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iPhone and the Future of Qualcomm: Addendum

Posted on Tuesday, May 22nd 2007

I wrote iPhone and the Future of Qualcomm last week, and it generated a huge amount of controversy. My main point in the iPhone series is that if iPhone succeeds in becoming the industry galvanizing event that I think it will be (even if the product itself is a limited success for Apple), it will impact a lot of players in the eco-system.

One such player is Qualcomm, who owns most of the IP around CDMA, one of the two alternate network standards. The other one, ofcourse, is GSM. I suggested that if the world unites under one standard, and if that standard is GSM, then Qualcomm has trouble ahead. [There are 2 IFs here, folks …]

Readers pointed out that I have not taken into consideration the fact that Qualcomm owns a lot of the WCDMA patents as well. “In your recent blog, you state that the iPhone going with GSM(Cinglar) is bad news for Qualcomm. What you fail to mention is that Cingular/ATT is now rapidly upgrading their network to WCDMA to get faster data rates. Qualcomm is a leader in WCDMA and does sell chips and receive royalties. So, if Apple never plans to upgrade the iPhone to WCDMA, then your arguement would be correct. But, given that the iPhone could greatly benefit from a high speed data connection, logic might say that they would, at some time, move towards WCDMA, as this is what the Cingular network is doing. This would seem to be a benefit to Qualcomm.” (This reader requested anonimity, but was thoughtful and data-driven, unlike many others who suggested I stop blogging altogether because they disliked so much my analysis!)

I agree, that there is a very strong likelihood that Apple’s 3G strategy could include CDMA, given that they would likely need to work with Verizon to win market share in the foreseeable future. My question, however, remains: Does Qualcomm’s WCDMA royalties compare with what they have in CDMA? Will it be a meaningful substitute financially? And will WCDMA win over and / or be an essential component of 3G/4G GSM in the long run?

It is precisely on this question that the opinion differs. Some say, “Yes, in fact, this is what made Qualcomm a hot stock. The fact that 80% of the world is GSM, but is migrating towards WCDMA, for which Qualcomm has chips and gets the same royalties as CDMA, because the essential patents are the same. Nokia is fighting this hard, but I think some agreement will
happen.” Key question to ask: How fast will the GSM to WCDMA transition be? Will it be global? Are Qualcomm’s projections realistic? And will WCDMA be as big a building block of 3G/4G GSM / UMTS?

Morningstar says, “Nokia is trying to obtain a lower royalty rate for the next generation of mobile phones (or 3G WCDMA) by arguing that Qualcomm’s share of the intellectual property (IP) behind the 3G WCDMA standard is much lower than its share of the IP behind the CDMA standard. In addition, Nokia’s share of the IP behind the WCDMA is second only to Qualcomm and much larger than it was in the CDMA standard. Nokia therefore argues it should be allowed to pay a lower royalty rate on WCDMA handsets. Qualcomm currently receives a royalty rate of between 4% and 5% on the sale of every CDMA- or WCDMA-based handset, with the royalty rate being the same regardless of whether it is CDMA or WCDMA technology.”

Qualcomm’s future, therefore, relies on two things: WCDMA winning over GSM (UMTS/HSDPA) as the 3G standard, and CDMA sustaining itself, especially in the emerging markets, continuing to provide a strong royalty stream. (Note: Low-end phones on CDMA will also suffer from lower royalty revenue due to dropping handset prices, but that’s a totally different issue.)

Well, I am a huge fan of IP-Licensing business models. In fact, Qualcomm’s IP Licensing business QTL has an operating margin of 87%, and even if it drops a few points, it is unlikely to drop below 80%. QTL posted revenue of $759 million (34% of total). Whether this business will continue to thrive at the same growth levels or not, depends on how the standards war fares in the upcoming years, and whether a universal standard emerges in the next 5-7 years.

So what’s iPhone’s role in all this? As another reader points out, “If rumors are to be believed, then Apple tried to pitch the iPhone to Verizon first (which would have been a CDMA product). Only after Verizon walked away, did Apple pursue Cingular with a GSM variant. GSM, of course, also makes the most sense from a global perspective for Apple because it can then leverage the product throughout LTA, APAC and Europe (whereas the vast majority of CDMA subscribers are isolated in North America, Japan, Korea and India). And if Cingular’s exclusive on the iPhone expires, Apple would gladly create a CDMA version if Verizon is willing to commit to volume levels that create a sound business case.”

All of the above is true. Apple is not YET in the position to call the shots on standards. If the iPhone becomes a huge success, then they COULD take the position that they would only support one standard, but this won’t be for 3-5 years. Meanwhile, the iPhone needs to establish itself as a Product success first, not just a PR success. Again, lots of IFs.

