Friday, 31 January 2020

Valuing SEP portfolios and determining FRAND rates: How, and who should "get it done"?

While there is much uncertainty about the outlook for standard-essential patent royalty rates in court determinations, there are plenty of solid benchmarks in well-established comparable licenses (“comps”). The former rates are thin on the ground and have been made up based on some dubious and fiercely contested tenets as judges scrabble to set figures that are fair, reasonable and on-discriminatory. The latter rates have been agreed in droves through negotiation in licensing programs with dozens of licensors, hundreds of licensees and many thousands of patents. These are not meaningless asking prices with no takers —or just one or two transactions specifically conceived and executed to establish a desired marker— they are economically significant because they are underpinned by many billions of dollars of licensing trade over decades.

And, many players in the cellular industry have self-servingly colluded to cap aggregate royalties since the introduction of 3G twenty years ago. Unsurprisingly, these voices dominate because most, by far, of the interested parties, including OEMs, must become licensees to implement the standards legally. For only a few is licensing more an income generator than a cost in manufacturing.

Who is to say how much all the patents in devices are worth, how that valuation should be derived and how value should be divided among technology owners, implementers and end users? Weighing up all of this is significantly a matter of personal judgment—not of simply applying some supposedly pre-ordained formula. Vacating the District Court Judge Selna’s bench trial decision in TCL v. Ericsson on appeal, the Federal Circuit has prescribed retrial with a jury. This will recalibrate awards based on the subjective judgement of randomly selected non-experts. It will likely include consideration of bottom-up valuation methodologies reflecting consumers’ purchasing preferences, price sensitivities and the perceived value for smartphone features and performance improvements.

The math(s) is not easy or proven


Even using comps is not straightforward in many cases because most licenses are cross licenses and so the prices and monies paid typically reflect significant netting off between the notional royalty rates of the parties and also account for the respective trading flows of their manufactures. Where licensors do not have downstream manufacturing businesses, that need licensing—such as smartphone manufacturing—royalty rates can more easily be directly compared among licensees, in many cases, without adjustment. For example, Qualcomm and InterDigital do not make or sell devices, which account for most, by far, of the trading value in the cellular products (e.g. around $500 billion per year for mobile phones). Adjustments are also required in the comparison of licenses due to up-front lump sum payments, per-device caps, per device floors, total payment caps and other differences.

So how on earth could something as seemingly complex and difficult as valuing a portfolio of SEPs be left to a bunch of jurors? Judge Selna’s decision was extensive and 115 pages long. It applied two different methodologies —"top down” and “comparable license analysis” with the “unpacking” of two-way licenses—and disregarded a third—a bottom up “Ex Standard approach” designed to estimate the value of SEPs independent of any value arising from incorporation of SEPs into a standard. With his judgement vacated, Judge Selna’s analysis no longer has any legal authority; but it does reveal some of the methods and arguments that may continue to be applied in the valuation of SEPs and determination of royalties for these under FRAND terms.

The wisdom of lay folk


Perhaps the jurors will see through all the bluff and complexities, as they do in so many other trials. They can be unburdened by the weight of consensus, self-interested majorities and conventional wisdom. The Seventh Amendment constitutional right to a jury trial in civil proceedings has served the US well. It is probably one of the reasons why the nation is for centuries the most successful technological innovator in the world. If not, the US has evidently not been held back by its patent law and execution of this right.

Significantly, the New [December 2019] Policy Statement on Remedies for Standards-Essential Patents Subject to Voluntary F/RAND Commitments issued by The U.S. Patent & Trademark Office (USPTO), the National Institute of Standards and Technology (NIST), and the U.S. Department of Justice, Antitrust Division (DOJ) offers views on remedies for standards-essential patents that are subject to a RAND or FRAND licensing commitment. This overturns interpretations of the 2013 policy statement by the USPTO and DOJ: ‘the agencies have heard concerns that the 2013 policy statement has been misinterpreted to suggest that a unique set of legal rules should be applied in disputes concerning patents subject to a F/RAND commitment that are essential to standards.’ In addition to saying a lot about how injunctions should become more readily available—an important issue, but which is outside the scope of my article— the new Policy Statement advises that ‘with respect to damages, the Federal Circuit has explained, “We believe it unwise to create a new set of Georgia-Pacific-like factors for all cases involving RAND-encumbered patents.” The court further stated that “[a]lthough we recognize the desire for bright line rules and the need for district courts to start somewhere, courts must consider the facts of record when instructing the jury and should avoid rote reference to any particular damages formula.”’ (Emphasis added and citations omitted.)


With the above developments, we are likely to see rather higher awards for SEPs than, for example, the paltry figure of somewhat less than one US cent per LTE SEP resulting from Judge Selna’s overturned decision.[1]

Juries tend to award rather larger damages figures. In Qualcomm v. Apple, San Diego, March 2019, the figure of $1.41 per iPhone was awarded for infringement of three non-SEPs (i.e. 47 cents per US patent. A Los Angeles jury just awarded the California Institute of Technology (Caltech) $838 million from Apple and $270 million from Broadcom—totalling approximately $1.1 billion—for infringement of four patents used in the implementation of the WiFi standard (IEEE 802.11). Per device, this is equivalent to $1.40 (35 cents per patent) for Apple and 26 cents (6.5 cents per patent) for Broadcom.

