals and harms consumers. But the court incorrectly asserts that only one mechanism operates—and it makes no effort to quantify it. 

The court cites “basic economics” via Mankiw’s Principles of Microeconomics text for its conclusion:

The surcharge affects demand for rivals’ chips because as a matter of basic economics, regardless of whether a surcharge is imposed on OEMs or directly on Qualcomm’s rivals, “the price paid by buyers rises, and the price received by sellers falls.” Thus, the surcharge “places a wedge between the price that buyers pay and the price that sellers receive,” and demand for such transactions decreases. Rivals see lower sales volumes and lower margins, and consumers see less advanced features as competition decreases.

But even assuming the court is correct that Qualcomm’s conduct entails such a surcharge, basic economics does not hold that decreased demand for rivals’ chips is the only possible outcome. 

In actuality, an increase in the cost of an input for OEMs can have three possible effects:

  1. OEMs can pass all or some of the cost increase on to consumers in the form of higher phone prices. Assuming some elasticity of demand, this would mean fewer phone sales and thus less demand by OEMs for chips, as the court asserts. But the extent of that effect would depend on consumers’ demand elasticity and the magnitude of the cost increase as a percentage of the phone price. If demand is highly inelastic at this price (i.e., relatively insensitive to the relevant price change), it may have a tiny effect on the number of phones sold and thus the number of chips purchased—approaching zero as price insensitivity increases.
  2. OEMs can absorb the cost increase and realize lower profits but continue to sell the same number of phones and purchase the same number of chips. This would not directly affect demand for chips or their prices.
  3. OEMs can respond to a price increase by purchasing fewer chips from rivals and more chips from Qualcomm. While this would affect rivals’ chip sales, it would not necessarily affect consumer prices, the total number of phones sold, or OEMs’ margins—that result would depend on whether Qualcomm’s chips cost more or less than its rivals’. If the latter, it would even increase OEMs’ margins and/or lower consumer prices and increase output.

Alternatively, of course, the effect could be some combination of these.

Whether any of these outcomes would substantially exclude rivals is inherently uncertain to begin with. But demonstrating a reduction in rivals’ chip sales is a necessary but not sufficient condition for proving anticompetitive foreclosure. The FTC didn’t even demonstrate that rivals were substantially harmed, let alone that there was any effect on consumers—nor did the district court make such findings. 

Doing so would entail consideration of whether decreased demand for rivals’ chips flows from reduced consumer demand or OEMs’ switching to Qualcomm for supply, how consumer demand elasticity affects rivals’ chip sales, and whether Qualcomm’s chips were actually less or more expensive than rivals’. Yet the court determined none of these. 

Conclusion

Contrary to established Supreme Court precedent, the district court’s decision relies on mere inferences to establish anticompetitive effect. The decision, if it stands, would render a wide range of potentially procompetitive conduct presumptively illegal and thus harm consumer welfare. It should be reversed by the Ninth Circuit.

Joining ICLE on the brief are:

  • Donald J. Boudreaux, Professor of Economics, George Mason University
  • Kenneth G. Elzinga, Robert C. Taylor Professor of Economics, University of Virginia
  • Janice Hauge, Professor of Economics, University of North Texas
  • Justin (Gus) Hurwitz, Associate Professor of Law, University of Nebraska College of Law; Director of Law & Economics Programs, ICLE
  • Thomas A. Lambert, Wall Chair in Corporate Law and Governance, University of Missouri Law School
  • John E. Lopatka, A. Robert Noll Distinguished Professor of Law, Penn State University Law School
  • Daniel Lyons, Professor of Law, Boston College Law School
  • Geoffrey A. Manne, President and Founder, International Center for Law & Economics; Distinguished Fellow, Northwestern University Center on Law, Business & Economics
  • Alan J. Meese, Ball Professor of Law, William & Mary Law School
  • Paul H. Rubin, Samuel Candler Dobbs Professor of Economics Emeritus, Emory University
  • Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics, Chapman University School of Business; Nobel Laureate in Economics, 2002
  • Michael Sykuta, Associate Professor of Economics, University of Missouri


[TOTM: The following is the eighth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case recently decided by Judge Lucy Koh in the Northern District of California. Other posts in this series are here. The blog post is based on a forthcoming paper regarding patent holdup, co-authored by Dirk Auer and Julian Morris.]

Samsung SGH-F480V – controller board – Qualcomm MSM6280

In his latest book, Tyler Cowen calls big business an “American anti-hero”. Cowen argues that the growing animosity towards successful technology firms is to a large extent unwarranted. After all, these companies have generated tremendous prosperity and jobs.

Though it is less known to the public than its Silicon Valley counterparts, Qualcomm perfectly fits the anti-hero mold. Despite being a key contributor to the communications standards that enabled the proliferation of smartphones around the globe – an estimated 5 Billion people currently own a device – Qualcomm has been on the receiving end of considerable regulatory scrutiny on both sides of the Atlantic (including two in the EU; see here and here). 

In the US, Judge Lucy Koh recently ruled that a combination of anticompetitive practices had enabled Qualcomm to charge “unreasonably high royalty rates” for its CDMA and LTE cellular communications technology. Chief among these practices was Qualcomm’s so-called “no license, no chips” policy, whereby the firm refuses to sell baseband processors to implementers that have not taken out a license for its communications technology. Other grievances included Qualcomm’s purported refusal to license its patents to rival chipmakers, and allegations that it attempted to extract exclusivity obligations from large handset manufacturers, such as Apple. According to Judge Koh, these practices resulted in “unreasonably high” royalty rates that failed to comply with Qualcomm’s FRAND obligations.

Judge Koh’s ruling offers an unfortunate example of the numerous pitfalls that decisionmakers face when they second-guess the distributional outcomes achieved through market forces. This is particularly true in the complex standardization space.

The elephant in the room

The first striking feature of Judge Koh’s ruling is what it omits. Throughout the more than two-hundred-page long document, there is not a single reference to the concepts of holdup or holdout (crucial terms of art for a ruling that grapples with the prices charged by an SEP holder). 

At first sight, this might seem like a semantic quibble. But words are important. Patent holdup (along with the “unreasonable” royalties to which it arguably gives rise) is possible only when a number of cumulative conditions are met. Most importantly, the foundational literature on economic opportunism (here and here) shows that holdup (and holdout) mostly occur when parties have made asset-specific sunk investments. This focus on asset-specific investments is echoed by even the staunchest critics of the standardization status quo (here).

Though such investments may well have been present in the case at hand, there is no evidence that they played any part in the court’s decision. This is not without consequences. If parties did not make sunk relationship-specific investments, then the antitrust case against Qualcomm should have turned upon the alleged exclusion of competitors, not the level of Qualcomm’s royalties. The DOJ said this much in its statement of interest concerning Qualcomm’s motion for partial stay of injunction pending appeal. Conversely, if these investments existed, then patent holdout (whereby implementers refuse to license key pieces of intellectual property) was just as much of a risk as patent holdup (here and here). And yet the court completely overlooked this possibility.

The misguided push for component level pricing

The court also erred by objecting to Qualcomm’s practice of basing license fees on the value of handsets, rather than that of modem chips. In simplified terms, implementers paid Qualcomm a percentage of their devices’ resale price. The court found that this was against Federal Circuit law. Instead, it argued that royalties should be based on the value the smallest salable patent-practicing component (in this case, baseband chips). This conclusion is dubious both as a matter of law and of policy.

From a legal standpoint, the question of the appropriate royalty base seems far less clear-cut than Judge Koh’s ruling might suggest. For instance, Gregory Sidak observes that in TCL v. Ericsson Judge Selna used a device’s net selling price as a basis upon which to calculate FRAND royalties. Likewise, in CSIRO v. Cisco, the Court also declined to use the “smallest saleable practicing component” as a royalty base. And finally, as Jonathan Barnett observes, the Circuit Laser Dynamics case law cited  by Judge Koh relates to the calculation of damages in patent infringement suits. There is no legal reason to believe that its findings should hold any sway outside of that narrow context. It is one thing for courts to decide upon the methodology that they will use to calculate damages in infringement cases – even if it is a contested one. It is a whole other matter to shoehorn private parties into adopting this narrow methodology in their private dealings. 

