China’s anti-trust investigation of the American chip maker Qualcomm came to an end when the chip giant agreed to pay a record fine of about $975 million last Monday. According to the decision issued by China’s National Development and Reform Commission, the royalties Qualcomm collected from Chinese smartphone manufactures were “unfair” and “excessively high,” and Qualcomm’s other conduct, such as product bundling and patent cross-licensing, violated China’s Anti-Monopoly Law.

As part of the settlement, Qualcomm agreed to lower the royalties on third-generation devices to 5 percent and to 3.5 percent for some fourth-generation devices. In each case, the royalty base will be set at 65 percent of the net selling price of the devices. The settlement also forbids Qualcomm to continue to demand its clients sign “umbrella” cross-licensing agreements, which require smartphone manufactures who obtain licenses from Qualcomm to license their own patents to Qualcomm and Qualcomm’s other licensees for free. Under the settlement, if Qualcomm seeks such cross-licensing agreements from a Chinese licensee, it must negotiate with the licensee in good faith and provide fair consideration for such rights.

The settlement is expected to only have a limited impact on Qualcomm’s revenues in the short term. Despite the lower royalties, Qualcomm will still be able to collect royalties based on the whole price of the device, a much higher valuation method compared to basing the royalties on a specific part of the device. In fact, Qualcomm’s estimated annual revenue for fiscal year ending September 27 stayed roughly the same after the settlement was announced.

On the other hand, the cancellation of “umbrella” cross-licensing agreements may have a significant long-term effect on the Chinese smartphone market. Prior to the settlement, “umbrella” cross-licensing agreements provided incentives for Chinese smartphone manufactures with very few patents to focus only on cost control and marketing and ignore R&D since these agreements allowed any Chinese smartphone manufacture who obtains licenses from Qualcomm to “free-ride” patents owned by Qualcomm’s other partners in China. On the other end of the spectrum, those agreements preclude Chinese smartphone manufactures that have with a large number of patents but still rely on Qualcomm’s technology from enforcing their intellectual property rights. The cancellation of “umbrella” cross-licensing agreements will force all Chinese smartphone manufactures to recognize the importance of intellectual property and invest more on R&D. This may undermine Qualcomm’s business in the long term as Chinese smartphone manufactures develop new solutions to replace those from Qualcomm. In fact, Huawei, a Chinese smartphone manufacture, produced almost 20 million smartphones running on its own solutions in 2014. How Qualcomm will change its business strategies in China accordingly remains to be seen.

Peiyuan Guo

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