Three different portfolio valuation and FRAND determination methods where presented by the parties for Ericsson’s 2G, 3G and 4G SEPs in TCL v. Ericsson.

“Reasonable, maximum aggregate royalties” with “proportionality”


I have already criticized at length Judge Selna’s top-down approach and so I provide no more than a summary of that here. When I wrote my critique of Judge Selna’s subsequently vacated Decision, I focused almost entirely on his top-down analysis; but indicated I might return to assess the other methods of FRAND rate determination and his analysis of them.

Top-down is fundamentally flawed for two reasons, and thirdly, Judge Selna’s corresponding determinations were biased and erroneous in his application of the methodology.

Firstly, the selected aggregate royalty rate caps—of 6 to 10 percent for 4G LTE and 5 percent for 3G— do not reflect the value of the underlying technologies. The figures are quite arbitrary and were only advocated by those who wanted to limit royalties to those levels. Why should the value of IP versus hardware in a smartphone be limited to such small percentages of its purchase price when the corresponding percentages for IP in music CDs, video DVDs, software CD ROMs or patented pharmaceuticals are more like 80 percent?

Judge Selna justified use of this approach on the basis that Ericsson and others had in 2008 encouraged the industry to allocate royalties based on a maximum aggregate rate and proportionality among licensors based on relative patent strength among portfolios. However, there were several in the industry that never subscribed to such an approach and were, instead, for good reasons, vociferously opposed to it.  For example, in December 2008, Qualcomm publicly stated it was against such a formulaic approach because it ‘would arbitrarily limit the value of standards essential patents, discourage innovation, encourage the filing of marginal patents, complicate and delay the standardization process, and be impossible to implement in practice.’ There is no reason to bind these dissenters to such an approach. It should be possible for them and others to derive significantly higher royalties, if enough value is there.

Secondly, apportionments among patent holders are inaccurate. For example, patent-portfolio stand-essentiality determinations are cursory, inconsistent and patent counting methods typically assume all patents are of equal value, which is antithetical to valuation principles in patent law. Counting technical contributions to standard-setting organizations also has the shortcoming of rewarding quantity instead of quality.

Thirdly, Judge Selna erroneously whittled the rates down for Ericsson in several ways:

I.                     Regarding company and aggregate single-mode rates as multimode rates,
II.                   Using inaccurate, unreliable and likely biased patent assessments in apportionment of the aggregate rate to Ericsson with:
a.       inflated patent counts in the denominator,
b.       deflated patent counts in the numerator,
III.                  Regarding announced rates, including aggregate rates, as US rates rather than global rates,
IV.                 Discounting indicated rates based on patent expirations, even though indicated rates were based on certain expectations for these expirations,
V.                  Disregarding the value of standard-essential improvements and Ericsson’s share of these.

While the cap is purportedly to protect implementers from the “worst case” scenario with a “royalty stack;” in fact, nobody pays anywhere the maximum figure. On average, as I have shown and as others have confirmed, here and here, the aggregate royalty paid on mobile phones including smartphones is no more than around 5 percent including all generations of cellular SEPs, non-cellular SEPs and non-SEPs.  That is net of cross-licensing, but even those with nothing to cross license are not paying much more. For example, TCL managed to hold out payment to Ericsson for 7 years before trial. There was no evidence presented in that case that TCL was paying anywhere near or above an aggregate of 10 percent, nor that it would be doing so with payment to Ericsson at the rates set in Judge Selna’s Decision.  I have never seen evidence that anyone has paid an aggregate figure reaching or even approaching 10 percent for LTE licensing.

Fair shares for all


While the value created in an invention can be enormous, this is shared among various participants in the value chain. Ultimately, virtually all the benefits tend to flow downstream to end users. In the interim, some of the value is rightly captured in profits by technology developers, OEMs and service providers.

Judge Selna threw out the “Ex Standard” valuation methodology of Ericsson’s expert David Kennedy because, in Selna’s opinion, the values it derived were too high:

‘Ericsson's 4G Essential Patents confer $6.15 to $7.14 of value on a 4G handset. The Court finds that Kennedy's result are highly suggestive of royalty stacking; i.e, valuing individual components of a standard in manner that accedes the aggregate value of the standard.’

He also wrote: ‘it is simply not logical that two features could have a value in excess of Ericsson's entire portfolio.’

These statements confuse the concept of value to the user with the technology-licensing price to an OEM that is fair and reasonable or that would be negotiated commercially under market conditions. The above figures represent maxima — not figures demanded, let alone expected or likely to be anywhere near realised by licensors.

Consumer surplus is defined as the difference between the consumers’ willingness to pay for a good and the amount that they actually pay. On average, producers capture only small percentages of the total welfare gains from innovation, with consumers capturing the remaining surplus. Licensing rates determine how the licensors and licensees split the producers’ share of those total welfare gains.

The FRAND rate licensing price reflects two factors:
Value to consumer ($) x share of value to be accrued by licensor (%) = royalty to licensor ($).

Bottom-up valuation methods, including Ericsson’s Ex Standard approach derive an upper limit to what features are worth. What licensors may yield from them in licensing fees is a question of rent splitting and how the economic surplus is shared among licensors, their licensees and downstream parties including mobile operators, over-the-top service providers (e.g. Google, Facebook and Netflix) and end users.

