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20 July 2017

Apple forces Taiwanese ODM firms to act in concert on Qualcomm

This week Apple has managed to get its suppliers to lodge anti-trust actions in the US District Court of Southern California this week, a court known for its “home court” rulings in favor of Apple.

But while Californian legal actions have stripped Samsung of about $1 billion on Apple’s say so over patent actions made against indefensible software patents, what they show is that Apple is increasingly desperate, and that it is just a matter of time before the anti-trust finger is pointed fairly and squarely back at Apple.

Foxconn’s parent Hon Hai Precision Industry, Wistron, Pegatron and Compal will be wincing at the uncomfortable position that Apple has put them under – file a counterclaim or draw Apple’s displeasure, which would likely meaning being dropped from its manufacturing processes with the consequent loss of revenue.

There are only so many companies that can make as many phones, reliably for a company the size of Apple, and these companies have businesses queuing up to have them build devices – albeit in lower volumes, and so are in a strong position if they wished to push back against Apple – but they have gone along for the ride – hoping that maybe their bottom lines may indeed be improved. If this goes to court and emails emerge which show that Apple has coerced these moves, then a massive and potentially global anti-trust case will be brought against Apple and bring the company to its knees.

The position of the ODMs is massively weakened by the fact that they are choosing to pay Qualcomm royalties on other devices they make for other handset vendors – Wistron makes windows and Android phones, Compal used to make Motorola phones when it was the world’s second largest handset maker and Pegatron has its own brands of phones. If they continue to pay these royalties and not those of the iPhone, that shoots holes through this case.

Foxconn, part of Hon Hai Precision, and the name most closely allied with Apple phones is famous for both making iPhones, but also phones for other companies, including recently for Chinese firm Xiaomi and also makes other famous devices such as Sony PlayStations. Has it withdrawn royalties on these? We think not.

Both Pegatron and Foxconn a few years back, were embroiled in allegations of poor working conditions which triggered a series of mass suicides at the Foxconn plants, a situation that will almost be sure to be brought up to ensure that US courts look less sympathetically at these employers.

The manufacturers could not sue in Taiwan as it only has the most basic of Fair Trade Laws, which only takes in behavior inside Taiwan, and many of these factories are outside of Taiwan. And anyway they were passing on the cost of royalties to Apple.

Qualcomm can do most harm by a US court not allowing their products into the US, but at the same time, price fixing is illegal under Taiwanese law and Qualcomm would have a case if it lodged a complaint there, as they have all acted in concert. The only thing saving them is that they say they are responding to the Qualcomm suit brought in May seeking to force them to pay license fees which had been at Apple’s direction. But they all acted in concert together in withholding patent royalties in the first place, and that would almost certainly be punishable by a fine equal to 10% of their revenues under Taiwanese law. Unless Taiwanese courts also bring in home court decisions.

The Taiwan Fair Trade Laws prohibit concerted action. Concerted action is defined as competing enterprises at the same production and/or marketing stage, by means of contract, agreement or any other form of mutual understanding, jointly determining price or trading terms resulting in an impact on the market function. We can’t think of a better way of describing this. The best place to hit Apple would be in Europe, under the European Commission anti-trust laws, which have been widely used to curb the excesses of US tech firms in the past (such as IBM, Microsoft, Intel and Google).

However an adverse ruling could be the end of Qualcomm’s practice of forcing a patent license to all of its inventions whenever a company uses its chips, in which case, it will severely restrict Qualcomm’s ability to sustain its level of profits, and quite possibly make it less of a market leader in its core wireless modem marketplace. It will certainly crash its value on the stock market.

But what will Apple do next in its vainglorious attempt to inflate its margins in a market tired of $700 smartphones. History tells us that prices in such markets fall, as fresh rivals enter, and that being the most profitable company in the world by margin, only sticks to technology businesses for a handful of years, before market pricing falls – so this is unsustainable. In fact it is these ODM companies which will prove the downfall of Apple, as Chinese firms take on their core manufacturing skills, to go up against Apple.

In other words, in the long run Apple’s margins will fall off a cliff and its share price too. The only issue is whether or not Qualcomm’s have already gone of that same cliff.

The nature of Qualcomm’s business model of linking the sale of chips and patent licenses, has come under scrutiny by regulators in South Korea, China and the US and it has always previously survived, despite fines being imposed.

Qualcomm’s next quarter came out today with numbers down considerably, in sales and in profits. Investors are famous for never betting on the outcome of a legal action, but the scrabble to re-acquire Qualcomm shares, in the event of a good outcome will be undignified in the least. At its results Qualcomm attacked Apple and told of new actions it is taking in Germany to prevent Apple devices being sold there.