To end, I believe, that in the 5-7 year window, an opportunity for the market to converge on one standard would arise. If the iPhone does become successful, they would be in a position to drive this standardization, and if the Nokia-Qualcomm situation is any indicator, they would have allies in the market. Those include, at least, Nokia, Eriksson, Motorola, and possibly also Alcatel, Philips and others.

Why? Because, these are the companies who are the owners of the GSM patents, and those amongst them who manufacture handsets, negotiate cross-licensing agreements with each other, and don’t have to shell out the 5% royalty that they do to Qualcomm, if CDMA or WCDMA became the standard.

You can read more of the discussion around the previous article, under comments on my site. And if you participate in the discussion, please refrain from using rude language, and stick to data and logic, but by all means, do feel free to disagree with me.

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[…] iPhone & the Future of Qualcomm: Addendum […]

Sramana Mitra on Strategy » Blog Archive » iPhone and the Future : Synthesis Tuesday, May 22, 2007 at 5:30 PM PT

You still don’t get it. “I agree, that there is a very strong likelihood that Apple’s 3G strategy could include WCDMA, given that they would likely need to work with Verizon to win market share in the foreseeable future.” Huh? Verizon doesn’t have a WCDMA system. They have a CDMA system. Cingular/ATT has a WCDMA system, and when Apple puts out a 3G phone on the Cingular/ATT system, Qualcomm will get royalties. They have signed licensing deals with over 100 handset and chip makers, with rates the same for any flavor of CDMA; WCDMA, TD-SCDMA or CDMA.

Jdub Thursday, May 24, 2007 at 1:39 AM PT

You are so smart!

Sorry about the typo on Verizon, but the royalty issue depends entirely on whether Qualcomm gets the same royalties from WCDMA that they get from CDMA, which is not yet clear. Other people have claims to that royalty pool, including Nokia who is fighting it.

May be you don’t quite get the fact that there is a difference between 5% royalty on every handset and 2% royalty, 3% royalty, even 4% royalty. All the latter numbers are smaller than 5%. Qualcomm’s QTL division’s revenues will be impacted by the number, although potentially somewhat offset by the total volume. Remains to be seen.

Sramana Mitra Thursday, May 24, 2007 at 10:43 AM PT

Oh – a typo. Yes I do understand the difference between 5% and 2%. You are changing the subject from whether Apple will influence the telecomm industry to whether Qualcomm will receive the same royalty for WCDMA IP as CDMA IP. That is a subject that has been hashed around for years. The courts have always found for Qualcomm. Nokia is in deep doo-doo because their dominance is being challenged by disruptive technology provided by Qualcomm, and they are desperately trying to avoid this happening. In the meantime, many handset makers are now able to challenge Nokia in the WCDMA and HSDPA market, happily using Qualcomm’s technology and paying WCDMA IP royalties to Qualcomm AT THE SAME RATE AS CDMA IP royalties. The 3G chip that goes into the Apple 3G iPhone will not be a Nokia (or TI) chip. So Nokia can steal Qualcomm’s IP for awhile, but in the end, they will pay Qualcomm for the (W)CDMA IP because they have no choice, no matter how much noise they are making and how effective their BS marketing campaign v. Qualcomm is at the moment.

Jdub Thursday, May 24, 2007 at 1:54 PM PT

Sorry, I don’t understand how I changed the subject …

iPhone -> GSM vs. CDMA -> Qualcomm royalties threatened or not? This is the logic thread we’re discussing, right?

If you are correct that Qualcomm will preserve the same royalties for WCDMA that they have for CDMA, then the GSM vs. CDMA qs. will not impact them at all. That is certainly one scenario.

The other scenario is that it will.

I frankly don’t claim to know the answer to this question. You seem to have a position on the issue.

I am sure that position reflects on your stock purchase decisions. Could it be why you find my
raising the question so offensive?

Sramana Mitra Thursday, May 24, 2007 at 4:57 PM PT

I am not offended. You are not the first one to have raised the question. I am disagreeing with you. But your original notion that Apple, by selling many millions of phones, will somehow cause Verizon and Sprint to think about ripping up their billions of dollars in CDMA infrastructure and go with GSM is absurd. As it pertains to Qualcomm, the more likely scenario is: Apple sells a few million phones, Apple then comes out with a 3G phone, Qualcomm makes some money on Apple’s 3G phones, competitors to Apple come out with equally or more compelling 3G phones, which will run on Verizon and Sprint as well as Cingular/Att, Qualcomm makes some more money, then there is more leap-frogging in phone competition, and Qualcomm makes some more money. But yes, go ahead and continue to believe that Qualcomm is perhaps in danger because Apple is coming out with a phone.

Jdub Thursday, May 24, 2007 at 5:51 PM PT

The whole point of this forum is for discussion, and discussion includes disagreement.