Economics and market dynamics tend to determine outcomes including how economic surpluses are shared. For example, while research has shown that the value a consumer derives from Google search may be tens of thousands of dollars per year per user, Google is happily making huge profits while generating, only, hundreds of dollars per person. Hypothetical choice experiments can derive consumer values, even for services such as Google that have zero pricing for consumers. Internet platforms—such as Google— are under intense scrutiny by competition authorities due to their dominance and how they might be abusing that rather than for their high profits per se. In litigation, such as in TCL v. Ericsson, jurors must decide how much of the large economic surpluses generated by SEP technologies are awarded in licensing fees. 

Get (un)packing


While comparable licenses are potentially the very best valuation benchmarks because they reflect billions of dollars of trade with many licensing agreements over many years, not all of these can be employed directly before significant adjustments. Lump sum payments, differences between sales forecasts (most applicable because the assumption is that licenses should have been completed before trading) and actual sales (20:20 hindsight), and assumed “net present value” discount rates can all have significant effects on derivation of simple, one-way licensing rates from complex two-way licensing agreements including multiple terms and conditions.

I also explained the complexities and difficulties of “unpacking” comparable licenses to derive the effective one-way licensing rates in another article I published last year. One of the issues I discussed there is that licensing rates tend not always to be proportional to the number of patents— as assumed by both parties’ experts in TCL v. Ericssonin unpacking Ericsson’s cross licenses to derive simple “one-way” licensing rates. Among many examples of that phenomenon, is IBM’s historic licensing approach, with pronounced non-linearity in licensing fees for more than five patents:

Number of Licensed Patents Covering the Product
Percentage of the Selling Price
1
1%
2
2%
3
3%
4
4%
5 or more
5%
        

Bottoms up


In a presentation I gave on the topic of top down and bottom up valuation methodologies at the Patents in Telecoms and the Internet of Things conference at Tokyo University in November 2019, I reused some analysis I have been presenting since 2015 showing how cellular functionality is priced by Apple at a much higher mark-up than other costs. Apart from the absence of cellular capabilities, the iPhone Touch 5th Generation had very similar specifications to the iPhone 5c. However, the latter was sold for $450, which was more than twice the price of the former, despite costing only around $32 more in manufacturing.

Even more remarkable from an economic perspective was the fact that sales volumes for iPhones in 2014 were more than 12 times greater volume terms and 46 times greater in revenue terms than for all iPods.  Apple is free to price at any level it wishes and so its prices are only an indirect indicator of consumers’ perceptions of value. Relative sales performance is an outcome of its pricing. According to basic economic principles, if two products are close substitutes a much lower price for one would tend to result in much greater demand for versus the other product.  The much higher demand for the cellular devices— despite the much higher price— underlines the premium value in cellular and that no iPods are close substitutes for iPhones.


Out on the range


FRAND rates are not as range bound or unique, as many might imagine they should be. It all depends on the circumstances, other licensing terms and market developments over the years. On appeal, Justice Birss’ Decision in Unwired Planet v. Huawei was largely upheld and partially annulled. The higher court ruled several different sets of rates and terms could all be FRAND and that there did not have to be only a single FRAND rate, as Birss had ruled.[2]

I have been arguing here since 2013 that the FRAND rate range should be quite wide because, for example, patent pool participants legitimately tend to agree on relatively low rates in the interests of their downstream-oriented members versus legitimately agreed bilateral FRAND rates. I have not yet come across anyone arguing that royalty-free patent pools or “platforms”, such as that for the Bluetooth and USB standards, have rates that are non FRAND.  Common sense suggests that royalty free is not an isolated incidence of what is FRAND where other licensing arrangements set a significant non-zero FRAND rate. The range of rates that are FRAND must at least span between these figures, subject to other licensing terms and conditions.

In my abovementioned Tokyo presentation, I also showed that FRAND rates for video codecs have varied enormously over time and between competing patent pools. It is remarkable that the maximum licensing cost (set in dollars rather than as a percentage of the product selling price) for the MPEG 2 standard technology pool was 10 times higher than the 20 cents maximum for its higher-performing successor MPEG 4 (AVC/H.264)—even over the years in which use of the two standards was substantially overlapping. Many commercial factors were at play, including the fact that the latter standard was adopted in much higher volumes by being software based rather than hardware based and being used mostly in smartphones rather than in the domestic CE products including TVs, set top boxes and DVDs into which MPEG 2 was primary introduced.  

Have we had enough of experts?


As a testifying expert witness, I would be one of the last to propose getting rid of them: but none of them, nor their sponsors or acolytes, nor those who are swayed by them have a monopoly on wisdom or are infallible. Following those with prevailing views is a safe bet for those in the firing line of scrutiny with tricky and contentious decisions to make. But that does not make those views right. Bias towards consensus or the majority is not justice. As the New Policy Statement identifies, courts have misguidedly tended to follow a unique set of rules in dealing with FRAND disputes. 

