Dramatic structural changes in mobile communications technology supply, with the demise of vertical integration, is forcing those who are developing standard-essential technologies for 4G and "5G" networks to monetise these efforts through patent licensing, as well as their own product sales. Exiting the handset business, as have most of the original major technology suppliers, including former market leader Nokia earlier this year, eliminates participation in the largest product market, and the need for cross-licensed patent protection there.
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| Under New Management |
The market size for mobile standard-essential patent (SEP) royalties paid remains below 5 per cent ($19 billion [€15.2 billion]) of the $377 billion in annual smartphones sales.
Netting-off
Once upon a time, new mobile communications technologies such as 2G GSM were developed by small clutches of vertically integrated players. Mobile technology pioneers including Alcatel, Ericsson, Nokia, Nortel Networks, Motorola, Qualcomm and Siemens all manufactured handsets, as well as network equipment. Some of these companies also produced communications chips.
Business models were predominantly oriented towards generating income from product sales. Technology development costs and risks of failure (e.g. with demise of the rival U.S. 2G TDMA standard) were compensated for through product sales and in cross-licensing, for little or no cash royalty payments among these major players, to obtain access to all the SEP technologies required to make and sell products.
Vertical disintegration
Over the last decade or so, virtually all the diversified mobile technology manufacturers have exited the handset market. From among the above, brand names Alcatel, Motorola and Nokia live on in handsets, but ownership is now completely removed from the original parent companies. I tracked the demise of some of these in the face of new market entrant challengers in
another of my recent postings. Some of them have also ceased sales of other mobile products, including network equipment and chips.
Consequently, all the above parents have lost their ability to obtain a financial return on their mobile technology R&D investments directly through sales of handsets, which is by far the largest product market in the mobile sector. Global market revenues in 2013 were $377 billion for handsets, according to Morgan Stanley; $61 billion for network equipment, including radio, IP & transport and core equipment, according to Ericsson; and around $20 billion in baseband modems (which are mostly embodied in handset products). Nevertheless, the pace of technology development is continuing relentlessly in standard-essential technologies and in mobile technologies in general.
R&D spending continues to increase
Despite so many mobile technology vendors no longer selling handsets, mobile R&D spending, of approximately $42 billion in 2013, has grown 50 per cent since 2008, as indicated in table below. The figures include 12 large technology companies with a predominant or exclusive focus on mobile communications, including several named above. Some of these are quite diversified and do not break out their wireless R&D expenditures in public disclosures, so these figures include some R&D related to other technologies and product markets. However, my total excludes many companies that also invest significantly in cellular R&D; so I believe the table provides a fair, yet approximate, and consistent representation of total R&D investments and their growth by the mobile technology industry as a whole.
Total Sales and
R&D for Leading Cellular Technology Companies
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2008
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2009
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2010
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2011
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2012
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2013
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Total Sales
(millions)
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$399,917
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$353,836
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$401,722
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$510,840
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$559,173
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$582,011
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Total R&D
(millions)
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$27,990
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$27,854
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$30,829
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$37,922
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$39,970
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$41,927
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R&D/Sales
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7.0%
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7.9%
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7.7%
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7.4%
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7.1%
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7.2%
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Sources: Includes public disclosures for
Alcatel-Lucent, Apple, BlackBerry, Ericsson, Huawei, LG Electronics, MediaTek,
Nokia, Qualcomm, Samsung, Electronics and ZTE.
New business model
Value is derived from standard-essential and other patented technologies through the manufacture and sale of one's own products, through cross-licensing to protect one's own product sales from infringement claims and through licensing for receipt of cash royalty payments.
Licensing value, in kind through cross-licensing or in cash, tends to correlate positively or proportionally with product sales revenues. Significantly for Alcatel-Lucent, Ericsson and Nokia, as indicated above, the network equipment business has only around one-sixth the market value of that for handsets. This means the value potential for royalty-generating licenses or royalty-mitigating cross-licenses is also likely to be correspondingly lower there for the mobile SEPs, which tend to apply to both networks and devices.
Therefore, in order to maintain R&D investment levels or increase them, technology developers are increasingly dependent on licensing others' handsets for cash royalties to recoup returns on their costly and risky R&D.
