By Don Clark
One Saturday night in February, Qualcomm Inc. arranged for
documents to be slipped under the doors of a select group of guests
at the New Orleans Hyatt Regency. The spiral-bound folders,
according to one recipient, contained articles aimed at swaying an
influential industry group in a hard-fought debate over technology
patents.
The chip maker's last-ditch maneuver, the culmination of a
lobbying campaign that included ads, op-eds and a website, failed.
Directors of the Institute of Electrical and Electronics Engineers,
which establishes standards governing communications products like
Wi-Fi routers, voted the following day for policy changes that
could weaken the ability of Qualcomm and other big holders of
technology patents to set lucrative royalty rates.
Decisions by groups like the IEEE have played a key role in the
fortunes of Qualcomm, whose unusual business model was thrust into
the spotlight this week by the actions of an activist investor.
Qualcomm, founded in 1985, is the biggest maker of chips used in
smartphones. But the San Diego-based company has also parlayed its
pioneering role in cellular technology into a patent-licensing
business that generates most of its profits. Qualcomm charges a
royalty on nearly every smartphone made, whether or not the device
uses its chips.
As a result, Qualcomm has reaped more than $50 billion in
licensing revenues since 2000. But investors like Jana Partners LLC
aren't satisfied with Qualcomm's $114 billion valuation. The hedge
fund has invested $2 billion in Qualcomm's shares, and on Monday
suggested options such as a spinning off the chip business to
unlock more shareholder value.
Some investors see more trouble ahead from owning both patent
and chip businesses, a combination that helped fuel a series of
antitrust investigations and played into the unusually intense
debate at the IEEE last February.
The organization's decision didn't affect Qualcomm's current
licensing business. But its new policies run against the core
principles of the revenue engine that Jana sees as the source of
Qualcomm's future value.
Arrayed against Qualcomm in the IEEE vote was a cadre of
competitors and customers including Intel Corp., Apple Inc.,
Microsoft Corp. Samsung Electronics, and Cisco Systems Inc. They
hope to convince other standards groups to change their policies in
ways that could reduce royalty fees on technologies essential to
ubiquitous consumer products like smartphones.
The outcome of IEEE's February vote left Qualcomm executives
feeling stung. They say opposing forces hijacked the group's
deliberations.
"A small, exclusive group of companies stacked each of the
different rungs in the decision-making process," Sean Murphy,
Qualcomm's vice president and counsel for international government
affairs, said in an interview shortly before the final IEEE
vote.
Qualcomm's opponents denied the accusation.
"The implication that somehow we gamed this system is
incorrect," said Chuck Mulloy, an Intel spokesman. "We worked
through the process."
Qualcomm's royalty stream is attributable largely to its success
in working with standard-setting organizations like the IEEE. The
company pioneered an innovation chosen in 1999 by the International
Telecommunication Union as part of third-generation, or 3G,
cellular networks. Qualcomm typically charges makers of 3G
devices--and 3G-compatible 4G models--up to 5% of their products'
wholesale price; say, $20 on a $400 phone.
Steve Mollenkopf, Qualcomm's chief executive officer, defended
the formula, noting that Qualcomm often spends billions developing
technology before standards are set and royalty payments start
rolling in.
"It's actually a screaming good deal," he said in a recent
interview.
But Qualcomm's practices have prompted harsh scrutiny, including
a 15-month investigation in China for antitrust violations. The day
after the IEEE decision, the company announced a settlement that
would trim its royalty formula there and agreed to pay a fine of
nearly $1 billion.
Mr. Mollenkopf looks forward to a new period of stability in
China. But the company still faces government probes in the U.S.,
Europe and South Korea.
The formula's opponents say the royalties on feature-laden
mobile devices can combine into a crushing burden. Apple and others
have objected to calculating royalties as a percentage of handset
prices. Smartphones, they argue, derive much of their value from
features other than cellular connections.
Big licensees want industry groups to press patent holders to
limit potential royalty rates before their technologies are chosen
as standards--rather than wait until the choice increases the value
of their patents.
"This should be uniform across the industry," said Mark
Chandler, Cisco's general counsel. "It really is a matter of simple
fairness."
The IEEE studied such issues during a debate that stretched over
nearly two years, ending in a closed-door board vote at the New
Orleans hotel on Feb. 8.
Long-standing IEEE rules encourage companies to promise to
license their patents on a "fair, reasonable, and
non-discriminatory basis." Such voluntary pledges can affect
whether standard-setting committees choose a particular technology.
But the IEEE didn't define what reasonable meant, leaving companies
to set terms through negotiations.
The new IEEE policies for the first time link "reasonable" rates
to the "smallest saleable implementation" of a technology. That
phrase points to applying royalty percentages to the price of chips
that carry out a particular function--components that may cost a
10th as much as an entire handset.
Another change discourages patent holders from seeking court
injunctions against companies that implement inventions adopted as
standards, limiting a tactic patent holders have used to pressure
companies that refuse to pay royalties.
Patent-rich companies such as Qualcomm, Ericsson, Nokia Corp.,
Alcatel-Lucent SA and InterDigital Inc. bitterly opposed the IEEE's
new policies. They assert that Intel and others conspired to
manipulate the group's processes and ignored hundreds of their
suggestions.
"We were taken by surprise," said Gustav Brismark, Ericsson's
vice president of patent strategy.
IEEE officials say the process was fair.
"There was plenty of opportunity for discussion and dialogue,"
said John Kulick, who chairs the IEEE standards board.
IEEE officials also note that members of the group are expected
to vote according to their own opinions, not those of their
employers.
Intel and other proponents link the changes in part to ideas
voiced by a Justice Department official in 2012. Patent holders, in
turn, are quick to point out that an IEEE member who worked for
Intel brought those ideas to a key committee that oversaw the
policy changes. At a meeting in June 2014, the Intel employee voted
with members affiliated with Apple and Microsoft to approve the
policy changes, outvoting members employed by Ericsson and
Alcatel-Lucent.
Qualcomm wasn't immediately affected by the latest IEEE changes.
That is because its royalties flow from standards set by other
groups. Those bodies haven't changed their policies, despite
lobbying by the likes of Intel and Cisco.
But the changes could affect Qualcomm's future licensing
royalties. The IEEE is extending Wi-Fi, evaluating technology from
Qualcomm and others. The group may also help define upcoming 5G
cellular services. And its new policies may influence similar
organizations to follow suit.
For now, Qualcomm doesn't plan to comply with the IEEE's revised
rules, which remain voluntary, says Qualcomm President Derek
Aberle. He foresees no negative consequences.
But Mr. Aberle worries that litigation might ensue if the IEEE
were to reject technology submissions from companies that didn't
comply.
"There will be a number of companies that would be very
concerned about that," Mr. Aberle said.
Write to Don Clark at don.clark@wsj.com
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