On account of it finally being Brexit Day, today, it is most fitting to paraphrase British Member of Parliament and outspoken Brexiteer Michael Gove—who maintains he was misrepresented when it was reported he had said ‘people have had enough of experts’ in the highly contentious debate about the merits and costs of Brexit. Rather than do away with experts, one should always look for the dissenting voice. When there appears to be a settled consensus, look at the people who are challenging it. If their arguments are well constructed, then pay close attention; if you think it is just bogus nonsense then reject it— but test alternative propositions. The notion that things should be taken simply on trust because of someone’s position is an invitation to intellectual conformity and what we need is a vigorous, debating, dissenting culture.

While all but a relatively small proportion of SEP portfolio licenses are negotiated to completion between or among parties, it is time for some fresh thinking and judgement on where value lies and how it should be shared when there is dispute. I am looking forward to seeing what jurors will come up with.




[1] A figure of 0.5 cents per SEP can be calculated by dividing Judge Selna’s 0.45% LTE royalty rate award by the figure of 125 patents declared essential and claim charted by Ericsson and then multiplying that figure by the approximate average selling price of $140 per LTE handset manufactured and sold by TCL in the relevant period from 2013 to 2015. The calculated figure increases to 0.9 cents if, as TCL’s Expert Dr Kakaes opined, only 70 of Ericsson’s patents are deemed standard-essential to LTE.
[2] As noted by Herbert Smith FreehillsOne of the few points on which the Court of Appeal disagreed with Birss J was on the question of whether there can only ever be a single set of FRAND terms as between a potential licensor and licensee, as the judge had found at first instance.  The Court of Appeal were of the view that it was ‘unreal’ to think that two parties will necessarily arrive at precisely the same set of terms as two other parties (all of them acting fairly and reasonably and faced with the same set of circumstances).  Rather, the Court of Appeal held that a number of sets of terms may all be fair and reasonable in a given set of circumstances, finding that this approach was supported by the economic evidence.’ 


Friday, 24 January 2020

Kerrigan on The Financing of Intangible Assets


In an ambitious and relatively short book (290 pages) titled, "The Financing of Intangible Assets: TMT Finance and Emerging Technologies" (LexisNexis), editor and author Charles Kerrigan of CMS law provides a treatment of financing of intangible assets in the technology, media and telecom sectors.  The book has wide breadth and selective depth in its coverage of the subject matter.  Moreover, it is a practical book which discusses mitigating risk and anticipating potential issues, including focusing on potential problems that may arise with new and emerging technology.  The book first opens with five chapters that provide an overview of various relevant agreements and the role of players in the field.  The second part covers security and regulation, such as “Taking Security over Intellectual Property Rights,” and “Restrictions on Assignment, Floating Charges.”  The next ten chapters cover financing in various industries, including Software, Telecoms, Gambling, Music, Biotech and Healthtech, Publishing, Advertising and Adtech, Technology, TV Broadcast Media and Media Technology, and Film.  The next ten chapters ambitiously highlight specific countries’ law concerning the subject matter, which are each authored by practitioners from those respective countries, or Mr. Kerrigan in collaboration with law firms in the geographic area.  Finally, the book ends with ten chapters generally dedicated to an area of new technology involving finance, such as Digital Money, Blockchain and Artificial Intelligence.  This book is helpful as a resource for those who desire an overview of the field and those who need a relatively detailed treatment of a specific area.  It is a welcome addition to the resources concerning the topic.

Thursday, 23 January 2020

California Consumer Privacy Act Effective in the New Year

California Attorney General Becerra has issued a press release concerning an “advisory” discussing the rights of consumers under the California Consumer Privacy Act, which is effective on January 1, 2020.  The press release states: 


CCPA grants new rights to California consumers

  • Right to know – Consumers may request that businesses disclose what personal information is collected, used, shared or sold by the business, in both categories and specific pieces of information;
  • Right to delete — Consumers may request that a business delete the consumer’s personal information held by both the business and by extension, the business’s service providers;
  • Right to opt-out  Consumers may direct a business to cease the sale of the consumer’s personal information. As required by the law, businesses must provide a “Do Not Sell” information link on their websites or mobile apps;
  • Rights for minors regarding opt-in consent — Children under the age of 16 must provide opt-in consent, with a parent or guardian consenting for children under 13; and
  • Right to non-discrimination — Businesses may not discriminate against consumers in terms of price or service when a consumer exercises a privacy right under CCPA.

Businesses subject to CCPA

Not all California businesses are subject to CCPA. A business is subject to CCPA if the business:

  • Has gross annual revenue in excess of $25 million;
  • Buys, receives, or sells the personal information of 50,000 or more consumers, households, or devices; or
  • Derives 50 percent or more of its annual revenues from selling consumers’ personal information.

In addition, as proposed by the draft regulations, businesses that handle the personal information of more than four million consumers will have additional record-keeping obligations.

Data Broker Registry 

As required by California Civil Code section 1798.99.80, a data broker must register with the Attorney General at https://www.oag.ca.gov/data-broker/register. The law mandates that a data broker shall pay a registration fee and provide information including primary physical, email, and internet website addresses, as well as any additional information or explanation the data broker chooses to provide concerning its data collection practices. The registry is accessible to consumers.

Consumers’ private right of action in the case of a data breach 

Businesses are required to implement and maintain reasonable security procedures and practices to protect consumers’ personal information, and CCPA authorizes a consumer to institute a civil action if their personal information, as defined in subparagraph (A) of paragraph (1) of subdivision (d) of Section 1798.81.5 is subject to an unauthorized breach as a result of a business’s failure to reasonably secure this data.

