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Huge US$975m fine may help China raise sway in chip sector
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THE debate is on. Who is the real winner in the more than 6 billion yuan (US$975 million) settlement fine levied on chip giant Qualcomm by Chinese anti-trust regulators?
After a 14-month investigation, the National Development and Reform Commission found Qualcomm guilty of abusing its dominance in wireless technology by charging manufacturers “unfairly high” licensing fees. Qualcomm agreed to pay the fine, announced on February 11, and promised to adopt royalty commission rates favorable to Chinese firms.
In my opinion, the agreement will have a far-reaching effect on the domestic mobile phone market, the world’s biggest, and on the chip market, and even the realm of government regulation. But it’s still too early to evaluate the final results.
Most would initially hail the settlement outcome as a big win for the NDRC, China’s top economic planning agency.
“China has the world’s biggest chip market, but we have had little voice in it globally,” said Gu Wenjun, a Shanghai-based semiconductor analyst at research firm IHS iSuppli. “This is a good start toward rectifying that.”
It was the first time Qualcomm was slapped with such a large fine, though the company has faced similar investigations in the US and overseas markets like South Korea.
Under the settlement, Qualcomm is to pay a fine of 6.09 billion yuan and henceforth charge royalties of 5 percent for 3G devices and 3.5 percent for 4G devices, using a royalty base of 65 percent of the net selling price. The company had been charging royalties based on 100 percent of the selling price.
Domestic phone vendors using Qualcomm chips are expected to pay less than a third of current royalty costs under the new settlement. The royalty cost of a Qualcomm-equipped phone selling for 2,000 yuan would be about 35 yuan cheaper.
Xiaomi, Huawei and Lenovo all use Qualcomm chips in their high-end models. They will now pay smaller royalty fees.
At the same time, Qualcomm retains its business model and removes uncertainty about its future development. The settlement terms were generally regarded as less onerous than expected, which could be interpreted by some to be a Qualcomm victory.
“It was less than we had been expecting in a worst-case scenario,” said Ehud Gelblum, a Citigroup analyst, who gives Qualcomm a “buy” rating. “The US$975 million fine amounts to just 7.5 percent of Qualcomm’s China revenue and was less than the maximum allowable 10 percent.”
The fine came in under the maximum because of the company’s “good attitude” during negotiations with the regulator, said Xu Kunlin, head of the NDRC’s anti-monopoly bureau.
The regulator said Qualcomm had improperly bundled unrelated licenses with mobile phone technology, forcing Chinese customers to pay for licenses they didn’t need.
Industry insiders previously thought Qualcomm might be forced to abandon royalty fees based on the phone price in favor of the chip cost, Gu added.
To better evaluate the long-term effects of the settlement, consider the following facts.
Qualcomm still dominant
Qualcomm still has 70 percent of the global phone market and is the only chip designer charging phone companies royalty fees based on the whole phone cost.
Its market dominance won’t be altered unless the whole market itself becomes more balanced.
Samsung, the world’s biggest phone maker, is expected to abandon Qualcomm chips in its latest flagship model to be released in March. It will be using its own chips.
That may spur other phone makers to take note of other chip options. Besides Samsung, China has its own chip designers, including Taiwan-based Mediatek, Huawei-owned Hisilicon and Shanghai-based Spreadtrum Communications.
There may still be a quality gap between Chinese and Qualcomm chips, but the popularity of Huawei’s Mate 7, with its self-developed chip, portends change ahead.
The regulator confirmed on February 14 that the Qualcomm fine already had been paid. The NDRC has not revealed how it will use the money.
Netizens have suggested the money be put in the social fund to reimburse, at least nominally, the cost to consumers of the royalty fees at the heart of the dispute.
I think at least part of the money should be earmarked for Chinese research and development in chip technology. China’s national integrated circuit fund announced in February that it will extend a 30 billion yuan loan to Tsinghua Unigroup, parent of Spreadtrum.
The chip industry is capital-intensive and requires investment and government support. It’s also the mainstream of mobile phone and consumer electronics, which are related to national security.
‘Umbrella’ deals removed
Qualcomm previously demanded that its clients sign so-called “umbrella” cross-licensing agreements, allowing Qualcomm access to the patents of clients, which were, in turn, licensed to other clients. Qualcomm claimed the move was designed to protect small vendors from being sued by bigger ones over alleged patent infringement.
The settlement requires Qualcomm to remove the cross-licensing requirement. That will result in Chinese phone makers’ patents becoming more valuable and may reshape patent licensing in China, according to Digitimes Research.
Generally speaking, it benefits phone makers with patent reserves, like Huawei and ZTE. But it also creates risks for vendors involved in overseas expansion without Qualcomm’s umbrella patent protection. For example, Xiaomi was sued by Ericsson for patent infringement in India.
These are very technical, complicated matters.
So where does that leave the debate? In my opinion, there are elements of victory for both the NDRC and for Qualcomm.
Without a doubt, Chinese companies will have to pay more attention and invest more heavily in innovation and patents. The industry can’t just depend on regulators forever.
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