apple-iphone-qualcomm

What happens when two titans go to battle? Sometimes one is triumphant over the other, other times they arrive at a compromise. Mostly though, it ends with both parties getting battered and bloody. Either way, we are soon to find out as two giants of the tech industry have declared war on each other.

The animosity between Qualcomm and Apple has come to a head, and it seems like things are about to get ugly. Qualcomm Inc. (NASDAQ:QCOM) and Apple Inc. (NASDAQ:AAPL) have been butting heads for a while now. However, after extensive rounds of failed negotiations, it seems that it is only a matter of time that this feud will be escalated to the courts. To truly understand the cause of the feud, and its ramifications, let us dig a bit deeper.

Qualcomm vs. Apple: The Tug of War

The last few months have been quite turbulent for smartphone chip maker Qualcomm. Trouble started when South Korea’s antitrust regulator fined Qualcomm a massive 1.03 trillion won (US$853 million) for “violating antitrust laws” in December 2016. According to the South Korean Fair Trade Commission, Qualcomm was guilty of licensing its patents only to mobile phone makers. They were also accused of improper negotiating of licensing terms and unfair payment for patents held by other phone makers.

This was only the beginning, as just next month Qualcomm was sued by the United States Federal Trade Commission for anti-competitive practices. This was not regarding Qualcomm’s smartphone chip business, but rather their modems. Qualcomm was accused of disproportionately high fees and strong-arming companies into agreeing to unreasonable licensing terms.

Basically, Qualcomm charged higher fees from smartphone manufacturers using competitor modems, thereby increasing their cost and undermining the competition. As a result, Apple made an exclusivity deal with Qualcomm. Under this deal, Apple could not use any other company’s modems for a period of five years. In exchange, Qualcomm rebated a fraction of the patent licensing fees back to Apple.

Apple Turns On Qualcomm

Apple’s relationship with Qualcomm soured when their exclusivity deal expired last year. Apple has since begun to use Intel chips in some of their phones. As a direct response to this, Qualcomm started withholding rebates which have totalled up to nearly $1 billion to date. This was the last straw for Apple, who then sued Qualcomm for $1 billion in damages. Apple’s main bone of contention is Qualcomm’s practice of charging royalties based on a device’s total value, as opposed to the value of the chips used in the device. This means that Qualcomm benefit even more as phone prices go up. Apple accused them of charging more than five times than other cellular patent license holders. In turn, Qualcomm responded by criticising Apple for “misrepresenting facts and withholding information“.

Things have turned even more ugly since then, with Apple stopping payments to iPhone manufacturers for royalties owed to Qualcomm for the first quarter of 2017. This has forced Qualcomm to reduce their financial forecasts by $500 million, down to $4.8 billion – $5.6 billion. Adjusted earning per share forecasts also fell to 75 cents – 85 cents, down from 90 cents – $1.15. Qualcomm has now responded in kind, as they now reportedly look to block all iPhone imports to the US. Allegedly, Qualcomm is preparing to ask the International Trade Commission to forbid Apple from importing its flagship handset, which is produced in Asia.

Apple and Qualcomm Both Have A Lot To Lose

Needless to say, this feud could be catastrophic for both parties. Although Qualcomm is known most for their chip manufacturing business, that only makes up a part of their revenue stream. In fact, the lion’s share of profit comes from Qualcomm’s patent licensing royalties. For 2016, Qualcomm reported $6.5 billion of pretax profit from $7.6 billion revenue from royalties alone! In contrast, their chip business managed $1.8 billion of pretax profit from $15.4 billion revenue. This means that  Qualcomm’s royalty business model brings in nearly 78.3% of their profit. Now, this model is under serious threat. While the $1 billion lawsuit filed by Apple is a significant setback, the threat to Qualcomm’s royalty model is a much bigger problem.

As expected Qualcomm have hit back at Apple too, and in a big way. Their decision to go to the ITC spells trouble for Apple, as they are known to process cases faster. If Qualcomm manages to get iPhone imports to the US blocked, Apple’s losses would be unthinkable. The US is a key market for Apple, with nearly 35% of their revenue coming from there in the last fiscal quarter. The upcoming iPhone 8 sales cycle is also immensely important to Apple, with predictions of exploded sales and ever-increasing stock price targets. Should Qualcomm get what they want, the damage to Apple would be irreparable.

Takeaways

  • Qualcomm is in trouble. After facing heavy fines in South Korea and China, their troubles have compounded due to a $1 billion lawsuit by Apple. With the FTC also coming after them, Qualcomm’s profitability and stock are likely to keep suffering in the near future.
  • Qualcomm’s profitability is largely contingent on their patent licensing royalties. If they end up losing and having to change their licensing terms, it could mean the end of Qualcomm’s dominance in the market.
  • All of Qualcomm’s recent troubles provide a window of opportunity that competitors like Intel can take advantage of.
  • If Qualcomm succeeds in their case against Apple, the smartphone manufacturers losses would be immeasurable. The loss of a key market like the US would leave Apple reeling behind competitors like Samsung and Huawei.