Qualcomm has been able to focus on developing its patent licensing while substantially growing its R&D. It needs to do so because R&D spending (e.g. $5 billion in 2013) exceeds the profit it makes on its chip sales. Qualcomm led the way in licensing with the company being the majority developer of CDMA technologies in the 1990s. Qualcomm's exit from network equipment and handset businesses around the turn of the millennium eliminated its need to patent-protect those operations through cross-licensing. Qualcomm's licensing revenues of $7.9 billion in 2013 are equivalent to a royalty rate yield of 1.77 per cent of total global handset revenues indicated above.
The opportunity to grow licensing income with SEPs and non-SEPs (also referred to as implementation patents) was presented as a significant strategic objective by Ericsson and Nokia at their recent Capital Markets Days in Stockholm and London. Ericsson's 2013 licensing income was around $1.6 billion, which corresponds to a royalty rate of 0.42 per cent on the same basis as for Qualcomm above. Corresponding figures for Nokia were $650 million and 0.17 per cent, respectively.
Nokia, in particular, has a history of handset patent licensing agreements which sought to minimize or eliminate royalty out-payments through cross-licensing, rather than to maximise royalty income. The company needs to unravel previous arrangements and substitute sales volume-dependent agreements for legacy sales volume-independent agreements. The latter were highly beneficial while handset market shares were up to around 40 per cent last decade. These two companies and Qualcomm are also including non-mobile SEPs and non-SEPs in some of their licensing. Ericsson, Nokia and others still need cross-licensing to provide "freedom to operate" in design, manufacture, sale and use of network equipment.
Low barriers with modest royalties paid
The mobile device business--including smartphones, feature phones, tablets and Internet of Things connectivity--has relatively low barriers to market entry through the freely available 3GPP standards. That is why there are so many new handset OEM names in recent years--with the most notable successes including Apple since 2007 and Xiaomi since 2011--seizing substantial market shares.
Ericsson, Nokia and Qualcomm are widely regarded as holding, in total, a substantial proportion, and quite likely the majority, of SEPs reading on 3GPP standards. On this basis, and the fact that Qualcomm has a far more well-developed patent licensing programme than any other company, a total aggregate SEP royalty across all handsets worldwide is most likely to be no more than a mid-single-digit percentage. Five per cent is conservatively more than double the total of 2.36 per cent in royalty rates I have calculated for Ericsson, Nokia and Qualcomm. Other significant SEP holders account for only relatively small licensing revenues. For example, InterDigital Communications, with a business model entirely focused on patent licensing, reported $264 million in patent licensing revenues in 2013. That corresponds to a comparable royalty rate of 0.07 per cent.
Smartphones designers also seek to include features which are subject to non-mobile SEPs and which might be subject to non-SEPs. But the latter are more easily ignored or worked around with alternative technologies, and some features might be omitted if this is not possible. In the case of SEPs, it is at least in theory not possible to implement the standard or part thereof without infringing.
On the basis of financially audited royalty incomes from leading licensors, my estimate that total mobile SEP royalties amount to less than a mid-single-digit percentage of handset revenues is in marked contrast to the erroneous aggregate royalty rate estimates of Intel and others. Elsewhere, I have published a detailed
rebuttal of Intel's defective assessment that the smartphone "royalty stack" could amount to $120 on an average $400 smartphone, including SEPs and non-SEPs. That would correspond to a 30 per cent royalty rate, or around $100 billion per year in total royalties. This is more than five times my estimate of less than $19 billion, which includes all mobile SEPs, many non-cellular SEPs and many non-SEPs also thrown in to the licensing bundles. This figure is less than half the mobile industry's R&D spending.
Royalties paid on non-cellular SEPs (e.g. H.264 video and 802.11 Wi-Fi) and non-SEPs amount to no more than additional single-digit billions of dollars. It has been disclosed that Samsung, with 2013 smartphone revenue share of 34 per cent, paid Microsoft an
annual $1 billion in licensing fees to implement Android. This is exceptional and accounts for a significant proportion of all non-SEP royalties paid.
I originally published this article in the mobile communications industry trade press with FierceWireless.