More importantly, from a policy standpoint, there are important advantages to basing royalty rates on the price of an end-product, rather than that of an intermediate component. This type of pricing notably enables parties to better allocate the risk that is inherent in launching a new product. In simplified terms: implementers want to avoid paying large (fixed) license fees for failed devices; and patent holders want to share in the benefits of successful devices that rely on their inventions. The solution, as Alain Bousquet and his co-authors explain, is to agree on royalty payments that are contingent on success in the market:

Because the demand for a new product is uncertain and/or the potential cost reduction of a new technology is not perfectly known, both seller and buyer may be better off if the payment for the right to use an innovation includes a state-contingent royalty (rather than consisting of just a fixed fee). The inventor wants to benefit from a growing demand for a new product, and the licensee wishes to avoid high payments in case of disappointing sales.

While this explains why parties might opt for royalty-based payments over fixed fees, it does not entirely elucidate the practice of basing royalties on the price of an end device. One explanation is that a technology’s value will often stem from its combination with other goods or technologies. Basing royalties on the value of an end-device enables patent holders to more effectively capture the social benefits that flow from these complementarities.

Imagine the price of the smallest saleable component is identical across all industries, despite it being incorporated into highly heterogeneous devices. For instance, the same modem chip could be incorporated into smartphones (of various price ranges), tablets, vehicles, and other connected devices. The Bousquet line of reasoning (above) suggests that it is efficient for the patent holder to earn higher royalties (from the IP that underpins the modem chips) in those segments where market demand is strongest (i.e. where there are stronger complementarities between the modem chip and the end device).

One way to make royalties more contingent on market success is to use the price of the modem (which is presumably identical across all segments) as a royalty base and negotiate a separate royalty rate for each end device (charging a higher rate for devices that will presumably benefit from stronger consumer demand). But this has important drawbacks. For a start, identifying those segments (or devices) that are most likely to be successful is informationally cumbersome for the inventor. Moreover, this practice could land the patent holder in hot water. Antitrust authorities might naïvely conclude that these varying royalty rates violate the “non-discriminatory” part of FRAND.

A much simpler solution is to apply a single royalty rate (or at least attempt to do so) but use the price of the end device as a royalty base. This ensures that the patent holder’s rewards are not just contingent on the number of devices sold, but also on their value. Royalties will thus more closely track the end-device’s success in the marketplace.   

In short, basing royalties on the value of an end-device is an informationally light way for the inventor to capture some of the unforeseen value that might stem from the inclusion of its technology in an end device. Mandating that royalty rates be based on the value of the smallest saleable component ignores this complex reality.

Prices are almost impossible to reconstruct

Judge Koh was similarly imperceptive when assessing Qualcomm’s contribution to the value of key standards, such as LTE and CDMA. 

For a start, she reasoned that Qualcomm’s royalties were large compared to the number of patents it had contributed to these technologies:

Moreover, Qualcomm’s own documents also show that Qualcomm is not the top standards contributor, which confirms Qualcomm’s own statements that QCT’s monopoly chip market share rather than the value of QTL’s patents sustain QTL’s unreasonably high royalty rates.

Given the tremendous heterogeneity that usually exists between the different technologies that make up a standard, simply counting each firm’s contributions is a crude and misleading way to gauge the value of their patent portfolios. Accordingly, Qualcomm argued that it had made pioneering contributions to technologies such as CDMA, and 4G/5G. Though the value of Qualcomm’s technologies is ultimately an empirical question, the court’s crude patent counting  was unlikely to provide a satisfying answer.

Just as problematically, the court also concluded that Qualcomm’s royalties were unreasonably high because “modem chips do not drive handset value.” In its own words:

Qualcomm’s intellectual property is for communication, and Qualcomm does not own intellectual property on color TFT LCD panel, mega-pixel DSC module, user storage memory, decoration, and mechanical parts. The costs of these non-communication-related components have become more expensive and now contribute 60-70% of the phone value. The phone is not just for communication, but also for computing, movie-playing, video-taking, and data storage.

As Luke Froeb and his co-authors have also observed, the court’s reasoning on this point is particularly unfortunate. Though it is clearly true that superior LCD panels, cameras, and storage increase a handset’s value – regardless of the modem chip that is associated with them – it is equally obvious that improvements to these components are far more valuable to consumers when they are also associated with high-performance communications technology.

For example, though there is undoubtedly standalone value in being able to take improved pictures on a smartphone, this value is multiplied by the ability to instantly share these pictures with friends, and automatically back them up on the cloud. Likewise, improving a smartphone’s LCD panel is more valuable if the device is also equipped with a cutting edge modem (both are necessary for consumers to enjoy high-definition media online).

In more technical terms, the court fails to acknowledge that, in the presence of perfect complements, each good makes an incremental contribution of 100% to the value of the whole. A smartphone’s components would be far less valuable to consumers if they were not associated with a high-performance modem, and vice versa. The fallacy to which the court falls prey is perfectly encapsulated by a quote it cites from Apple’s COO:

Apple invests heavily in the handset’s physical design and enclosures to add value, and those physical handset features clearly have nothing to do with Qualcomm’s cellular patents, it is unfair for Qualcomm to receive royalty revenue on that added value.

The question the court should be asking, however, is whether Apple would have gone to the same lengths to improve its devices were it not for Qualcomm’s complementary communications technology. By ignoring this question, Judge Koh all but guaranteed that her assessment of Qualcomm’s royalty rates would be wide of the mark.

Concluding remarks

In short, the FTC v. Qualcomm case shows that courts will often struggle when they try to act as makeshift price regulators. It thus lends further credence to Gergory Werden and Luke Froeb’s conclusion that:

Nothing is more alien to antitrust than enquiring into the reasonableness of prices. 

This is especially true in complex industries, such as the standardization space. The colossal number of parameters that affect the price for a technology are almost impossible to reproduce in a top-down fashion, as the court attempted to do in the Qualcomm case. As a result, courts will routinely draw poor inferences from factors such as the royalty base agreed upon by parties, the number of patents contributed by a firm, and the complex manner in which an individual technology may contribute to the value of an end-product. Antitrust authorities and courts would thus do well to recall the wise words of Friedrich Hayek:

If we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place, it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its orders. We must solve it by some form of decentralization.

[TOTM: The following is the seventh in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case recently decided by Judge Lucy Koh in the Northern District of California. Other posts in this series are here.]

This post is authored by Gerard Lloblet, Professor of Economics at CEMFI, and Jorge Padilla, Senior Managing Director at Compass Lexecon. Both have advised SEP holders, and to a lesser extent licensees, in royalty negotiations and antitrust disputes.]

Over the last few years competition authorities in the US and elsewhere have repeatedly warned about the risk of patent hold-up in the licensing of Standard Essential Patents (SEPs). Concerns about such risks were front and center in the recent FTC case against Qualcomm, where the Court ultimately concluded that Qualcomm had used a series of anticompetitive practices to extract unreasonable royalties from implementers. This post evaluates the evidence for such a risk, as well as the countervailing risk of patent hold-out.

In general, hold up may arise when firms negotiate trading terms after they have made costly, relation-specific investments. Since the costs of these investments are sunk when trading terms are negotiated, they are not factored into the agreed terms. As a result, depending on the relative bargaining power of the firms, the investments made by the weaker party may be undercompensated (Williamson, 1979). 

In the context of SEPs, patent hold-up would arise if SEP owners were able to take advantage of the essentiality of their patents to charge excessive royalties to manufacturers of products reading on those patents that made irreversible investments in the standard (see Lemley and Shapiro (2007)). Similarly, in the recent FTC v. Qualcomm ruling, trial judge Lucy Koh concluded that firms may also use commercial strategies (in this case, Qualcomm’s “no license, no chips” policy, refusing to deal with certain parties and demanding exclusivity from others) to extract royalties that depart from the FRAND benchmark.

After years of heated debate, however, there is no consensus about whether patent hold-up actually exists. Some argue that there is no evidence of hold-up in practice. If patent hold-up were a significant problem, manufacturers would anticipate that their investments would be expropriated and would thus decide not to invest in the first place. But end-product manufacturers have invested considerable amounts in standardized technologies (Galetovic et al, 2015). Others claim that while investment is indeed observed, actual investment levels are “necessarily” below those that would be observed in the absence of hold-up. They allege that, since that counterfactual scenario is not observable, it is not surprising that more than fifteen years after the patent hold-up hypothesis was first proposed, empirical evidence of its existence is lacking.