Consumers were able to begin exercising the rights listed above under the CCPA on January 1, 2020. Under Civil Code 1798.100 - 1798.199, businesses subject to CCPA were required to begin complying with the law on January 1, 2020. 

The full press release is available, here

U.S. House Subcommittee Hears Complaints About Purported Anticompetitive Conduct by Platforms


The U.S. House Subcommittee on Antitrust, Commercial and Administrative Law recently held hearings concerning potential anticompetitive conduct by platforms against smaller companies who may offer services or products on those platforms at University of Colorado Law School.  Notably, the congressmen on the committee were all concerned about the activities of the platforms.  Here are a few of the notable points: 1) the relatively small companies do not spend a lot of money on lobbying; 2) some of the companies are very concerned about having to purchase their trademarks as keywords from Google; 3) there is concern about bargaining or the lack of it with Amazon; 4) there are concerns about the size of Apple’s cut of App Store sales as well as Apple using control over iOS to disfavor competitors of its own products; 5) there is potentially predatory pricing being conducted by some platforms; 6) there is fear that the platforms are using data about a smaller companies’ products or services created when they use the platform against them to compete; 7) none of the smaller companies could very clearly answer the question of whether the complained about conduct violated current antitrust law; and 8) the congressmen repeatedly thanked the smaller companies for their courage for speaking out against the platforms.  There was some discussion concerning intellectual property.  Sonos, the speaker company, noted that a platform was involved in “efficient infringement” against them.  The smaller companies also complained about the cost of litigating against the platforms and how it diverts funding from research and development.  At least one company noted that having the government pursue these cases would help them because of the cost.  As previously mentioned, there was also concern expressed about trademarks, and additionally, how platforms use similar trade dress to competitor's trade dress on products that platforms use to compete against smaller competitors.  Counterfeiting was also a concern. The full hearings can be found, here

Wednesday, 8 January 2020

How innovative, competitive and well adopted was 4G LTE in mobile communications— implications for outlook in 5G?

LTE's introduction a decade ago and its development as the definitive 4G mobile communications standard which predominates in smartphones is an outstanding accomplishment. Competition has served technology innovators, manufacturers, mobile network operators (MNOs), over-the-top service providers and end-users extremely well.  Markets have functioned and advanced superbly with a vibrant supply ecosystem and providing 4.1 billion LTE connections out of 9.4 billion in total worldwide. In the U.S., 63 percent of the nation’s 479 million mobile connections use LTE.

4G Communications Power to the People

Despite overwhelming evidence of this extraordinary and widespread success, some allege that illegal and anticompetitive practices have caused significant harms including suppressed innovation, market exclusion and excessive pricing. While legal arguments and economic theories are extensively articulated by the parties and their amici in the U.S. Federal Trade Commission’s antitrust action against Qualcomm—with this case still on appeal following the Northern California District Court’s ruling against the latter—my analysis here focuses on market and economic facts and figures in innovation, competition and consumer welfare over the last decade with LTE. While there is no evidence of those negative effects, there is proof of commercial failure by the alleged principal injured party, Intel, due to its poor strategic judgment and inability to keep up with the exacting technical pace of a most fiercely competitive marketplace in smartphone chips.
Antitrust law is to ensure competitive processes are preserved, not that competitors are protected. High prices are not per se illegal because they provide incentive for increased competition, such as from new market entrants and lower-cost innovations. Suppliers that are inefficient in terms of costs, quality or speed-to-market versus competitors should not be protected from their failings.

Every new decade, a new G

A new generation of mobile technology is introduced approximately every 10 years. As the new decade turns, it is most opportune to assess how well LTE has exceeded all expectations, and what has made this possible, since its first introduction around the turn of the previous decade.  Were concerns about introduction of yet another new G—including the need to invest in a network overlay, more spectrum, replace devices and pay additional patent license fees—well founded or needless?
Many MNOs, particularly in Europe, were very disappointed with their transitions to 3G in the early 2000s, due to high spectrum costs and initially disappointing demand for new data services. Conversely, in the US, AT&T waited until availability of mobile broadband with HSDPA in 2005 and deployed this on its existing spectrum. With exclusivity over iPhones in the US, its network became overloaded and in dire need of capacity expansion by around the end of the decade.
The very first commercial launches of LTE were in Scandinavia by TeliaSonera in late 2009. Following several more launches in 2010, the new standard was most significantly established with its introduction by Verizon at the end of that year and by AT&T in 2011. Both of those MNOs largely deployed LTE initially in new spectrum at 700MHz. It provided great coverage, together with much improved data speeds and network capacity. That was just the beginning for LTE.

Consumer demand surges with smartphones and LTE

While press and consumer attention in the smartphone and mobile broadband revolution over the last decade or so is mostly with device original equipment manufacturers (OEMs) including Apple and Samsung, the increases in communications performance have largely been down to others in their technology development and through chip component and network equipment supply, together with network deployments by the MNOs.
While mobile broadband data initially grew from a low base at a fast rate using 3G technologies CDMA EV-DO and HSDPA from the mid 2000s—with most demand from PC data cards and dongles— that exponential trajectory has been maintained with data growth compounding at around 60 percent or more annually for the last decade.