As I said, I don’t believe one way or another. I don’t have a position on Qualcomm. I do have a question mark against the company.

Time will tell if standardization will happen or not. In the power outlet industry, standardization did NOT happen, as a result, you need adapters to plug into wall jacks in Europe, UK, Asia.

I DO personally believe that standardization is a good thing, and it complicates life for those who travel a lot internationally to not be able to plug into jacks without adapters.

Similarly, it seems to me that it would be a great deal easier to standardize things on GSM than on CDMA.

Steve Jobs has always been a “Simplication” and “Usability” torchbearer in the industry. In his attempts to revolutionalize the cellular business, IF he does manage to create for himself a solid success platform, my thesis is that he may decide to take on the standardization issue as well.

And if he does, he will have allies.

That’s my logic.

Yours is different, and that’s perfectly okay.

Sramana Mitra Thursday, May 24, 2007 at 6:56 PM PT

[…] product itself is a limited success for Apple), it will impact a lot of players in the eco-system. more… AccuWeather.com: Weather […]

psms.mobi » iPhone and the Future of Qualcomm Tuesday, May 29, 2007 at 11:03 PM PT

Bravo to Jdub!
“But your original notion that Apple, by selling many millions of phones, will somehow cause Verizon and Sprint to think about ripping up their billions of dollars in CDMA infrastructure and go with GSM is absurd.”

The whole line of thought in this particular set of blogs is riddled with inadequate knowledge of the industry. Handsets (and that’s all the iPhone is) have never and will never drive standards or network operator’s decisions. The handset ecosystem on the whole might, but not one clever little device from our friends in Cupertino. And so, the bottom line to Sramana’s original topic “IPhone & Qualcomm”: zero to +. Just another device that will eventually have a QC chipset in it.

bms Wednesday, May 30, 2007 at 1:04 PM PT

Right. You are saying what I said. “Even if the product itself is a limited success for Apple …” see above? I said, the category – the NEW category – “Laptop replacement device” category – will be a success.

iPhone’s role is to introduce and legitimize this category.

And this is what will impact the carrier eco-system.

Get it?

Sramana Mitra Wednesday, May 30, 2007 at 1:53 PM PT

oh, I GOT what you were saying, and I disagree that we were saying the same thing.

The part that the iPhone may have an impact on the mobile carrier business is at least worth discussing, I’ll give you that.

The assertion that it will change the standards choices of the market and will affect the revenues of a MAJOR mobile chipset vendor is and remains absurd. See all my other posts in Alpha. Technology standards choices are made based on much different grounds than a single device or even device category. With 80 million laptops sold annually, compared to maybe 5-7x that in mobile phones, do you think even a smash success of the iphone and the introduction of a “laptop replacement” would make a difference?

Also, GSM proliferating is a global phenomenon that affects QC in the short term. WiMax coming on the scene also has the potential of affecting QC revenue. Those are material. The iPhone is not.

Give up already on the assertion that the iPhone will be a landscape altering event for the wireless industry. It’s not.

bms Thursday, May 31, 2007 at 11:43 PM PT

[…] The one advantage Verizon has over AT&T is its 3G network. Most of its customers would rather wait for an iPhone rival version that is 3G capable rather than shift to the slow EDGE network of AT&T. Verizon is a CDMA shop and there is no chance at least for five years that an iPhone version will hit its network. Verizon has some 3G products in the pipeline and it is taking steps to minimize the effect of the ban on the import of Qualcomm 3G chips. It is reportedly paying Broadcom $6 for every handset, smart phone or data card affected. The deal is subject to a maximum payment of $40 million per calendar quarter and a lifetime maximum fee of $200 million. Verizon’s stock is fluctuating between $40 and $44. [For more color on Qualcomm and the GSM-CDMA debate, here are 2 prior pieces: the highly controversial iPhone and the Future of Qualcomm and its addendum.] […]

iPhone’s Carrier Competitors: Verizon - Sramana Mitra on Strategy Thursday, August 23, 2007 at 8:57 AM PT

You seem to have a misunderstanding; you talk as if WCDMA is somehow different to UMTS/HSDPA. WCDMA is the air interface of these 3G standards.

cmca Monday, August 27, 2007 at 7:00 PM PT

Why do you claim, Sramana, that based on travelers’ experiences, standardization is a good thing? for adapters, phones, and so on?

Whatfraction ofthe general population do you think is constantly globetrotting, and bothered by these disparate standards?

seattlesonic Sunday, November 11, 2007 at 6:31 PM PT

You are absolutely correct that only a small portion of the global population travels, and hence this may be a far-fetched dream.

Sramana

Sramana Mitra Sunday, November 11, 2007 at 8:06 PM PT