Meanwhile, innovators are concerned about a risk in the opposite direction, the risk of patent hold-out. As Epstein and Noroozi (2018) explain,

By “patent holdout” we mean the converse problem, i.e., that an implementer refuses to negotiate in good faith with an innovator for a license to valid patent(s) that the implementer infringes, and instead forces the innovator to either undertake significant litigation costs and time delays to extract a licensing payment through court order, or else to simply drop the matter because the licensing game is no longer worth the candle.

Patent hold-out, also known as “efficient infringement,” is especially relevant in the standardization context for two reasons. First, SEP owners are oftentimes required to license their patents under Fair, Reasonable and Non-Discriminatory (FRAND) conditions. Particularly when, as occurs in some jurisdictions, innovators are not allowed to request an injunction, they have little or no leverage in trying to require licensees to accept a licensing deal. Secondly, SEP owners typically possess many complementary patents and, therefore, seek to license their portfolio of SEPs at once, since that minimizes transaction costs. Yet, some manufacturers de facto refuse to negotiate in this way and choose to challenge the validity of the SEP portfolio patent-by-patent and/or jurisdiction-by-jurisdiction. This strategy involves large litigation costs and is therefore inefficient. SEP holders claim that this practice is anticompetitive and it also leads to royalties that are too low.

While the concerns of SEP holders seem to have attracted the attention of the leadership of the US DOJ (see, for example, here), some authors have dismissed them as theoretically groundless, empirically immaterial and irrelevant from an antitrust perspective (see here). 

Evidence of patent hold-out from litigation

In an ongoing work, Llobet and Padilla (forthcoming), we analyze the effects of the sequential litigation strategy adopted by some manufacturers and compare its consequences with the simultaneous litigation of the whole portfolio. We show that sequential litigation results in lower royalty payments than simultaneous litigation and may result in under-compensation of innovation and the dissipation of social surplus when litigation costs are high.

The model relies on two basic and realistic assumptions. First, in sequential lawsuits, the result of a trial affects the probability that each party wins the following one. That is, if the manufacturer wins the first trial, it has a higher probability of winning the second, as a first victory may uncover information about the validity of other patents that relate to the same type of innovation, which will be less likely to be upheld in court. Second, the impact of a validity challenge on royalty payments is asymmetric: they are reduced to zero if the patent is found to be invalid but are not increased if it is found valid (and infringed).

Our results indicate that these features of the legal system can be strategically used by the manufacturer. The intuition is as follows. Suppose that the innovator sets a royalty rate for each patent for which, in the simultaneous trial case, the manufacturer would be indifferent between settling and litigating. Under sequential litigation, however, the manufacturer might be willing to challenge a patent because of the gain in a future trial. This is due to the asymmetric effects that winning or losing the second trial has on the royalty rate that this firm will have to pay. In particular, if the manufacturer wins the first trial, so that the first patent is invalidated, its probability of winning the second one increases, which means that the innovator is likely to settle for a lower royalty rate for the second patent or see both patents invalidated in court. In the opposite case, if the innovator wins the first trial, so that the second is also likely to be unfavorable to the manufacturer, the latter always has the option to pay up the original royalty rate and avoid the second trial. In other words, the possibility for the manufacturer to negotiate the royalty rate downwards after a victory, without the risk of it being increased in case of a defeat, fosters sequential litigation and results in lower royalties than the simultaneous litigation of all patents would produce. 

This mechanism, while being applicable to any portfolio that includes patents the validity of which is related, becomes more significant in the context of SEPs for two reasons. The first is the difficulty of innovators to adjust their royalties upwards after the first successful trial, as it might be considered a breach of their FRAND commitments. The second is that, following recent competition law litigation in the EU and other jurisdictions, SEP owners are restricted in their ability to seek (preliminary) injunctions even in the case of willful infringement. Our analysis demonstrates that the threat of injunction mitigates, though it is unlikely to eliminate completely, the incentive to litigate sequentially and, therefore, excessively (i.e. even when such litigation reduces social welfare).

We also find a second motivation for excessive litigation: business stealing. Manufacturers litigate excessively in order to avoid payment and thus achieve a valuable cost advantage over their competitors. They prefer to litigate even when litigation costs are so large that it would be preferable for society to avoid litigation because their royalty burden is reduced both in absolute terms and relative to the royalty burden for its rivals (while it does not go up if the patents are found valid). This business stealing incentive will result in the under-compensation of innovators, as above, but importantly it may also result in the anticompetitive foreclosure of more efficient competitors.

Consider, for example, a scenario in which a large firm with the ability to fund protracted litigation efforts competes in a downstream market with a competitive fringe, comprising small firms for which litigation is not an option. In this scenario, the large manufacturer may choose to litigate to force the innovator to settle on a low royalty. The large manufacturer exploits the asymmetry with its defenseless small rivals to reduce its IP costs. In some jurisdictions it may also exploit yet another asymmetry in the legal system to achieve an even larger cost advantage. If both the large manufacturer and the innovator choose to litigate and the former wins, the patent is invalidated, and the large manufacturer avoids paying royalties altogether. Whether this confers a comparative advantage on the large manufacturer depends on whether the invalidation results in the immediate termination of all other existing licenses or not.

Our work thus shows that patent hold-out concerns are both theoretically cogent and have non-trivial antitrust implications. Whether such concerns merit intervention is an empirical matter. While reviewing that evidence is outside the scope of our work, our own litigation experience suggests that patent hold-out should be taken seriously.

[TOTM: The following is the sixth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case recently decided by Judge Lucy Koh in the Northern District of California. Other posts in this series are here.

This post is authored by Jonathan M. Barnett, Torrey H. Webb Professor of Law at the University of Southern California Gould School of Law.]

There is little doubt that the decision in May 2019 by the Northern District of California in FTC v. Qualcomm is of historical importance. Unless reversed or modified on appeal, the decision would require that the lead innovator behind 3G and 4G smartphone technology renegotiate hundreds of existing licenses with device producers and offer new licenses to any interested chipmakers.

The court’s sweeping order caps off a global campaign by implementers to re-engineer the property-rights infrastructure of the wireless markets. Those efforts have deployed the instruments of antitrust and patent law to override existing licensing arrangements and thereby reduce the input costs borne by device producers in the downstream market. This has occurred both directly, in arguments made by those firms in antitrust and patent litigation or through the filing of amicus briefs, or indirectly by advocating that regulators bring antitrust actions against IP licensors.

Whether or not FTC v. Qualcomm is correctly decided largely depends on whether or not downstream firms’ interest in minimizing the costs of obtaining technology inputs from upstream R&D specialists aligns with the public interest in preserving dynamically efficient innovation markets. As I discuss below, there are three reasons to believe those interests are not aligned in this case. If so, the court’s order would simply engineer a wealth transfer from firms that have led innovation in wireless markets to producers that have borne few of the costs and risks involved in doing so. Members of the former group each exhibits R&D intensities (R&D expenditures as a percentage of sales) in the high teens to low twenties; the latter, approximately five percent. Of greater concern, the court’s upending of long-established licensing arrangements endangers business models that monetize R&D by licensing technology to a large pool of device producers (see Qualcomm), rather than earning returns through self-contained hardware and software ecosystems (see Apple). There is no apparent antitrust rationale for picking and choosing among these business models in innovation markets.

Reason #1: FRAND is a Two-Sided Deal

To fully appreciate the recent litigations involving the FTC and Apple on the one hand, and Qualcomm on the other hand, it is necessary to return to the origins of modern wireless markets.

Starting in the late 1980s, various firms were engaged in the launch of the GSM wireless network in Western Europe. At that time, each European telecom market typically consisted of a national monopoly carrier and a favored group of local equipment suppliers. The GSM project, which envisioned a trans-national wireless communications market, challenged this model. In particular, the national carrier and equipment monopolies were threatened by the fact that the GSM standard relied in part on patented technology held by an outside innovator—namely, Motorola. As I describe in a forthcoming publication, the “FRAND” (fair, reasonable and nondiscriminatory) principles that today govern the licensing of standard-essential patents in wireless markets emerged from a negotiation between, on the one hand, carriers and producers who sought a royalty cap and, on the other hand, a technology innovator that sought to preserve its licensing freedom going forward.

