Qualcomm's Day of Reckoning May Have Arrived

A US federal judge may have done what Apple and a succession of foreign governments couldn't do: Force Qualcomm to change how it does business.

Concluding a long-running legal case, US District Judge Lucy Koh said late Tuesday that the San Diego chip company, whose products are essential building blocks for modern smartphones, broke the law by squashing competition in important corners of industry and tying sales of its chips to fees for Qualcomm's technology patents.

The ruling strikes at the heart of Qualcomm's unusual and controversial business model. Qualcomm makes chips that smartphones need to connect to the Internet, but it makes most of its profit from licensing its technologies to makers of phones and other computing devices.

Qualcomm's terms for licensing - which covers technology essential to the functioning of modern phones - mean the company is paid even if a smartphone maker uses non-Qualcomm chips, and Qualcomm's fees are based on the consumer price of smartphones rather than on the cost of the parts Qualcomm makes.

Apple, rival computer chip companies and regulatory agencies in multiple countries have challenged Qualcomm's business approach. The Federal Trade Commission two years ago sued over the arrangement, which the FTC said gave Qualcomm the power to overcharge for its patents and unfairly reduced the appeal of products from Qualcomm's chip competitors. Qualcomm has so far withstood every challenge to its business model and even fought off - with the US government's help - an unwanted takeover offer that might have changed how the company does business.

The FTC case, on which Judge Koh ruled, may have been one legal challenge too far for Qualcomm. The company said Wednesday that it would appeal the decision and disagreed with the judge's "interpretation of the facts and her application of the law." The company has long said that its prices are fair and that its business model isn't uncommon; that it plows its revenue back into development of future technologies that help the industry and consumers; and that the market for cellular chips is competitive.

But assuming the finding holds up, this may be the long-delayed day of reckoning for Qualcomm. The company may have to reduce its royalty payments, rewrite every customer contract and open up its trove of intellectual property to rival chip companies.

Qualcomm shares soared in April when the company settled litigation with Apple over similar claims to the case Judge Koh heard. Two weeks ago, Qualcomm awarded stock bonuses to top executives for their "outstanding efforts" in ending the fights with Apple and its partners. Those payouts look awkward now. Qualcomm's stock opened down nearly 10 percent on Wednesday. The settlement with Apple seemed to signal that Qualcomm's royalty-rate structure and business model would remain essentially intact. Maybe not.

The timing of Qualcomm's legal loss couldn't be worse. Smartphone sales are sagging globally, which is already weighing on sales for Qualcomm and other companies that make smartphone components. And companies including Qualcomm and its customers are planning for the transition to the next generation wireless internet standard, known as 5G, and the legal ruling adds uncertainty to that transition.

The ultimate cost to Qualcomm is difficult to calculate. For now, Qualcomm will keep collecting royalty payments as usual. And investors have already baked some caution into Qualcomm's share price. Its business model was under siege so often that it may have been inevitable it couldn't maintain it forever.

Now we will see whether Qualcomm is prepared for its business to be upended. Does the company have a "break glass if our business model must change" plan? If not, investors need to hold the company to account for failing to have a Plan B.

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