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Qualcomm Gets the Majority of Profits from Its Licensing Business

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Qualcomm’s business model

In the previous part of this series, we saw that despite many headwinds, Qualcomm (QCOM) continues to pose tough competition in the mobile application processor market. The company’s strong business model has helped it gain competitive advantage over the long term and overcome headwinds.

Now let’s take a look at Qualcomm’s business model.

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Qualcomm’s business segments

Qualcomm operates through two major segments:

  • QCT (Qualcomm CDMA Technologies) – manufactures wireless semiconductors
  • QTL (Qualcomm Technology Licensing) – licenses its IP (intellectual property) to handset makers in return for royalty payments

Both businesses have separate challenges and opportunities, which we’ll look at in later parts of this series.

QCT contributes 67% toward the company’s revenue but accounts for only 26% of operating income, as you can see in the above graph. QTL contributes only 31% toward the company’s revenue but earns 74% of operating income.

Correlation between chip and licensing business

There’s a correlation between QCT and QTL that makes Qualcomm more than a semiconductor company. This protects it from semiconductor industry headwinds that its peers face.

QCT earns high revenue by selling chips at competitive prices. This revenue is spent on R&D (research and development). QCT uses technology developed from R&D to manufacture mobile chips on a larger scale. QTL then licenses this technology to other handset makers. This results in high profit margins from QTL, as dual revenue is earned from a single R&D expense.

Competitive advantage

This business model gives Qualcomm an advantage over its competitors in the following three ways:

  • Custom chips from Samsung (SSNLF) and Apple (AAPL) can only be used in their products. Qualcomm chips can be used across various interfaces.
  • Qualcomm introduced the CDMA (code division multiple access) and 3G/4G (third/fourth generation) technologies. It owns the IP for them. This gives Qualcomm the first mover advantage and allows it to capture market share until the technology goes obsolete.
  • Qualcomm holds 66% of the smartphone chip market. Technology architects prefer working on familiar systems to avoid high switching costs. The company’s dominant position forced NVIDIA (NVDA) to exit the mobile market in fiscal 2Q15.

The Powershares QQQ ETF (QQQ) has more than 50% of its holdings in large-cap information technology stocks. It has 12.4% exposure in Apple (AAPL) and 1.4% in QCOM.

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