This negotiation history is important. Any informed discussion of the meaning of FRAND must recognize that this principle was adopted as something akin to a “good faith” contractual term designed to promote two objectives:

  1. Protect downstream adopters from holdup tactics by upstream innovators; and
  2. enable upstream innovators to enjoy an appreciable portion of the value generated by sales in the consumer market.

Any interpretation of FRAND that does not meet these conditions will induce upstream firms to reduce R&D investment, limit participation in standard-setting activities, or vertically integrate forward to capture directly a return on R&D dollars.

Reason #2: No Evidence of Actual Harm

In the December 2018 appellate court proceedings in which the Department of Justice unsuccessfully challenged the AT&T/Time-Warner merger, Judge David Sentelle of the D.C. Circuit said to the government’s legal counsel:

If you’re going to rely on an economic model, you have to rely on it with quantification. The bare theorem . . . doesn’t prove anything in a particular case.

The government could not credibly reply to that query in the AT&T case and, if appropriately challenged, could not do so in this case.

Far from being a market that calls out for federal antitrust intervention, the smartphone market offers what appears to be an almost textbook case of dynamic efficiency. For over a decade, implementers, along with sympathetic regulators and commentators, have argued that the market suffers (or, in a variation, will imminently suffer) from inflated prices, reduced output and delayed innovation as a result of “patent hold-up” and “royalty stacking” by opportunistic patent owners. In the course of several decades that have passed since the launch of the GSM network, none of these predictions have yet to materialize. To the contrary. The market has exhibited expanding output, declining prices (adjusted for increased functionality), constant innovation, and regular entry into the production market. Multiple empirical studies (e.g. this, this and this) have found that device producers bear on average an aggregate royalty burden in the single to mid-digits.

This hardly seems like a market in which producers and consumers are being “victimized” by what the Northern District of California calls “unreasonably high” licensing fees (compared to an unspecified, and inherently unspecifiable, dynamically efficient benchmark). Rather, it seems more likely that device producers—many of whom provided the testimony which the court referenced in concluding that royalty rates were “unreasonably high”—would simply prefer to pay an even lower fee to R&D input suppliers (with no assurance that any of the cost-savings would flow to consumers).

Reason #3: The “License as Tax” Fallacy

The rhetorical centerpiece of the FTC’s brief relied on an analogy between the patent license fees earned by Qualcomm in the downstream device market and the tax that everyone pays to the IRS. The court’s opinion wholeheartedly adopted this narrative, determining that Qualcomm imposes a tax (or, as Judge Koh terms it, a “surcharge”) on the smartphone market by demanding a fee from OEMs for use of its patent portfolio whether or not the OEM purchases chipsets from Qualcomm or another firm. The tax analogy is fundamentally incomplete, both in general and in this case in particular.

It is true that much of the economic literature applies monopoly taxation models to assess the deadweight losses attributed to patents. While this analogy facilitates analytical tractability, a “zero-sum” approach to patent licensing overlooks the value-creating “multiplier” effect that licensing generates in real-world markets. Specifically, broad-based downstream licensing by upstream patent owners—something to which SEP owners commit under FRAND principles—ensures that device makers can obtain the necessary technology inputs and, in doing so, facilitates entry by producers that do not have robust R&D capacities. All of that ultimately generates gains for consumers.

This “positive-sum” multiplier effect appears to be at work in the smartphone market. Far from acting as a tax, Qualcomm’s licensing policies appear to have promoted entry into the smartphone market, which has experienced fairly robust turnover in market leadership. While Apple and Samsung may currently dominate the U.S. market, they face intense competition globally from Chinese firms such as Huawei, Xiaomi and Oppo. That competitive threat is real. As of 2007, Nokia and Blackberry were the overwhelming market leaders and appeared to be indomitable. Yet neither can be found in the market today. That intense “gale of competition”, sustained by the fact that any downstream producer can access the required technology inputs upon payment of licensing fees to upstream innovators, challenges the view that Qualcomm’s licensing practices have somehow restrained market growth.

Concluding Thoughts: Antitrust Flashback

When competitive harms are so unclear (and competitive gains so evident), modern antitrust law sensibly prescribes forbearance. A famous “bad case” from antitrust history shows why.

In 1953, the Department of Justice won an antitrust suit against United Shoe Machinery Corporation, which had led innovation in shoe manufacturing equipment and subsequently dominated that market. United Shoe’s purportedly anti-competitive practices included a lease-only policy that incorporated training and repair services at no incremental charge. The court found this to be a coercive tie that preserved United Shoe’s dominant position, despite the absence of any evidence of competitive harm. Scholars have subsequently shown (e.g. this and  this; see also this) that the court did not adequately consider (at least) two efficiency explanations: (1) lease-only policies were widespread in the market because this facilitated access by smaller capital-constrained manufacturers, and (2) tying support services to equipment enabled United Shoe to avoid free-riding on its training services by other equipment suppliers. In retrospect, courts relied on a mere possibility theorem ultimately to order the break-up of a technological pioneer, with potentially adverse consequences for manufacturers that relied on its R&D efforts.

The court’s decision in FTC v. Qualcomm is a flashback to cases like United Shoe in which courts found liability and imposed dramatic remedies with little economic inquiry into competitive harm. It has become fashionable to assert that current antitrust law is too cautious in finding liability. Yet there is a sound reason why, outside price-fixing, courts generally insist that theories of antitrust liability include compelling evidence of competitive harm. Antitrust remedies are strong medicine and should be administered with caution. If courts and regulators do not zealously scrutinize the factual support for antitrust claims, then they are vulnerable to capture by private entities whose business objectives may depart from the public interest in competitive markets. While no antitrust fact-pattern is free from doubt, over two decades of market performance strongly favor the view that long-standing licensing arrangements in the smartphone market have resulted in substantial net welfare gains for consumers. If so, the prudent course of action is simply to leave the market alone.

[TOTM: The following is the fifth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here.

This post is authored by Douglas H. Ginsburg, Professor of Law, Antonin Scalia Law School at George Mason University; Senior Judge, United States Court of Appeals for the District of Columbia Circuit; and former Assistant Attorney General in charge of the Antitrust Division of the U.S. Department of Justice; and Joshua D. Wright, University Professor, Antonin Scalia Law School at George Mason University; Executive Director, Global Antitrust Institute; former U.S. Federal Trade Commissioner from 2013-15; and one of the founding bloggers at Truth on the Market.]

[Ginsburg & Wright: Professor Wright is recused from participation in the FTC litigation against Qualcomm, but has provided counseling advice to Qualcomm concerning other regulatory and competition matters. The views expressed here are our own and neither author received financial support.]

Introduction

In a recent article Joe Kattan and Tim Muris (K&M) criticize our article on the predictive power of bargaining models in antitrust, in which we used two recent applications to explore implications for uses of bargaining models in courts and antitrust agencies moving forward.  Like other theoretical models used to predict competitive effects, complex bargaining models require courts and agencies rigorously to test their predictions against data from the real world markets and institutions to which they are being applied.  Where the “real-world evidence,” as Judge Leon described such data in AT&T/Time Warner, is inconsistent with the predictions of a complex bargaining model, then the tribunal should reject the model rather than reality.

K&M, who represent Intel Corporation in connection with the FTC v. Qualcomm case now pending in the Northern District of California, focus exclusively upon, and take particular issue with, one aspect of our prior article:  We argued that, as in AT&T/Time Warner, the market realities at issue in FTC v. Qualcomm are inconsistent with the use of Dr. Carl Shapiro’s bargaining model to predict competitive effects in the relevant market.  K&M—no doubt confident in their superior knowledge of the underlying facts due to their representation in the matter—criticize our analysis for our purported failure to get our hands sufficiently dirty with the facts.  They criticize our broader analysis of bargaining models and their application for our failure to discuss specific pieces of evidence presented at trial, and offer up several quotations from Qualcomm’s customers as support for Shapiro’s economic analysis.  K&M concede that, as we argue, the antitrust laws should not condemn a business practice in the absence of robust economic evidence of actual or likely harm to competition; yet, they do not see any conflict between that concession and their position that the FTC need not, through its expert, quantify the royalty surcharge imposed by Qualcomm because the “exact size of the overcharge was not relevant to the issue of Qualcomm’s liability.” [Kattan and Muris miss the point that within the context of economic modeling, the failure to identify the magnitude of an effect with any certainty when data are available, including whether the effect is statistically different than zero, calls into question the model’s robustness more generally.]

