Why a Non-Discriminatory Royalty Surcharge Is Not Chip-Neutral: The Error in FTC v. Qualcomm

Abstract

Qualcomm's No License, No Chips policy let it levy a royalty surcharge on every handset, whether or not it used a Qualcomm modem chip. In FTC v. Qualcomm, the Ninth Circuit reversed the district court after accepting Qualcomm's argument that, because the surcharge did not vary with the chip, it was "chip neutral" and left handset makers' choices undistorted. I develop an equilibrium model of the modem chip market and show the defense to be wrong: the surcharge's facial neutrality does not imply economic neutrality. For per handset surcharges, a surcharge and an equal government tax affect the rival's pricing identically, but not Qualcomm's: a tax is remitted to the Treasury, whereas Qualcomm collects the surcharge -- including on handsets using a rival's chip. Raising its own price therefore yields Qualcomm a smaller gain under the surcharge (the surcharge it collects on the demand diverted to the rival) than under the tax (the tax it avoids on its own lost sales), because the diversion ratio is less than one. Under the very conditions that would make a tax chip neutral, the surcharge raises the rival's all in price by strictly more than Qualcomm's -- and, under symmetric demand, lowers its output by more as well -- tilting handset makers toward Qualcomm. For ad valorem surcharges, the defense fails for a different reason: even a non discriminatory tax is generically chip neutral only if the FRAND royalty rate is zero, so the argument's premise itself does not hold. I also analyze discriminatory surcharges.