The history of antitrust law is littered with sweeping decisions that sought to reengineer entire markets but were later shown to have lacked a sound foundation in fact or economics.
There is now a new candidate for this ignominious club: the Northern District of California opinion and order issued on May 21 in the Federal Trade Commission’s suit against Qualcomm.
Notwithstanding little credible evidence of anticompetitive effect, the court issued a remedy that would effectively tear up hundreds of contracts and endanger a patent-based licensing model that has supported innovation across several generations of wireless communications technology.
To no avail, the Department of Justice had petitioned the court to hold an evidentiary hearing before ordering a remedy with such potentially far-reaching consequences.
Modern antitrust law emphasizes that courts should take into account the error costs of potentially wrong decisions.
Given that principle, it might be expected that a court would only issue a remedy of this scope based on overwhelming evidence that the licensing practices contested by the government have inflicted substantial harm on consumers. Remarkably, that is not the case.
The court implicitly concedes this point by specifically rejecting the necessity of finding a causal relationship between Qualcomm’s licensing practices and competitive harm.
Instead, the court held that it is sufficient to find that the defendant has engaged in conduct that “reasonably appear[s] capable of making a significant contribution to … maintaining monopoly power.”
While the court’s opinion borrows that standard from the D.C. Circuit’s 2001 opinion in the landmark case against Microsoft, the D.C. Circuit had also stated that, when using such an “edentulous” standard for finding liability, it would be inappropriate to order the most extensive equitable remedies “[a]bsent some measure of confidence that there has been an actual loss to competition.”
The district court’s opinion adopts the FTC’s narrative that the acknowledged pioneer behind smartphone technology has imposed a “patent tax” that has resulted in allegedly exorbitant royalties and inflated prices for consumers.
Over approximately the past decade, competition regulators in China, the European Union and other jurisdictions have pursued this line of argument against Qualcomm and other research and development (R&D)-intensive firms in the smartphone supply chain, resulting in hundreds of millions of dollars in fines and, conveniently, reduced royalty rates for local device manufacturers.
There’s a small problem with this theory: It’s wrong. If the “patent tax” narrative were correct, we would expect to see the smartphone market suffering from escalating prices, declining output and delayed innovation. None of these things are true.
Since its inception, this market has exhibited falling prices (adjusted for quality), expanding output and unrelenting innovation. Empirical studies have found that estimated aggregate royalty rates paid on average by handset makers are in the single to mid-digits (a far cry from the double-digit rates that had been reported).
Modest royalty rates nicely account for the robust entry of new firms into the global device production market and the rapid adoption of smartphones across a broad range of income segments.
Without credible evidence of competitive harm, the court’s intervention represents dramatic action to “protect” a market that shows every sign of economic health. The error costs may be high.
If upheld, the court’s order would require the renegotiation of existing licenses with handset makers and the negotiation of new licenses with chipmakers, subject in the case of dispute to resolution in court or through arbitration.
Given that the court finds that existing royalty rates are “unreasonably high,” renegotiation means redistribution. Upstream firms (and economies) that invest billions of dollars annually in the R&D that makes the smartphone possible will be forced to cede market surplus to downstream firms (and economies) that make no such comparable investment.
The follow-on effect is the key concern. A quasi-utility model of judicial rate-setting for smartphone patents would disadvantage firms that operate under licensing-based business models in which R&D is monetized externally and disseminated broadly. It is these firms that have primarily driven innovation in 3G and 4G wireless communications.
At the same time, the court’s order would advantage firms that operate under integrated business models in which R&D is monetized internally and not disseminated at all.
Far from opening up the wireless market, the court’s order is prone to drive firms to construct “walled garden” ecosystems that mostly keep their intellectual property to themselves.
Upon appeal, the Ninth Circuit has an opportunity to rectify the district court’s missteps. An expansive remedy that rewrites a thriving industry’s long-standing licensing arrangements must rest on compelling evidence of competitive harm. No such evidence has been presented.
Absent a course correction, the Northern District of California has embarked on a misguided trajectory that places at risk a critical element in the success story of the smartphone market.
Jonathan Barnett is the Torrey H. Webb professor of law at the University of Southern California, Gould School of Law.