Though our prior article was a broad one, not limited to FTC v. Qualcomm or intended to cover record evidence in detail, we welcome K&M’s critique and are happy to accept their invitation to engage further on the facts of that particular case.  We agree that accounting for market realities is very important when complex economic models are at play.  Unfortunately, K&M’s position that the evidence “supports Shapiro’s testimony overwhelmingly” ignores the sound empirical evidence employed by Dr. Aviv Nevo during trial and has not aged well in light of the internal Apple documents made public in Qualcomm’s Opening Statement following the companies’ decision to settle the case, which Apple had initiated in January 2017.

Qualcomm’s Opening Statement in the Apple litigation revealed a number of new facts that are problematic, to say the least, for K&M’s position and, even more troublesome for Shapiro’s model and the FTC’s case.  Of course, as counsel to an interested party in the FTC case, it is entirely possible that K&M were aware of the internal Apple documents cited in Qualcomm’s Opening Statement (or similar documents) and simply disagree about their significance.  On the other hand, it is quite clear the Department of Justice Antitrust Division found them to be significantly damaging; it took the rare step of filing a Statement of Interest of the United States with the district court citing the documents and imploring the court to call for additional briefing and hold a hearing on issues related to a remedy in the event that it finds Qualcomm liable on any of the FTC’s claims. The internal Apple documents cited in Qualcomm’s Opening Statement leave no doubt as to several critical market realities that call into question the FTC’s theory of harm and Shapiro’s attempts to substantiate it.

(For more on the implications of these documents, see Geoffrey Manne’s post in this series, here).

First, the documents laying out Apple’s litigation strategy clearly establish that it has a high regard for Qualcomm’s technology and patent portfolio and that Apple strategized for several years about how to reduce its net royalties and to hurt Qualcomm financially. 

Second, the documents undermine Apple’s public complaints about Qualcomm and call into question the validity of the underlying theory of harm in the FTC’s case.  In particular, the documents plainly debunk Apple’s claims that Qualcomm’s patents weakened over time as a result of a decline in the quality of the technology and that Qualcomm devised an anticompetitive strategy in order to extract value from a weakening portfolio.  The documents illustrate that in fact, Apple adopted a deliberate strategy of trying to manipulate the value of Qualcomm’s portfolio.  The company planned to “creat[e] evidence” by leveraging its purchasing power to methodically license less expensive patents in hope of making Qualcomm’s royalties appear artificially inflated. In other words, if Apple’s made-for-litigation position were correct, then it would be only because of Apple’s attempt to manipulate and devalue Qualcomm’s patent portfolio, not because there had been any real change in its value. 

Third, the documents directly refute some of the arguments K&M put forth in their critique of our prior article, in which we invoked Dr. Nevo’s empirical analysis of royalty rates over time as important evidence of historical facts that contradict Dr. Shapiro’s model.  For example, K&M attempt to discredit Nevo’s analysis by claiming he did not control for changes in the strength of Qualcomm’s patent portfolio which, they claim, had weakened over time. According to internal Apple documents, however, “Qualcomm holds a stronger position in . . . , and particularly with respect to cellular and Wi-Fi SEPs” than do Huawei, Nokia, Ericsson, IDCC, and Apple. Another document states that “Qualcomm is widely considered the owner of the strongest patent portfolio for essential and relevant patents for wireless standards.” Indeed, Apple’s documents show that Apple sought artificially to “devalue SEPs” in the industry by “build[ing] favorable, arms-length ‘comp’ licenses” in an attempt to reduce what FRAND means. The ultimate goal of this pursuit was stated frankly by Apple: To “reduce Apple’s net royalty to Qualcomm” despite conceding that Qualcomm’s chips “engineering wise . . . have been the best.”

As new facts relevant to the FTC’s case and contrary to its theory of harm come to light, it is important to re-emphasize the fundamental point of our prior article: Model predictions that are inconsistent with actual market evidence should give fact finders serious pause before accepting the results as reliable.  This advice is particularly salient in a case like FTC v. Qualcomm, where intellectual property and innovation are critical components of the industry and its competitiveness, because condemning behavior that is not truly anticompetitive may have serious, unintended consequences. (See Douglas H. Ginsburg & Joshua D. Wright, Dynamic Analysis and the Limits of Antitrust Institutions, 78 Antitrust L.J. 1 (2012); Geoffrey A. Manne & Joshua D. Wright, Innovation and the Limits of Antitrust, 6 J. Competition L. & Econ. 153 (2010)).

The serious consequences of a false positive, that is, the erroneous condemnation of a procompetitive or competitively neutral business practice, is undoubtedly what caused the Antitrust Division to file its Statement of Interest in the FTC’s case against Qualcomm.  That Statement correctly highlights the Apple documents as support for Government’s concern that “an overly broad remedy in this case could reduce competition and innovation in markets for 5G technology and downstream applications that rely on that technology.”

In this reply, we examine closely the market realities that with and hence undermine both Dr. Shapiro’s bargaining model and the FTC’s theory of harm in its case against Qualcomm.  We believe the “large body of evidence” offered by K&M supporting Shapiro’s theoretical analysis is insufficient to sustain his conclusions under standard antitrust analysis, including the requirement that a plaintiff alleging monopolization or attempted monopolization provide evidence of actual or likely anticompetitive effects.  We will also discuss the implications of the newly-public internal Apple documents for the FTC’s case, which remains pending at the time of this writing, and for future government investigations involving allegedly anticompetitive licensing of intellectual property.

I. Kattan and Muris Rely Upon Inconsequential Testimony and Mischaracterize Dr. Nevo’s Empirical Analysis

K&M march through a series of statements from Qualcomm’s customers asserting that the threat of Qualcomm discontinuing the supply of modem chips forced them to agree to unreasonable licensing demands.  This testimony, however, is reminiscent of Dr. Shapiro’s testimony in AT&T/Time Warner concerning the threat of a long-term blackout of CNN and other Turner channels:  Qualcomm has never cut off any customer’s supply of chips.  The assertion that companies negotiating with Qualcomm either had to “agree to the license or basically go out of business” ignores the reality that even if Qualcomm discontinued supplying chips to a customer, the customer could obtain chips from one of four rival sources.  This was not a theoretical possibility.  Indeed, Apple has been sourcing chips from Intel since 2016 and made the decision to switch to Intel specifically in order, in its own words, to exert “commercial pressure against Qualcomm.”

Further, as Dr. Nevo pointed out at trial, SEP license agreements are typically long term (e.g., 10 or 15 year agreements) and are negotiated far less frequently than chip prices, which are typically negotiated annually.  In other words, Qualcomm’s royalty rate is set prior to and independent of chip sale negotiations. 

K&M raise a number of theoretical objections to Nevo’s empirical analysis.  For example, K&M accuse Nevo of “cherry picking” the licenses he included in his empirical analysis to show that royalty rates remained constant over time, stating that he “excluded from consideration any license that had non-standard terms.” They mischaracterize Nevo’s testimony on this point.  Nevo excluded from his analysis agreements that, according to the FTC’s own theory of harm, would be unaffected (e.g., agreements that were signed subject to government supervision or agreements that have substantially different risk splitting provisions).  In any event, Nevo testified that modifying his analysis to account for Shapiro’s criticism regarding the excluded agreements would have no material effect on his conclusions.  To our knowledge, Nevo’s testimony is the only record evidence providing any empirical analysis of the effects of Qualcomm’s licensing agreements.

