Why Apple's fight against Qualcomm in China is ill-conceived

Apple recently sued Qualcomm in the US and the UK, claiming Qualcomm had been significantly overcharging for the use of basic patents and generally abusing its position as a market leader. These lawsuits were filed quickly after the Federal Trade Commission, in one of its final acts under the Obama administration, announced that it would sue Qualcomm for violations of anti-competition law. 

Today, Qualcomm filed its Answer and Counterclaims to Apple's California lawsuit, detailing the value of the technologies Qualcomm has invented, contributed, and shared with the industry through its licensing program, as well as Apple's failure to engage in good faith negotiations for a license to Qualcomm's 3G and 4G standard essential patents on fair, reasonable and non-discriminatory terms. The filing also claims that Apple:

1. Breached agreements and mischaracterized agreements and negotiations with Qualcomm;
2. Interfered with Qualcomm's long-standing agreements with Qualcomm licensees that manufacture iPhones and iPads for Apple;
3. Encouraged regulatory attacks on Qualcomm's business in various jurisdictions around the world by misrepresenting facts and making false statements;
4. Chose not to utilize the full performance of Qualcomm's modem chips in its iPhone 7, misrepresented the performance disparity between iPhones using Qualcomm modems and those using competitor-supplied modems; and 
5. Threatened Qualcomm in an attempt to prevent it from making any public comparisons about the superior performance of the Qualcomm-powered iPhones. 

My personal view on these lawsuits generally (keep in mind I am a former Qualcomm'er) is that essentially, Qualcomm could have chosen one of two paths: (1) ask for reasonable royalty rates and rarely litigate, or (2) ask for high royalty rates are litigate on a regular basis. Qualcomm chose option (1) a long time ago, and the fact that it has so rarely sued on its best-of-class patent portfolio shows both the quality of the portfolio as well as reasonableness of its licensing terms. If anyone wants more details, please email me, but today's post relates to Apple's attack on Qualcomm in China.

In China, Apple filed two lawsuits, both in Beijing. In the first, Apple is seeking 1 billion yuan (over $145 million USD), according to Reuters, claiming that Qualcomm violated China’s anti-monopoly law and harmed it by abusing the company’s market position as a dominant chip supplier. The second lawsuit focuses on patent deals, with Apple asking for the court to rule on the terms of a licensing agreement between the two companies. 

On the surface, the Beijing filings seem to make sense for Apple. After all, Qualcomm receives over half of its revenue from China. Plus, in December 2013, the NDRC (National Development and Reform Commission) announced it was investigating Qualcomm for violating China’s 2008 AML (Anti-monopoly Law) and in February 2015 Qualcomm settled with the NDRC for a $975M fine, and for Chinese phones sold in China, a requirement to offer separate licenses for certain patents, with licensees paying 3.5% for devices using only its 4G technology and 5% for 3G-only devices or those that use both cellular technologies. Also, in addition to the rates being cut, so was the based to which those rates are applied. Instead of applying the percentage to the wholesale price of the handset, Qualcomm now applies it to 65% of the net selling price of a device, a lower figure than the wholesale price. So there were three decreases: (A) the rate, (B) the net selling price instead of the wholesale price, and (C) getting only 65% (of the wholesale price). 

So attacking a company while it is down makes sense, right? But while Qualcomm emerged from the NDRC matter bloodied and battered, it did, in fact, emerge. Not only did it survive, but through the settlement with the NDRC, Qualcomm had received an official government blessing for its licensing protocol -- at least with Chinese phone-makers selling in China. The old saying, "What doesn't kill you makes you stronger" applies aptly to Qualcomm here. While the Chinese government via its Anti-Monopoly Agencies may not love Qualcomm, it made a deal with them. 

Note, too, that Qualcomm is a necessary supplier to many Chinese companies, including the many smartphone makers. A supplier is not an an enemy. A competitor is -- especially a foreign competitor that has traditionally never been a friend of China. What? Apple? But Chinese people love Apple, right? Well, I am not sure that was ever true, and it seems even less true recently. And even if it is, it is not for the love of functionality, but rather the prestige of the iPhone as a "brand-identity status symbol" like Gucci or Louis Vuitton. This does not make Apple a friend of China. Not by a long shot, especially when Apple has a long history of not giving back to China. 

