Nearly 20 years ago, Qualcomm Incorporated’s founder, Irwin Jacobs, made one hell of a bet. Jacobs believed that a technique invented for guiding torpedoes during World War II-a highly complex but efficient way of directing traffic in the airwaves-would someday become the basis for a worldwide standard in digital wireless communication.
It was a risky bet. Most of the major wireless carriers had committed to a different technology. The system championed by Jacobs was widely seen as too complicated and commercially unworkable. But Jacobs, a former professor of electrical engineering at the Massachusetts Institute of Technology, wouldn’t let the idea die. As Qualcomm developed and patented wireless technology, Jacobs campaigned for the system he favored, known as code division multiple access (CDMA). Slowly, the rest of the world bought in. By the late 1990s, it had become the fastest-growing global wireless standard.
As Qualcomm pushed for CDMA, Jacobs made an equally fateful decision about how his company would make money. Instead of manufacturing its own cell phones, Qualcomm would license the patents it had stockpiled. Phone makers like Samsung Group, Ericsson, and Motorola, Inc., would have to forge licensing deals with Qualcomm in order to produce phones that operated with CDMA technology.
For a long time, Qualcomm’s business plan worked beautifully. In 1999-the year CDMA was included as standard technology for a new generation of phones that had previously used a competing system-licensing deals generated more than $454 million, 12 percent of Qualcomm’s revenue (Qualcomm also sells its own chips and software). This year Qualcomm’s licensing business has generated $2.77 billion-31 percent of the company’s total revenue.
Every phone maker marketing to the regions that rely on CDMA technology needs to license Qualcomm patents, and from each of them, Qualcomm has always demanded big fees. Phone and chip makers tried to argue that Qualcomm was asking too much, that its patents were less significant in increasingly sophisticated phones. But Qualcomm insisted that the phones couldn’t be made without its intellectual property. Its customers would have to ante up for licensing deals: The Big Q intended to rake in as much as it possibly could, and for as long as it possibly could.
But somewhere along the way to endless licensing revenues, Qualcomm’s plan went awry. Beginning in 2005, the Big Q’s licensees decided they’d had enough of Qualcomm’s bullying and mounted a concerted, worldwide attack. Rival chip maker Broadcom Corporation, led by its lawyers at Wilmer Cutler Pickering Hale and Dorr and Cleary Gottlieb Steen & Hamilton, sued Qualcomm in California and Washington, D.C., for patent infringement, and in New Jersey for antitrust violations. Nokia Corporation, represented by Quinn Emanuel Urquhart Oliver & Hedges, filed a breach of contract case in Delaware Chancery Court and a patent infringement case in Washington, D.C. Broadcom, Nokia, and four other wireless companies filed complaints with the European Commission. Everywhere Qualcomm looked, someone was filing a suit.
The Big Q has responded with all the vigor one would expect of a company whose multibillion-dollar business model is under siege, filing a raft of claims and counterclaims of its own. The company expects to spend more than $200 million on litigation next year, which will include bills from such high-priced legal talent as Evan Chesler, the presiding partner at Cravath, Swaine & Moore.
So far, however, things are not going well for Qualcomm. In its most significant defeat, a federal district court judge in San Diego found that Qualcomm employees and outside counsel engaged in misconduct, covering up evidence that Qualcomm gamed the very system on which its lucrative licensing deals depend. That ruling could also hurt the company’s credibility before other courts in the United States, and beyond. It may be too early to predict the ultimate impact of the litigation morass on the Big Q’s bottom line. But it’s not too soon to say that Qualcomm’s quandary proves a new maxim: In the IP age, business models have about as short a half-life as the technology that supports them.
Today’s digital cell phone market, with its estimated 3 billion users-yes, that would be about half the world’s population-is a stunning achievement. And one that might have seemed unattainable just 20 years ago, when the market consisted of fewer than 16 million urbanites. In those days the technological picture wasn’t pretty. Phones relied on analog signals. They were the size of bricks, and got only spotty reception.
A crucial turning point came in the late 1980s. Demand for cell phones was growing fast, but the analog system couldn’t handle the increasing volume. The industry poured billions of dollars into building an infrastructure to transmit calls digitally, which promised more caller capacity and better reception. To make the transition from analog to digital technology, industry leaders (in the U.S.) and governments (in Europe) formed standard-setting bodies to ensure that all the elements of cell phone systems-products and equipment-would work together.
Those standards groups, which have continued to oversee every major shift in wireless technology, have proved crucial to the phenomenal growth of the cell phone market. For consumers, their work means that people around the world are able to choose from among dozens of phones without worrying about whether they can communicate with other cell phone users. For companies in the wireless industry, the standard-setting bodies not only regulate the technology-they determine financial futures.
The standard makers require wireless companies to play by certain rules. Generally, when a new standard is under consideration, companies in the industry are required to report patents they own that might be necessary to the new technology. The goal is to avoid “patent holdups,” in which companies that control crucial technology charge exorbitant and unfair royalties. Before deciding on a standard that uses a company’s technology, the body will seek assurances that the company will license its intellectual property on “fair, reasonable, and nondiscriminatory” terms.
Qualcomm’s success exemplifies the financial significance of the standards groups’ decisions. Since the company’s founding in 1985, Qualcomm has heavily promoted its patent portfolio to standards bodies. It got one of its first big breaks in 1993, when a major industry group approved its technology as a North American digital standard. That approval gave Qualcomm the legitimacy it needed to convince carriers that its technology would be widely accepted. It also marked the beginning of the company’s licensing bonanza.
As standards bodies adopted systems that relied on Qualcomm patents, the Big Q could act like a toll collector: Any company that wanted to produce a product compliant with wireless standards had to pay Qualcomm a licensing fee. Over the years, Qualcomm began also to hit phone manufacturers for an estimated 5 percent royalty on the sale of every phone that used its technology.
Such tactics didn’t make the Big Q many friends in the industry. “Qualcomm used to stick it to others for years,” says wireless technology analyst Craig Mathias of Farpoint Group.
Qualcomm’s litigation war with the wireless industry grew out of the work of the leading European wireless standards body in the late 1990s. The group was considering technologies for a new generation of phones that would be sold throughout the world. Qualcomm lobbied hard for a chance to break into markets that had long used a different wireless technology, but failed to get its way. When the standards body rejected its proposals, Qualcomm retaliated by refusing to share its intellectual property under the terms required by the standards body.