Apple's legal surrender is a blow for its supply chain strategy

[SAN FRANCISCO] Apple Inc's legal surrender this week is a blow for the company's supply chain strategy, and one of the biggest tests of its push to cut reliance on providers of key components.

The iPhone maker struck a deal Tuesday with Qualcomm Inc to halt all litigation and start using the chipmaker's modems again, likely including important new 5G versions. That ended a bruising two-year battle over technology that underpins all smartphones.

The agreement includes a six-year licensing pact, creating a telling new deadline for Apple to design its own modems and finally cut ties to Qualcomm. That's an eternity in the technology business and shows how difficult it is to make this crucial component.

"Modems are the sport of kings," said Gus Richard, a chip analyst at Northland Capital Markets. "Qualcomm's probably the only company on the planet that can get a 5G modem in an Apple phone by next year." Apple declined to comment.

The Qualcomm detente is a bitter pill for Tim Cook, Apple's chief executive officer. Squeezing efficiencies out of a sprawling supply chain and bringing component design in house are two of his signature strategies. The company likes to have multiple suppliers if for no other reason than to keep costs down. It sometimes removes suppliers entirely once its own engineers master the technology enough to build it themselves.

This has been a major part of the success of the iPhone, differentiating the device from competitors. Apple's mobile processors are the best in the industry, making the phones fast and slick. The company is also working on its own display technology for future devices and hiring indicates that it could be exploring work on building batteries. It's designed many other parts to improve iPads, Apple Watches, Apple TVs, AirPods and Mac computers.

Modems require more layers of engineering than some other types of processors. The modem connects phones to cellular networks and lets devices browse the web, download apps and make phone calls. Getting this to operate smoothly everywhere in the world is a complex task requiring broad industry know-how that's hard to acquire. Apple began in-house work on modems about a year ago, and the part typically takes at least two years to build and another year and a half to test.

Wireless network operators, from China Mobile Ltd to Orange SA to AT&T Inc, build networks in different ways, using varying equipment and distinct radio frequencies. Modems have to integrate with this diverse technology, while also hopping back onto older wireless systems seamlessly.

For a phone to go on sale globally, it must be qualified to work on many local networks, a process that requires rigorous field testing by expert engineers.

Qualcomm does a lot of this work for phone makers and spent years building relationships with all the major telecom equipment makers and vendors. Its San Diego headquarters and other sites are home to labs that can recreate the network conditions that a phone will experience anywhere in the world. That becomes all the more crucial when standards change, and new gear and services are rolled out.

"Getting modems qualified around the world is extremely difficult," said Mr Richard. "Companies gain a lot of tribal knowledge going through 2G, or 3G, or 4G. You likely will not have the experience needed to succeed without having that history."

Intel, the most dominant company in the history of the semiconductor industry, added its name to a list of well-known firms that have thrown in the towel on modems. Apple had tapped Intel as an alternative supplier. But the chipmaker fell so far behind that it wasn't a viable option for the iPhone. Apple plans to release a 5G iPhone with Qualcomm modems as early as 2020, according to a people familiar with the situation.

In contrast, Qualcomm plans to have its second 5G, or fifth generation, modem in the market this year. That's even before the services have been fully switched on.

Still, Apple isn't giving up on its goal to be self-sufficient when it comes to modems. While its legal battle with Qualcomm raged, Apple began work on its own component. It has teams dedicated to this in San Diego, Cupertino, California, and Munich, Germany.

There are a couple hundred Apple engineers working on modems in the UTC innovation hub of San Diego, people with knowledge of the matter said. This team will also integrate 5G modems from Qualcomm into future iPhones, and support Intel modems for the current models, said these people, asking not to be identified discussing private work. Apple plans to hire hundreds more for the initiative.

On its website, Apple has 30 open positions that mention modems. It has 33 that mention 5G.

BLOOMBERG