As previously mentioned, K&M also claim that Dr. Nevo’s analysis failed to account for the alleged weakening of Qualcomm’s patent portfolio over time.  Apple’s internal documents, however, are fatal to that claim..  K&M also pinpoint failure to control for differences among customers and changes in the composition of handsets over time as critical errors in Nevo’s analysis.  Their assertion that Nevo should have controlled for differences among customers is puzzling.  They do not elaborate upon that criticism, but they seem to believe different customers are entitled to different FRAND rates for the same license.  But Qualcomm’s standard practice—due to the enormous size of its patent portfolio—is and has always been to charge all licensees the same rate for the entire portfolio.

As to changes in the composition of handsets over time, no doubt a smartphone today has many more features than a first-generation handset that only made and received calls; those new features, however, would be meaningless without Qualcomm’s SEPs, which are implemented by mobile chips that enable cellular communication.  One must wonder why Qualcomm should have reduced the royalty rate on licenses for patents that are just as fundamental to the functioning of mobile phones today as they were to the functioning of a first-generation handset.  K&M ignore the fundamental importance of Qualcomm’s SEPs in claiming that royalty rates should have declined along with the quality adjusted/? declining prices of mobile phones.  They also, conveniently, ignore the evidence that the industry has been characterized by increasing output and quality—increases which can certainly be attributed at least in part to Qualcomm’s chips being “engineering wise . . . the best.”. 

II. Apple’s Internal Documents Eviscerate the FTC’s Theory of Harm

The FTC’s theory of harm is premised upon Qualcomm’s allegedly charging a supra-FRAND rate for its SEPs (the “royalty surcharge”), which squeezes the margins of OEMs and consequently prevents rival chipset suppliers from obtaining a sufficient return when negotiating with those OEMs. (See Luke Froeb, et al’s criticism of the FTC’s theory of harm on these and related grounds, here). To predict the effects of Qualcomm’s allegedly anticompetitive conduct, Dr. Shapiro compared the gains from trade OEMs receive when they purchase a chip from Qualcomm and pay Qualcomm a FRAND royalty to license its SEPs with the gains from trade OEMs receive when they purchase a chip from a rival manufacturer and pay a “royalty surcharge” to Qualcomm to license its SEPs.  Shapiro testified that he had “reason to believe that the royalty surcharge was substantial” and had “inevitable consequences,” for competition and for consumers, though his bargaining model did not quantify the effects of Qualcomm’s practice. 

The premise of the FTC theory requires a belief about FRAND as a meaningful, objective competitive benchmark that Qualcomm was able to evade as a result of its market power in chipsets.  But Apple manipulated negotiations as a tactic to reshape FRAND itself.  The closer look at the facts invited by K&M does nothing to improve one’s view of the FTC’s claims.  The Apple documents exposed at trial make it clear that Apple deliberately manipulated negotiations with other suppliers in order to make it appear to courts and antitrust agencies that something other than the quality of Qualcomm’s technology was driving royalty rates.  For example, Apple’s own documents show it sought artificially to “devalue SEPs” by “build[ing] favorable, arms-length ‘comp’ licenses” in an attempt to reshape what FRAND means in this industry. Simply put, Apple’s strategy was to negotiate cheap supposedly “comparable” licenses with other chipset suppliers as part of a plan to reduce its net royalties to Qualcomm. 

As part of the same strategy, Apple spent years arguing to regulators and courts that Qualcomm’s patents were no better than those of its competitors.  But their internal documents tell this very different story:

  • “Nokia’s patent portfolio is significantly weaker than Qualcomm’s.”
  • “[InterDigital] makes minimal contributions to [the 4G/LTE] standard”
  • “Compared to [Huawei, Nokia, Ericsson, IDCC, and Apple], Qualcomm holds a stronger position in , and particularly with respect to cellular and Wi-Fi SEPs.”
  • “Compared to other licensors, Qualcomm has more significant holdings in key areas such as media processing, non-cellular communications and hardware.  Likewise, using patent citation analysis as a measure of thorough prosecution within the US PTO, Qualcomm patents (SEPs and non-SEPs both) on average score higher compared to the other, largely non-US based licensors.”

One internal document that is particularly troubling states that Apple’s plan was to “create leverage by building pressure” in order to  (i) hurt Qualcomm financially and (ii) put Qualcomm’s licensing model at risk. What better way to harm Qualcomm financially and put its licensing model at risk than to complain to regulators that the business model is anticompetitive and tie the company up in multiple costly litigations?  That businesses make strategic plans to harm one another is no surprise.  But it underscores the importance of antitrust institutions – with their procedural and evidentiary requirements – to separate meritorious claims from fabricated ones. They failed to do so here.

III. Lessons Learned

So what should we make of evidence suggesting one of the FTC’s key informants during its investigation of Qualcomm didn’t believe the arguments it was selling?  The exposure of Apple’s internal documents is a sobering reminder that the FTC is not immune from the risk of being hoodwinked by rent-seeking antitrust plaintiffs.  That a firm might try to persuade antitrust agencies to investigate and sue its rivals is nothing new (see, e.g., William J. Baumol & Janusz A. Ordover, Use of Antitrust to Subvert Competition, 28 J.L. & Econ. 247 (1985)), but it is a particularly high-stakes game in modern technology markets. 

Lesson number one: Requiring proof of actual anticompetitive effects rather than relying upon a model that is not robust to market realities is an important safeguard to ensure that Section 2 protects competition and not merely an individual competitor.  Yet the agencies’ staked their cases on bargaining models in AT&T/Time Warner and FTC v. Qualcomm that fell short of proving anticompetitive effects.  An agency convinced by one firm or firms to pursue an action against a rival for conduct that does not actually harm competition could have a significant and lasting anticompetitive effect on the market.  Modern antitrust analysis requires plaintiffs to substantiate their claims with more than just theory or scant evidence that rivals have been harmed.  That safeguard is particularly important when an agency is pursuing an enforcement action against a company in a market where the risks of regulatory capture and false positives are high.  With calls to move away from the consumer welfare standard—which would exacerbate both the risks and consequences of false positives–it is imperative to embrace rather than reject the requirement of proof in monopolization cases. (See Elyse Dorsey, Jan Rybnicek & Joshua D. Wright, Hipster Antitrust Meets Public Choice Economics: The Consumer Welfare Standard, Rule of Law, and Rent-Seeking, CPI Antitrust Chron. (Apr. 2018); see also Joshua D. Wright et al., Requiem For a Paradox: The Dubious Rise and Inevitable Fall of Hipster Antitrust, 51 Ariz. St. L.J. 293 (2019).) The DOJ’s Statement of Interest is a reminder of this basic tenet. 

Lesson number two: Antitrust should have a limited role in adjudicating disputes arising between sophisticated parties in bilateral negotiations of patent licenses.  Overzealous claims of harm from patent holdup and anticompetitive licensing can deter the lawful exercise of patent rights, good faith modifications of existing contracts, and more generally interfere with the outcome of arms-length negotiations (See Bruce H. Kobayashi & Joshua D. Wright, The Limits of Antitrust and Patent Holdup: A Reply To Cary et al., 78 Antitrust L.J. 701 (2012)). It is also a difficult task for an antitrust regulator or court to identify and distinguish anticompetitive patent licenses from neutral or welfare-increasing behavior.  An antitrust agency’s willingness to cast the shadow of antitrust remedies over one side of the bargaining table inevitably places the agency in the position of encouraging further rent-seeking by licensees seeking similar intervention on their behalf.

Finally, antitrust agencies intervening in patent holdup and licensing disputes on behalf of one party to a patent licensing agreement risks transforming the agency into a price regulator.  Apple’s fundamental complaint in its own litigation, and the core of the similar FTC allegation against Qualcomm, is that royalty rates are too high.  The risks to competition and consumers of antitrust courts and agencies playing the role of central planner for the innovation economy are well known, and are at the peak when the antitrust enterprise is used to set prices, mandate a particular organizational structure for the firm, or to intervene in garden variety contract and patent disputes in high-tech markets.

The current Commission did not vote out the Complaint now being litigated in the Northern District of California.  That case was initiated by an entirely different set of Commissioners.  It is difficult to imagine the new Commissioners having no reaction to the Apple documents, and in particular to the perception they create that Apple was successful in manipulating the agency in its strategy to bolster its negotiating position against Qualcomm.  A thorough reevaluation of the evidence here might well lead the current Commission to reconsider the merits of the agency’s position in the litigation and whether continuing is in the public interest.  The Apple documents, should they enter the record, may affect significantly the Ninth Circuit’s or Supreme Court’s understanding of the FTC’s theory of harm.