Traditionally Apple has taken the vast majority of the revenue it has obtained in China and sent it back to the US via Ireland. If Apple were to leave China or be enjoined from selling iPhones here, tens of thousands of Chinese workers would be unemployed... for three weeks. Then they would move across the street or even to a different part of the same factory to build phones for Huawei, ZTE, Xiaomi, Oppo, Vivo, Meizu, or any of the other dozen or so Chinese smartphone makers. These Chinese companies would not only fully pay Chinese taxes, but also would reinvest in the country, its people, and the next generation of innovators. As for Apple, investing a billion dollars in a Chinese e-taxi company does not make up for years of lack of investment in China.

So Qualcomm is a supplier to some of China's most important companies and Apple is a direct competitor of these companies. Not good for Apple. Further, what Apple is essentially asking for through its Chinese lawsuits is to be treated by Qualcomm the same as Chinese phone-makers are now treated based on the NDRC settlement. Right now, Chinese phone-makers get around a 33% discount on the most important and expensive part of the phone: the chips. This allows the Chinese companies to have a huge advantage in their home market. This is especially true for Samsung because it, like the Chinese smartphone companies, uses the Android operating system. Since Samsung has the same OS, Chinese consumers are treating smartphones as fungible. Much like desktop computers in the late 1990s and early 2000s, no one cares about the brand of the phone/computer, only the specs like processor speed, memory, and connectivity. Because Samsung phones are very similar to other Android phones in China (except the Chinese phones usually do not explode), and are generally much more expensive even without the discount Chinese companies receive on Qualcomm chips, the Korean company is having a hard time in China.

Apple has the "bling" advantage as a luxury brand, and also has a distinctive OS. So the iPhone is not fungible. But it is still a competitor to many Chinese companies. Further, if Apple wins against Qualcomm in China, then it will have essentially the same advantage that the Chinese smartphone companies have. This would drive sales away from Chinese companies to a company with an established record of not investing meaningfully in China. That would be bad for the Chinese economy and its people. 

Finally, even if Apple all of a sudden did want to become a fully-contributing friend of China, its basic business model prevents this. Apple is a hyper-secretive, closed, uber-proprietary company. Anyone who has visited the Apple campus or any Apple facility knows this. What most people do not know is that Apple does not even allow many companies to refer to it by name on their own campuses but rather by code words, either in conversations or in email. In short, Apple does not play nice with others and is as closed a company as exists in technology. This modus operandi has produced some amazing products such as the iPod, iPhone, and iPad. But there is simply no way to partner with Apple in any meaningful way technologically (other than as an add-on). And this is exactly what it means to be a friend of China. Long-term success in China requires not just investing money, but sharing technology with Chinese partners. For example, Intel's buy into Tsinghua Unigroup was ingenious. They became a Chinese company, developed instant "ears to the ground," and began the cross-pollination that China wants and needs as it continues to develop as an innovation and consumer nation. Investing in a taxi company just isn't the same.

So where does that leave Apple? It becomes a company attacking a licensing scheme recently blessed by the Chinese government. Also, Apple is asking for what China cannot, or at least should not, provide: the same advantage that its own companies have in terms of a discount on Qualcomm chips. All this by a company that directly competes with China's fastest growing companies and that has a record of not being a friend of China. This is not a good place to be.

Even if Qualcomm does not fire back with patent lawsuits or other actions in China, Apple is fighting a battle here it is likely not to. While I do not agree with the essence of the lawsuits in the US and UK, at least they make sense and have a reasonable chance of success, or at least a small chance of huge defeat. The rules are different in China, and American companies still seem to keep forgetting this. 

China is like a broad river with a swift current. To do well here, a company need only stay somewhere safely within the banks and aim downstream. With such a strategy, quick and effortless success is virtually guaranteed. But for those that are so "creative" or "better than others" that they think they can move upstream or outside the banks of the river, defeat is equally assured. Apple has no upside here, and there are many bad things that could happen. They would be well-advised to stay in the middle of the river and head downstream.