Mobile broadband data consumption has grown enormously in recent years

This was significantly due to the rapid adoption of smartphones following the introduction of the iPhone 3G and the first Android operating system device in 2008. Smartphones embodied a variety of innovative new technologies including applications processing, displays and sensors. Improved communications with LTE, in conjunction with an increasing supply of licensed spectrum for mobile, were perfectly placed to accommodate demand growth. The first Android smartphone with LTE was launched in 2010 and Apple’s first LTE smartphone was the iPhone 5 in 2012. It took less than a decade for smartphones to overwhelmingly substitute for feature phones.

Smartphones predominate in U.S. handset purchases since 2011

Market dominance and concentration in supply

Other measures commonly used to assess economic efficiency in antitrust investigations also indicate that mobile technology markets are healthy and dynamic.
Some industries are inherently and necessarily highly concentrated. For example, Boeing and Airbus have a duopoly in supply of large commercial aircraft. The number of suppliers and the relative positions among them reflect industry economies of scale, barriers to entry, strategic focus and competitive strengths in execution with customers purchasing largely based on technical specifications, cost and delivery performance. Trends in market concentration over several years are very informative about how market competition is developing.
The supply of mobile handsets including smartphones has remained unconcentrated for many years because merchant supply of highly standardized components and open standards in cellular technologies have reduced barriers to market entry to low levels. In the 2000s, Nokia dominated with a vertically integrated supply chain, up to 40 percent market share in handsets and even higher in the high-end devices that were precursors to modern smartphones. Since smartphones became mainstream in the 2010s, there have been many new market entrant OEMs and the positions of some leading incumbents including Nokia and BlackBerry have collapsed due to competition.
Concentration is inevitably rather higher in digital baseband modem chips than in mobile phones, because supply is rather different than in handsets including much higher barriers to entry with R&D requirements and economies of scale in product design and production. While some modem chip vendors have exited the marketplace in the last decade, MediaTek’s share of LTE modem chip sales rose to 24 percent in 2016 before falling with significantly rising shares for vertically integrated suppliers Samsung and Huawei with its HiSilicon division. Large shifts in market share away from leaders and rapid reductions in concentration indicate intense competition.
The extent of concentration in supply can be quantified by reference to the Herfindahl-Hirschman Index, a widely accepted measure of market concentration in competition analysis. The HHI is calculated by summing the squared market shares of all firms in any given market. U.S. antitrust authorities generally classify markets into three types: Unconcentrated (HHI < 1,500), Moderately Concentrated (1,500 < HHI < 2,500), and Highly Concentrated (HHI > 2,500).
High concentration in LTE modem chip supply was very transient. Concentration in new market segments is likely to be high as the first few suppliers enter. Between 2013 to 2016, LTE modem chip supply concentration trended down to lower levels than in the 3G UMTS, 2G GSM/GPRS and 3G CDMA modem chip segments. LTE supply concentration has fallen to a Moderately Concentrated level and Qualcomm now accounts for less than 40 percent share. In contrast, UMTS (i.e. WCDMA/HSDPA) and GSM/GPRS/EDGE modem chip supply concentration has increased as MediaTek’s shares have grown to exceed 50 percent in each of these market segments while Qualcomm’s shares have diminished to only a few percent in UMTS and zero percent in GSM/GPRS/EDGE. While the FTC also alleges that Qualcomm has illegally dominated CDMA chip supply, since 2017 it is VIA Telecom (acquired by Intel in 2015) that has the highest share of this market segment and largely accounts for the high and increasing HHI in this market segment.

Market concentration in supply of baseband modem chips and handsets including smartphones

Qualcomm has excelled in bringing the latest advanced features to market most rapidly, as has MediaTek with mid-range, low-cost solutions and VIA Telecom has focused on CDMA.

A lot more bang for your buck

Meanwhile, consumer prices—measured in dollars or whatever currency prevails nationally per gigabyte of data—have fallen dramatically to a small fraction of levels around the turn of the last decade, as is evident in the US. This has been due to the low costs of LTE technology and fierce competition throughout the value chain.
Source: Qualcomm’s Opening Statement presentation, p29, at trial on April 16, 2019. In Re: Qualcomm litigation Case No. 3:17cv0108-GPC-MDD (S.D. Cal.)
“I skate to where the puck is going to be, not where it has been”—Wayne Gretzky
Surviving, let alone winning in industry sectors with rapid technological change and major investment requirements is not easy. Sound strategic and commercial judgment as well as a modicum of good luck are as important as technical competence. Intel’s various incoherent forays in cellular chips make a pertinent case study in strategic failure, not of abuse by a much smaller company.
Each generation of mobile technology is commonly portrayed and perceived—particularly in hindsight—as a single entity. However, with a new 3GPP standard release every year or two, LTE was first specified in Release 8 (2009) and then improved with increased functionality and performance six times before 5G was first standardized in Release 15. Whereas LTE and 4G are now universally regarded synonymous, it was only with Release 10 (2011) that LTE became compliant with International Telecommunication Union’s IMT Advanced specifications which are generally regarded as defining 4G. LTE Advanced Pro in Release 13 (2016) was another significant performance upgrade milestone.
Numerous technological improvements in LTE’s introduction and continuous development have increased spectral efficiency, spectrum reuse, data speeds, network capacity, reduced latency and also provided entirely new capabilities. Improvements include the OFDMA waveform, carrier aggregation, MIMO, advanced channel coding, higher order modulation, use of unlicensed spectrum and improved positioning technologies.
Standards setting organizations (SSOs) map out, for all to see, which new features will be introduced in each new standard release. That is very helpful for product developers, but so much resulting from the collaboration among SSO participants and appearing in the standards means chip and network equipment vendors are chasing multiple moving targets. The general direction of travel might seem obvious in hindsight, but fast pace and good judgment with selection and commitment to the most important improvements are essential. Some features turn out to be much more important than others. While device OEMs design and manufacture smartphones, it is largely the modem chip vendors and network equipment OEMs that have developed and supplied the technologies and products that implement or enable MNOs and users to benefit from latest standard-based improvements.
Leaders must not only be the fastest to invent and bring to market, they must also know where and when to place their big bets. Those that make the wrong call will suffer significant adverse consequences with exacting requirements from OEMs and their MNO customers.