[TOTM: The following is the fourth in a series of posts by TOTM guests and authors on the FTC v. Qualcomm case, currently awaiting decision by Judge Lucy Koh in the Northern District of California. The entire series of posts is available here. This post originally appeared on the Federalist Society Blog.]

The courtroom trial in the Federal Trade Commission’s (FTC’s) antitrust case against Qualcomm ended in January with a promise from the judge in the case, Judge Lucy Koh, to issue a ruling as quickly as possible — caveated by her acknowledgement that the case is complicated and the evidence voluminous. Well, things have only gotten more complicated since the end of the trial. Not only did Apple and Qualcomm reach a settlement in the antitrust case against Qualcomm that Apple filed just three days after the FTC brought its suit, but the abbreviated trial in that case saw the presentation by Qualcomm of some damning evidence that, if accurate, seriously calls into (further) question the merits of the FTC’s case.

Apple v. Qualcomm settles — and the DOJ takes notice

The Apple v. Qualcomm case, which was based on substantially the same arguments brought by the FTC in its case, ended abruptly last month after only a day and a half of trial — just enough time for the parties to make their opening statements — when Apple and Qualcomm reached an out-of-court settlement. The settlement includes a six-year global patent licensing deal, a multi-year chip supplier agreement, an end to all of the patent disputes around the world between the two companies, and a $4.5 billion settlement payment from Apple to Qualcomm.

That alone complicates the economic environment into which Judge Koh will issue her ruling. But the Apple v. Qualcomm trial also appears to have induced the Department of Justice Antitrust Division (DOJ) to weigh in on the FTC’s case with a Statement of Interest requesting Judge Koh to use caution in fashioning a remedy in the case should she side with the FTC, followed by a somewhat snarky Reply from the FTC arguing the DOJ’s filing was untimely (and, reading the not-so-hidden subtext, unwelcome).

But buried in the DOJ’s Statement is an important indication of why it filed its Statement when it did, just about a week after the end of the Apple v. Qualcomm case, and a pointer to a much larger issue that calls the FTC’s case against Qualcomm even further into question (I previously wrote about the lack of theoretical and evidentiary merit in the FTC’s case here).

Footnote 6 of the DOJ’s Statement reads:

Internal Apple documents that recently became public describe how, in an effort to “[r]educe Apple’s net royalty to Qualcomm,” Apple planned to “[h]urt Qualcomm financially” and “[p]ut Qualcomm’s licensing model at risk,” including by filing lawsuits raising claims similar to the FTC’s claims in this case …. One commentator has observed that these documents “potentially reveal[] that Apple was engaging in a bad faith argument both in front of antitrust enforcers as well as the legal courts about the actual value and nature of Qualcomm’s patented innovation.” (Emphasis added).

Indeed, the slides presented by Qualcomm during that single day of trial in Apple v. Qualcomm are significant, not only for what they say about Apple’s conduct, but, more importantly, for what they say about the evidentiary basis for the FTC’s claims against the company.

The evidence presented by Qualcomm in its opening statement suggests some troubling conduct by Apple

Others have pointed to Qualcomm’s opening slides and the Apple internal documents they present to note Apple’s apparent bad conduct. As one commentator sums it up:

Although we really only managed to get a small glimpse of Qualcomm’s evidence demonstrating the extent of Apple’s coordinated strategy to manipulate the FRAND license rate, that glimpse was particularly enlightening. It demonstrated a decade-long coordinated effort within Apple to systematically engage in what can only fairly be described as manipulation (if not creation of evidence) and classic holdout.

Qualcomm showed during opening arguments that, dating back to at least 2009, Apple had been laying the foundation for challenging its longstanding relationship with Qualcomm. (Emphasis added).

The internal Apple documents presented by Qualcomm to corroborate this claim appear quite damning. Of course, absent explanation and cross-examination, it’s impossible to know for certain what the documents mean. But on their face they suggest Apple knowingly undertook a deliberate scheme (and knowingly took upon itself significant legal risk in doing so) to devalue comparable patent portfolios to Qualcomm’s:

The apparent purpose of this scheme was to devalue comparable patent licensing agreements where Apple had the power to do so (through litigation or the threat of litigation) in order to then use those agreements to argue that Qualcomm’s royalty rates were above the allowable, FRAND level, and to undermine the royalties Qualcomm would be awarded in courts adjudicating its FRAND disputes with the company. As one commentator put it:

Apple embarked upon a coordinated scheme to challenge weaker patents in order to beat down licensing prices. Once the challenges to those weaker patents were successful, and the licensing rates paid to those with weaker patent portfolios were minimized, Apple would use the lower prices paid for weaker patent portfolios as proof that Qualcomm was charging a super-competitive licensing price; a licensing price that violated Qualcomm’s FRAND obligations. (Emphasis added).

That alone is a startling revelation, if accurate, and one that would seem to undermine claims that patent holdout isn’t a real problem. It also would undermine Apple’s claims that it is a “willing licensee,” engaging with SEP licensors in good faith. (Indeed, this has been called into question before, and one Federal Circuit judge has noted in dissent that “[t]he record in this case shows evidence that Apple may have been a hold out.”). If the implications drawn from the Apple documents shown in Qualcomm’s opening statement are accurate, there is good reason to doubt that Apple has been acting in good faith.

Even more troubling is what it means for the strength of the FTC’s case

But the evidence offered in Qualcomm’s opening argument point to another, more troubling implication, as well. We know that Apple has been coordinating with the FTC and was likely an important impetus for the FTC’s decision to bring an action in the first place. It seems reasonable to assume that Apple used these “manipulated” agreements to help make its case.

But what is most troubling is the extent to which it appears to have worked.

The FTC’s action against Qualcomm rested in substantial part on arguments that Qualcomm’s rates were too high (even though the FTC constructed its case without coming right out and saying this, at least until trial). In its opening statement the FTC said:

Qualcomm’s practices, including no license, no chips, skewed negotiations towards the outcomes that favor Qualcomm and lead to higher royalties. Qualcomm is committed to license its standard essential patents on fair, reasonable, and non-discriminatory terms. But even before doing market comparison, we know that the license rates charged by Qualcomm are too high and above FRAND because Qualcomm uses its chip power to require a license.

* * *

Mr. Michael Lasinski [the FTC’s patent valuation expert] compared the royalty rates received by Qualcomm to … the range of FRAND rates that ordinarily would form the boundaries of a negotiation … Mr. Lasinski’s expert opinion … is that Qualcomm’s royalty rates are far above any indicators of fair and reasonable rates. (Emphasis added).

The key question is what constitutes the “range of FRAND rates that ordinarily would form the boundaries of a negotiation”?

Because they were discussed under seal, we don’t know the precise agreements that the FTC’s expert, Mr. Lasinski, used for his analysis. But we do know something about them: His analysis entailed a study of only eight licensing agreements; in six of them, the licensee was either Apple or Samsung; and in all of them the licensor was either Interdigital, Nokia, or Ericsson. We also know that Mr. Lasinski’s valuation study did not include any Qualcomm licenses, and that the eight agreements he looked at were all executed after the district court’s decision in Microsoft vs. Motorola in 2013.

A curiously small number of agreements

Right off the bat there is a curiosity in the FTC’s valuation analysis. Even though there are hundreds of SEP license agreements involving the relevant standards, the FTC’s analysis relied on only eight, three-quarters of which involved licensing by only two companies: Apple and Samsung.

Indeed, even since 2013 (a date to which we will return) there have been scads of licenses (see, e.g., herehere, and here). Not only Apple and Samsung make CDMA and LTE devices; there are — quite literally — hundreds of other manufacturers out there, all of them licensing essentially the same technology — including global giants like LG, Huawei, HTC, Oppo, Lenovo, and Xiaomi. Why were none of their licenses included in the analysis? 

