Is FRAND Litigation a Credible Threat?: A reply to Mark Lemley, Douglas Melamed and Steven Salop

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.

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Is FRAND Litigation a Credible Threat?: A reply to Mark Lemley, Douglas Melamed and Steven Salop