Self-harm

While Intel its portrayed as the major injured party in the FTC’s case against Qualcomm, Intel failed in modems for several significant reasons at Apple and elsewhere, despite its deep pockets, position as a leading semiconductor chip designer and silicon fabricator. It even squandered the advantages of its incumbency as the sole modem chip supplier to Apple for iPhones and iPads from 2007 until 2011, while also being, in that period and continuing to be ever since, Apple’s sole supplier of CPUs for its Mac computers.
Intel failed to recognize the (mis)match between what it was pushing and what OEMs wanted.  It foreclosed itself from all but a relatively small proportion of the LTE modem chip market segment. Most smartphones include chips that integrate the baseband modem processor with an application processor that is based on the ARM instruction set and architecture. There was never a distinct “thin modem” market—in the sense of defining a relevant market for competition purposes. Modem suppliers need to address the entire market segment of modem supply—including thin and integrated modems—to be efficient in development and production of technologies and products. The proportion of thin versus integrated modems in smartphones has fallen from around 40 percent in 2011, when most smartphone OEMs were just getting started, to only teens of percent in the last few years.
Intel has offered no ARM-based application processor since it sold its XScale business to Marvell in 2006. It failed in its alternative strategy with attempts to get its “Intel Architecture-based [X.86] processors” adopted in smartphones and tablets. Its x.86-based Atom application processor was uncompetitive for many reasons including higher power consumption and its inferior supply ecosystem with higher costs for the associated components needed to support the chip. Intel fared poorly despite spending billions on subsidies in its attempts to build a mobile device beachhead in tablets. It never achieved any more than a small share of supply to tablet OEMs and no more than a trivial share of supply to smartphone OEMs.
Intel captured Apple, as Apple’s sole 3G modem supplier for iPhones, when Intel re-entered the market with its acquisition on Infineon’s cellular chip division in August 2010.  However, Infineon would have known by then— as Intel should have also known through its acquisition due diligence, if that had been carried out thoroughly and competently—that modem business was about to be lost with the upcoming February 2011 launch of an iPhone 4 model based on a Qualcomm chip. Intel’s other 3G thin modem customers included Samsung and Huawei that subsequently have significantly switched to vertically integrated supply. Apple aside, Intel’s share in LTE supply was never more than a percent or two. Bad luck or poor market intelligence, judgment and execution?

Intel was too late in finding its voice

Having been ejected from Apple in 3G, Intel was very anxious to get back in there with LTE. But it failed to keep up with the pace of standard-based developments in LTE. Intel was late with LTE-Advanced (i.e. actual 4G) improvements and was at least two years late in being able to offer voice over LTE (VoLTE). LTE had no voice capability before VoLTE was standardized. Leading mobile operators—including AT&T and Verizon in the US—demand certain features in devices to exacting schedules.  For example, with major operators including T-Mobile US and Verizon launching VoLTE services by 2014, they were insisting on VoLTE in new phone models beforehand. This was significantly driven by their desires to seed the market for use of the new service and so that they could shut down older-generation networks, such Verizon’s 3G CDMA network by the end of 2019. Despite the above efforts, this date has slipped to 2020 to avoid leaving customers with phones that cannot make phone calls.
Many devices are used on networks for more than five years following new model introduction. Popular models are commonly sold for more than three years before being withdrawn from sale. For example, Verizon is still selling the iPhone 6s (2015) and Galaxy S7 (2016). The last of those sold are likely to be used for another few years before being retired.
It was not until 2016, with chip supply for launch of the iPhone 7 in September that year, that Intel could meet voice specification requirements of Apple and its MNO customers in LTE. In contrast, Metro PCS launched VoLTE with the LGE Connect 4G in January 2012 and VoLTE was incorporated in the iPhone 6 (September 2014). Qualcomm LTE modems were included in both devices.

What was he smoking?