At the same time, while Interdigital, Nokia, and Ericsson are among the largest holders of CDMA and LTE SEPs, several dozen companies have declared such patents, including Motorola (Alphabet), NEC, Huawei, Samsung, ZTE, NTT DOCOMO, etc. Again — why were none of their licenses included in the analysis?

All else equal, more data yields better results. This is particularly true where the data are complex license agreements which are often embedded in larger, even-more-complex commercial agreements and which incorporate widely varying patent portfolios, patent implementers, and terms.

Yet the FTC relied on just eight agreements in its comparability study, covering a tiny fraction of the industry’s licensors and licensees, and, notably, including primarily licenses taken by the two companies (Samsung and Apple) that have most aggressively litigated their way to lower royalty rates.

A curiously crabbed selection of licensors

And it is not just that the selected licensees represent a weirdly small and biased sample; it is also not necessarily even a particularly comparable sample.

One thing we can be fairly confident of, given what we know of the agreements used, is that at least one of the license agreements involved Nokia licensing to Apple, and another involved InterDigital licensing to Apple. But these companies’ patent portfolios are not exactly comparable to Qualcomm’s. About Nokia’s patents, Apple said:

And about InterDigital’s:

Meanwhile, Apple’s view of Qualcomm’s patent portfolio (despite its public comments to the contrary) was that it was considerably better than the others’:

The FTC’s choice of such a limited range of comparable license agreements is curious for another reason, as well: It includes no Qualcomm agreements. Qualcomm is certainly one of the biggest players in the cellular licensing space, and no doubt more than a few license agreements involve Qualcomm. While it might not make sense to include Qualcomm licenses that the FTC claims incorporate anticompetitive terms, that doesn’t describe the huge range of Qualcomm licenses with which the FTC has no quarrel. Among other things, Qualcomm licenses from before it began selling chips would not have been affected by its alleged “no license, no chips” scheme, nor would licenses granted to companies that didn’t also purchase Qualcomm chips. Furthermore, its licenses for technology reading on the WCDMA standard are not claimed to be anticompetitive by the FTC.

And yet none of these licenses were deemed “comparable” by the FTC’s expert, even though, on many dimensions — most notably, with respect to the underlying patent portfolio being valued — they would have been the most comparable (i.e., identical).

A curiously circumscribed timeframe

That the FTC’s expert should use the 2013 cut-off date is also questionable. According to Lasinski, he chose to use agreements after 2013 because it was in 2013 that the U.S. District Court for the Western District of Washington decided the Microsoft v. Motorola case. Among other things, the court in Microsoft v Motorola held that the proper value of a SEP is its “intrinsic” patent value, including its value to the standard, but not including the additional value it derives from being incorporated into a widely used standard.

According to the FTC’s expert,

prior to [Microsoft v. Motorola], people were trying to value … the standard and the license based on the value of the standard, not the value of the patents ….

Asked by Qualcomm’s counsel if his concern was that the “royalty rates derived in license agreements for cellular SEPs [before Microsoft v. Motorola] could very well have been above FRAND,” Mr. Lasinski concurred.

The problem with this approach is that it’s little better than arbitrary. The Motorola decision was an important one, to be sure, but the notion that sophisticated parties in a multi-billion dollar industry were systematically agreeing to improper terms until a single court in Washington suggested otherwise is absurd. To be sure, such agreements are negotiated in “the shadow of the law,” and judicial decisions like the one in Washington (later upheld by the Ninth Circuit) can affect the parties’ bargaining positions.

But even if it were true that the court’s decision had some effect on licensing rates, the decision would still have been only one of myriad factors determining parties’ relative bargaining  power and their assessment of the proper valuation of SEPs. There is no basis to support the assertion that the Motorola decision marked a sea-change between “improper” and “proper” patent valuations. And, even if it did, it was certainly not alone in doing so, and the FTC’s expert offers no justification for determining that agreements reached before, say, the European Commission’s decision against Qualcomm in 2018 were “proper,” or that the Korea FTC’s decision against Qualcomm in 2009 didn’t have the same sort of corrective effect as the Motorola court’s decision in 2013. 

At the same time, a review of a wider range of agreements suggested that Qualcomm’s licensing royalties weren’t inflated

Meanwhile, one of Qualcomm’s experts in the FTC case, former DOJ Chief Economist Aviv Nevo, looked at whether the FTC’s theory of anticompetitive harm was borne out by the data by looking at Qualcomm’s royalty rates across time periods and standards, and using a much larger set of agreements. Although his remit was different than Mr. Lasinski’s, and although he analyzed only Qualcomm licenses, his analysis still sheds light on Mr. Lasinski’s conclusions:

[S]pecifically what I looked at was the predictions from the theory to see if they’re actually borne in the data….

[O]ne of the clear predictions from the theory is that during periods of alleged market power, the theory predicts that we should see higher royalty rates.

So that’s a very clear prediction that you can take to data. You can look at the alleged market power period, you can look at the royalty rates and the agreements that were signed during that period and compare to other periods to see whether we actually see a difference in the rates.

Dr. Nevo’s analysis, which looked at royalty rates in Qualcomm’s SEP license agreements for CDMA, WCDMA, and LTE ranging from 1990 to 2017, found no differences in rates between periods when Qualcomm was alleged to have market power and when it was not alleged to have market power (or could not have market power, on the FTC’s theory, because it did not sell corresponding chips).

The reason this is relevant is that Mr. Lasinski’s assessment implies that Qualcomm’s higher royalty rates weren’t attributable to its superior patent portfolio, leaving either anticompetitive conduct or non-anticompetitive, superior bargaining ability as the explanation. No one thinks Qualcomm has cornered the market on exceptional negotiators, so really the only proffered explanation for the results of Mr. Lasinski’s analysis is anticompetitive conduct. But this assumes that his analysis is actually reliable. Prof. Nevo’s analysis offers some reason to think that it is not.

All of the agreements studied by Mr. Lasinski were drawn from the period when Qualcomm is alleged to have employed anticompetitive conduct to elevate its royalty rates above FRAND. But when the actual royalties charged by Qualcomm during its alleged exercise of market power are compared to those charged when and where it did not have market power, the evidence shows it received identical rates. Mr Lasinki’s results, then, would imply that Qualcomm’s royalties were “too high” not only while it was allegedly acting anticompetitively, but also when it was not. That simple fact suggests on its face that Mr. Lasinski’s analysis may have been flawed, and that it systematically under-valued Qualcomm’s patents.

Connecting the dots and calling into question the strength of the FTC’s case

In its closing argument, the FTC pulled together the implications of its allegations of anticompetitive conduct by pointing to Mr. Lasinski’s testimony:

Now, looking at the effect of all of this conduct, Qualcomm’s own documents show that it earned many times the licensing revenue of other major licensors, like Ericsson.

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Mr. Lasinski analyzed whether this enormous difference in royalties could be explained by the relative quality and size of Qualcomm’s portfolio, but that massive disparity was not explained.

Qualcomm’s royalties are disproportionate to those of other SEP licensors and many times higher than any plausible calculation of a FRAND rate.

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The overwhelming direct evidence, some of which is cited here, shows that Qualcomm’s conduct led licensees to pay higher royalties than they would have in fair negotiations.

It is possible, of course, that Lasinki’s methodology was flawed; indeed, at trial Qualcomm argued exactly this in challenging his testimony. But it is also possible that, whether his methodology was flawed or not, his underlying data was flawed.

It is impossible from the publicly available evidence to definitively draw this conclusion, but the subsequent revelation that Apple may well have manipulated at least a significant share of the eight agreements that constituted Mr. Lasinski’s data certainly increases the plausibility of this conclusion: We now know, following Qualcomm’s opening statement in Apple v. Qualcomm, that that stilted set of comparable agreements studied by the FTC’s expert also happens to be tailor-made to be dominated by agreements that Apple may have manipulated to reflect lower-than-FRAND rates.

What is most concerning is that the FTC may have built up its case on such questionable evidence, either by intentionally cherry picking the evidence upon which it relied, or inadvertently because it rested on such a needlessly limited range of data, some of which may have been tainted.

Intentionally or not, the FTC appears to have performed its valuation analysis using a needlessly circumscribed range of comparable agreements and justified its decision to do so using questionable assumptions. This seriously calls into question the strength of the FTC’s case.