Publication

Don’t fix what isn’t Broken: The Extraordinary Record of Innovation and Success in the Cellular Industry under Existing Licensing Practices

Fall 2016

The cellular industry has enabled fast rates of innovation and consumer adoption over the last 25 years. In his paper, Keith Mallinson explains: (i) the rapid global success of cellular technologies, (ii) why R&D funded by licensing fees allowed for this innovation, (iii) that the existing FRAND obligations set by SSOs have allowed for competition without stifling but instead encouraging R&D, and (iv) that the benefits of intellectual property protection for both companies and consumers far outweigh licensing costs.

The wireless industry has benefitted from explosive growth in new technologies utilized by manufacturers, carriers and consumers over the last few decades. These benefits have resulted from the substantial investment in R&D made by Qualcomm, among many others. The industry has experienced this growth while operating under the existing regime of SSO policies, including FRAND patent licensing, and well-established industry practices. In his paper, Keith Mallinson focuses on the following issues: (i) the rapid global success of cellular technologies, (ii) the reasons behind this growth, (iii) why the existing FRAND obligations set by SSOs have encouraged innovation and enhance competitions, and (iv) how the benefits of intellectual property protection for both companies and consumers far outweigh licensing costs.

1. The rapid global success of cellular technologies

  • Device data speeds have increased more than 100-fold during the period 2006 – 2014.
  • Technology innovations are significant because they reduce operators’ costs and increase network capacity. Research published in 2011 showed that LTE would provide 2.3 times the network capacity achieved by the existing 3G technologies while using the same amount of spectrum, rising to a 5.5 times gain by 2020.
  • While performance specifications have vastly increased, prices have substantially reduced. For example, after adjusting for a 14% increase in the U.S. consumer price index over the period 2006 2012, the 2012 Samsung device was 24% cheaper on an inflation-adjusted basis while providing much higher levels of functionality.
  • The cellular revolution has substantially benefitted countries around the world. For instance, The Economist has revealed that the market share of India’s indigenous market leader Micromax, with 22% of the Indian market, exceeds that of global market leader Samsung, with only 20% share.

 

2. The reasons behind this growth

  • The total R&D investments by major cellular industry participants increased from $400 billion in 2008 to more than $600 billion in 2014. 
  • Qualcomm spends more than 20% of its revenues on R&D. As of September 2014, Qualcomm had cumulatively spent more than $38 billion on R&D since 1985.  These large R&D investments could not be made based on profits from Qualcomm’s chip component sales alone. In 2014, Qualcomm reported earnings before taxes of approximately $3.8 billion from its chip business, while investing nearly $5.5 billion in R&D.
  • Chinese companies are now significantly contributing to the global development ecosystem in mobile communications technologies. Huawei and ZTE accounted for 9.7% of sales and 16.6% of R&D in 2014, up substantially from 6.2% of sales and 7.5% of R&D in 2008.
  • Cellular communication technologies are vital to much of the utility and value that consumers derive from even the non-cellular-specific technologies in their mobile devices. Smartphone software applications such as Google, YouTube, Facebook, Twitter, Instagram, would be far less useful, if useful at all, without high-data-rate cellular connections.

 

3. Why the existing FRAND obligations set by SSOs have encouraged innovation and enhance competition

  • The share of sales for leading smartphone suppliers shifted significantly every year between 2008 and 2014. This time period includes several well-known examples of new entry and rapid expansion. HTC grew quickly to become a major smartphone supplier from the mid-2000s. Since around that time, Huawei and ZTE rapidly established global leadership in the supply of data dongles and have advanced significantly in mobile phones.
  • Apple was a new cellular market entrant in 2007 with little or nothing in the way of cellular SEP, and yet it has achieved stellar growth and strong profit margins.
  • At the global level, sales of both smartphones and cell phones more generally have become increasingly unconcentrated, a trend that began with the decline of Nokia’s share since 2007. The Herfindahl-Hirschman Index, a widely accepted measure of market concentration in competition analysis, lies below 1500, which is a strong sign of unconcentrated market.
  • Consumers have enormous choice in handset suppliers and device models. By August 2012 there were 3,847 HSPA and 442 HSPA+ device models available worldwide, according to the GSA. Similarly, by November 2015, around 339 suppliers had launched 3,745 different LTE-enabled user devices, a 69% increase in one year.
  • The mobile chipset market is highly competitive and fluid. MediaTek is the global market leader in WCDMA baseband chips since Q1 2015 with 31% market share, and it has entered the market for LTE chips and grown its global LTE baseband processor share to 12%.

              

4. How the benefits of intellectual property protection for both companies and consumers far outweigh licensing costs

  • Patent royalties on cellular devices represent an important means by which innovators can recover their risky R&D investments and provide funding for the next cycle of research and innovation.
  • Cumulative royalties charged for 2G licenses to OEMs that did not have any patent rights to trade were estimated to have ranged from 40% in the 1990s to low single digits -- less than 5% -- a decade later.
  • Nokia stated publicly in 2007 that it paid less than 3% aggregate license fees on [3G] WCDMA handset sales under all its patent license agreements.
  • Financial reports of total licensing revenues reveal that cumulative royalty rates actually paid for 2G, 3G, and 4G technologies amount to only around 5% of wholesale sales revenues for mobile phones.
  • If a handset manufacturer pays a patent licensor a 1% royalty rate on the Average Wholesale Price of a handset, that payment corresponds to only 0.21%, 0.34%, and 0.31% of an average North American, European, Asian, respectively, consumer’s total cellular expenditures over the handset’s service lifetime.
  • Overall profits remain substantial for those who create the products most desired by consumers. The profit margins of Apple and Samsung Electronics are 29% and 13.5%, respectively.  Huawei, a relative newcomer, saw a profit margin of over 10%.
  • Cellular carriers have high operating income margins – 30.5% for Verizon Wireless and 18.3% for China Mobile.
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