In addition to strategic conflicts, Intel also suffered from delusions at the highest level. For example, despite Intel not being able even to do voice in LTE, in 2016, former Intel CEO Brian Krzanich proclaimed that Intel was the leader in 5G, including in modem technology. This was way off the mark. In fact, the main reason Intel exited modem supply, announced by replacement CEO Bob Swan in April 2019, and why Apple settled all its litigation with Qualcomm the very same day, was that Intel could not keep up the required pace and schedule in its 5G technology developments. Apple was clearly fearful it would not be ready to introduce 5G iPhone devices in 2020 without switching back to Qualcomm’s supply.
While the period of Qualcomm’s alleged misconduct is only to 2016, the FTC regurgitates the Court’s contention that Qualcomm will remain dominant in the transition to 5G, but without explicitly alleging any abuse there. Qualcomm has clearly competed on the merits in establishing itself as the leader in 5G modem chips. With a new air interface and addition of mmWave bands (i.e. with high-band frequencies at 24 GHz and abo)  its astute competitive strategy has included unmatched technology development in modems and acquisition in RF front-end components.

Voodoo economics II

The FTC’s most significant but hotly contested theory of harm, and that the district court has accepted, is that Qualcomm’s royalty charges to OEMs impose a “surcharge” on chip competitors that limits their ability to invest in R&D and makes them unable to compete on the merits such as in technical performance. Why the royalty charge is any different to any other necessary input cost—such as that for the display or battery components—is a mystery. OEMs are charged royalties non-discriminately regardless of modem supplier. According to the FTC’s allegations, and despite evidence to the contrary, Qualcomm’s royalty charges are excessive and are only paid because it supplies “must have” chips and has a “no license, no chips policy.”
That theory suggests that elimination of the alleged surcharge should enable a chip vendor to become competitive. However, Intel still failed despite that supposed relief. It commenced LTE modem chip supply to Apple for the iPhone 7 in 2016 and was the sole modem supplier to Apple for all subsequently launched models, including the iPhone X (2018) and iPhone 11 (2019). By April 2017, royalties paid to Qualcomm on Apple products, including those with Intel’s chips, had ceased and were not resumed until April 2019.
Rather than capitalizing on this window of opportunity, Intel failed on the merits, as indicated by its chip market exit, despite this non-payment of any royalties including the alleged surcharge to Qualcomm. While Intel’s dollar expenditures on R&D had been increased, R&D decreased as a percentage of its rising sales (i.e. including new sales of modems to Apple): $12.7 billion (21.4 percent) in 2016, $13.0 billion (20.8 percent) in 2017 and $13.5 (19.1 percent) in 2018. Based on the FTC’s economic theory, Intel supplying Apple should have had lower costs than other chip suppliers whose customers were still paying Qualcomm royalties. LTE modem chip market segment shares for Huawei (HiSilicon) and Samsung, that also buy Qualcomm chips and pay it licensing fees, have continued to increase since 2016.

Be careful what you wish for and be grateful for what you have

There will always be prophets of doom and self-serving interests who predict harms such as market failures if changes are not made. The kinds of accusation made by the FTC about Qualcomm in LTE echo those made against Qualcomm in UMTS, just before mobile broadband with HSDPA took off and before those charges were dropped  by the European antitrust authorities.
Prior to the introduction of LTE and for several years subsequently it was alleged that royalty stacking would make the technology prohibitively costly, particularly since LTE royalties would stack on those that had to be paid in multimode equipment including 2G and 3G.
A royalty stack never appeared in 3G and in never appeared in 4G. The only harms are the contentions over patent royalties that are costing a lot in legal fees and are enabling implementers including Apple and others to “efficiently infringe” by holding out from payment while enjoying the benefits of rich standard-based technologies.
As I explained here last month and previously, with patent licensing fees paid less than five percent of handset prices, such costs are dwarfed in comparison with the value that has been created with annual revenues of around half a trillion dollars in handsets, more than a trillion in operator services plus huge revenues to the over-the-top players that have flourished over the last decade in the smartphone and mobile broadband revolution with LTE.
Uber, Instagram, FaceTime and Netflix all launched in 2010 and have, among many other OTT providers, significantly benefitted from LTE’s mobile broadband capabilities. For example, Netflix has enjoyed a 4,000 percent stock rally with its streaming services significantly used on mobile devices. Smartphone OEMs have benefitted from these services because users want devices that can best access these services. Mobile operators benefit because they generate mobile broadband service revenues even from “free” services that are delivered on top. These services are transforming the way we work and play with daily hours of smartphone usage even exceeding TV watching.
Significant ongoing development has been required since introduction of LTE and the first 4G technologies. Whereas coverage and capacity were easily established with the deployment of additional spectrum at 2 GHz and below, there is nowhere near enough spectrum available there to satisfy escalating mobile broadband capacity demands. New technologies including Massive MIMO antenna arrays and HPUE to increase device uplink radio transmission performance in the latter LTE releases and in 5G are expanding capacity by better exploiting frequencies above 2 GHz. 5G has been designed to access mmWave bands with orders of magnitude more bandwidth than is accessible with previous generations of technology. All this, yet alone what is yet to come with URLCC and mMTC in the Internet of Things, would not be possible without major ongoing R&D investments. These should not be taken for granted—particularly in the race to establish and maintain global leadership and national security in 5G.
This article was originally published in RCR Wireless in a very similar form on 7th January 2020.

Keith Mallinson is a leading industry analyst, commercial consultant and testifying expert witness. Solving business problems in wireless and mobile communications, he founded consulting firm WiseHarbor in 2007.