This column has been updated from Oct. 12 to noted Qualcomm's request for a Chinese iPhone ban.
As Apple Inc. (AAPL) - Get Report and Qualcomm Inc. (QCOM) - Get Report dig in and maneuver for what could be a lengthy legal fight over iPhone royalty payments -- in its latest salvo, Qualcomm has petitioned Chinese courts to ban the sale and manufacture of iPhones in China, after having previously requested a partial U.S. ban -- it's worth rememberingwhat happened the last time Apple was involved in a major patent fight. That was a battle in which Apple failed to achieve its goals, on the surface. but from a big-picture perspective managed to accomplish some valuable things.
As most readers probably are aware, it was just a few years ago that Apple was mired in high-profile patent lawsuits (and countersuits) against Samsung (SSNLF) and several other Android OEMs over the alleged infringement of its software and design patents. Apple scored some tactical victories in the U.S. and elsewhere, with perhaps the largest being a $1 billion jury award (lowered to $548 million following appeals) it won in a San Jose court in 2012.
But gradually, the battle petered out. Apple, which at one point pursued injunctions against high-end Samsung devices such as the Galaxy S III phone and Galaxy Tab tablet, stopped seeking moves against new Samsung devices after they launched. It settled its disputes with HTC and Motorola Mobility via patent-licensing deals, and agreed in 2014 to drop all its battles with Samsung outside the U.S. Some old lawsuits are still outstanding, but it's clear that this fight is no longer an Apple priority.
Nonetheless, Apple's suits did arguably make Android OEMs more cautious about conspicuously imitating its iPhone and iPad designs -- some imitation still goes on, but compared with how much the Galaxy S III looked like the iPhone 4 and 4S, things have changed. Likewise, while Alphabet Inc./Google (GOOGL) - Get Report still "borrows" software ideas from Apple for new Android releases -- to be fair here, Apple borrows from Google and others as well now -- iOS and Android's user interfaces are more meaningfully different than they were a few years ago.
This end-game could be a sign of things to come for Apple's fight against Qualcomm. Especially in light of what was shared in an Oct. 4 Bloomberg report about the dispute.
Bloomberg notes that Qualcomm -- per analyst estimates -- had been getting a royalty of about $10 per iPhone (after accounting for rebates) before Apple instructed its contract manufacturers to stop making payments earlier this year. And it says that Apple legal chief Bruce Sewell remarked that his company thinks it should pay "$4 or so" per phone.
These figures are noteworthy in several respects. First, they suggest that Apple has been paying lower royalty rates than many of its peers. That's even true after accounting for the fact that its rates had been based on the price at which it bought an iPhone or 4G-capable iPad from a contract manufacturer such as Foxconn, rather than the price at which it sold a phone (subject to a royalty cap). Second, they suggest that Apple is either willing to compromise on its stance that it only pay royalties based on the price of the 3G/4G modem chips going into its devices -- these devices rely on standards-essential Qualcomm patents -- or that it has a rather unique view of what chip royalty rates should look like.
At one point during his talk with Bloomberg, Sewell suggested that the Qualcomm modem chips Apple uses cost "about $18." That's close to analyst estimates for what standalone modem chips are priced at. But it also means that if Apple was to pay roughly a $4 royalty per iPhone through a deal based on modem prices, it would be paying a 20%-plus royalty rate -- quite high by chip industry standards, and far more than the rates Qualcomm charges (often around 4% to 5%) based on a device's selling price.
One possible explanation for this is that Apple realizes that it's unlikely to convince courts that it should only be paying royalties based on a chip's price, given that device-based royalty rates are common in the mobile industry and elsewhere; Nokia Oyj (NOK) - Get Report , Ericsson (ERIC) - Get Report and other mobile patent holders have inked such deals as well. But Apple might believe it can apply enough legal pressure and inflict enough financial pain on Qualcomm to obtain a favorable settlement.
Here, it's worth keeping in mind that, according to an FTC suit against Qualcomm, Apple's relatively low per-device royalty payments were made possible in part by large rebate payments Qualcomm gave Apple in return for using Qualcomm modems exclusively for its iPhones. And that last year, Apple began partly relying on Intel Corp. (INTC) - Get Report modems.
Soon after that, the rebate payments ended; Apple alleges this was in retaliation for it cooperating with Korean regulators in a probe against Qualcomm, but Qualcomm begs to differ. In July, Qualcomm requested an ITC U.S. import ban on iPhones shipping with Intel modems, but not on ones shipping with Qualcomm modems.
It's also worth noting that before Apple and Qualcomm sued each other, the companies held talks for a direct patent-licensing deal; these discussions went nowhere due to significant disagreements over royalty rates. Given the terms of Qualcomm's other deals with OEMs, such an agreement would most likely have resulted in Apple paying higher per-device royalties than what it had been paying via its contract manufacturers. At the same time, it would have given it the flexibility to directly manufacture 4G devices if it wished to, and perhaps also provided access to non-standards essential Qualcomm patents that aren't covered by Qualcomm's deals with contract manufacturers.
Consequently, if Apple and Qualcomm agreed to a settlement that yielded a full direct-licensing deal and average per-device royalties of, say, $8 per phone, it might on the surface look like a bitter compromise for Apple. But in practice, that would be a much better deal for Apple than what was likely available to it before it sued Qualcomm.
And though Apple will probably have a hard time convincing courts it should only pay royalties based on chip prices, it might have more luck convincing some of them that Qualcomm's per-device rates are excessive, given the regulatory probes Qualcomm is facing over its licensing practices. Taiwanese regulators just fined Qualcomm $774 million over its refusal to license standards-essential patents to rival modem makers (who could then convey the rights to those patents to customers). Regulators also alleged the company used a monopoly position in the baseband modem market to force phone makers to agree to its licensing terms. Korean regulators fined Qualcomm $853 million last December, and the U.S. FTC filed a lawsuit against the company in January.
Meanwhile, Apple's decision to withhold any royalty payments from Qualcomm is taking a heavy toll on the company's bottom line. With analysts on average expecting 223 million iPhones to be sold in 2017, a $10 average royalty would equal $2.2 billion in lost revenue. And that's before accounting for any lost revenue related to sales of 4G-capable iPads and Apple Watches, as well as the fact that Qualcomm has also seen another major licensee (possibly Samsung) withhold royalty payments in the wake of Apple's lawsuit.
For all these reasons, Apple has a lot of leverage in this fight, even if its official legal stance is on shaky ground. Relative to what Apple's obligations to Qualcomm would have been in the absence of a lawsuit, there's a good chance the company comes out ahead. And odds are good that Tim Cook & Co. won't be too upset about such an outcome.