Apple and Qualcomm have spent the year battling over billions of dollars of patent royalty payments owed by the iPhone maker through its contract manufacturers. Now Apple, Qualcomm’s biggest customer, is reportedly moving to stop using any of Qualcomm’s wireless chips.
So what’s at stake for two of the largest and most profitable mobile market players? And will carriers, other phone makers, and consumers be collateral damage in the fight?
Why is Qualcomm such an essential player?
Qualcomm was started by a group of early pioneers in wireless phone technology that was led by Irwin Jacobs, an entrepreneur and former MIT computer science professor. The founders developed a method of sharing airwaves used by multiple wireless phones simultaneously that became known as code-division multiple access, or CDMA. The method was eventually adopted by some of the world’s largest wireless carriers including Verizon, Sprint, and China Unicom. Later innovations by Qualcomm were incorporated into the industry’s standards for faster 3G and 4G LTE networks.
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What does Qualcomm actually sell?
Qualcomm (QCOM) makes money from its wireless technology in two ways. First, it designs wireless modems and processing chips (both of which are actually made by outside contractors) for phones, tablets, and other mobile connected devices. Last year, Qualcomm’s chip division collected $1.8 billion of profit before taxes on $15.4 billion in sales.
Customers include virtually every major smartphone maker, from Apple to Samsung to LG, though not most Chinese vendors such as Huawei. Qualcomm’s top of the line Snapdragon 835 CPU and X16 LTE modem chips are used in many of the fastest phones on the market, like Samsung’s Galaxy S8, which can reach gigabit per second download speeds. Apple makes its own CPU but has used Qualcomm’s modem chips.
While Intel is trying to catch up, its fastest modems don’t have all the features needed to reach speeds as high as Qualcomm’s current chips. And although it (INTC) recently introduced a new modem chip that is compatible with the older CDMA standard, Intel isn’t yet selling those chips in large quantities.
The more lucrative side of Qualcomm’s business is collecting royalties on its thousands of patents related to mobile technology. The patents range from the basics of CDMA to 4G LTE to farther afield areas like a method of reducing battery drain in smartphones and a technology for cell towers to broadcast over multiple wireless spectrum channels to one device to increase data speeds. In 2016, the licensing unit brought $7.7 billion of revenue, generating $6.5 billion of profit before taxes for an impressive 85% profit margin.
Critically, Qualcomm doesn’t seek to collect royalties from its competitors in the mobile chip business, like Intel or MediaTek. Instead, the company forges agreements directly with phone makers, like HTC and LG, or their contract manufacturers, like Foxconn. And royalties are calculated as percentage of a phone’s total cost, not just the cost of the mobile chips inside.
Why are Apple and Qualcomm fighting?
The dispute actually started last year when Apple (AAPL) brought in Intel as an alternate supplier for wireless modem chips in about half of its iPhones and gave some information about Qualcomm’s business practices to regulators around the world. Apple complained that Qualcomm’s practice of charging royalties on a phone’s entire cost was excessive and should be disallowed since many of the patents involved are part of industry standards. Qualcomm in turn shut off a flow of payments—Apple described them as partial rebates on the royalties—leading Apple to sue Qualcomm and stop paying royalties. Qualcomm countersued and is trying to have iPhones with non-Qualcomm chips barred from being imported. But through it all, Apple has continued to pay for and buy wireless modem chips from Qualcomm for its newest iPhones.
Why is Apple finally moving away from Qualcomm’s chips?
Apple used approximately half Intel modem chips and half Qualcomm for iPhone and iPad models in 2016 and again this year. But the company is designing its 2018 mobile devices to work without any Qualcomm chips, the Wall Street Journal reported. Apple declined to comment to Fortune. According to the paper, Apple made the decision after Qualcomm withheld software needed to test the chips in prototype devices. By hitting Qualcomm’s sales further, or least floating the idea as a trial balloon, Apple also obviously puts pressure on Qualcomm to settle the legal disputes on terms more to Apple’s liking.
How badly could Qualcomm be hurt?
Apple has already cut off the flow of royalty payments that analysts estimate amounts to $3 billion of Qualcomm’s revenue and a substantial portion of its profits. The chip sales to Apple bring in another $1.5 billion to $2 billion, though with a much lower profit margin, analyst Stacy Rasgon at Bernstein Research estimates. Shares of Qualcomm, which were down 13% since Apple filed its lawsuit in January, sunk another 8% on Tuesday on news of Apple’s planned chip swap.
Won’t Apple iPhone buyers suffer from slower speeds without the Qualcomm chips?
Not much. Even though some iPhones and iPads contain Qualcomm chips and some contain Intel chips that lack key features, Apple limits the Qualcomm chips it uses from reaching top speeds because it would make iPhones with Intel chips look less desirable. The move was even one of the grounds Qualcomm cited in its countersuit as damaging its business. But even with the throttling of Qualcomm’s chips, some tests showed that the Qualcomm-equipped iPhone performed better last year. Also, to the extent that Qualcomm’s innovations pressured Intel to improve more quickly and keep its half of Apple’s business, Apple’s decision to drop Qualcomm chips completely could ease that stimulus.
Will other carriers or phone makers be hurt?
Unlikely. Qualcomm has a lengthy roadmap of planned wireless modem improvements. Its upcoming X20 modem, for example, can hit a top speed of 1.2 gigabits per second. And future models are coming for new 5G networks that will be even several times faster than that, allowing for new applications like real-time streaming of virtual reality content.
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