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Weekly Column

When a Bunny Suit Just Isn't Enough: The Aging of Intel

Status: [CLOSED]
By Robert X. Cringely

So you've read the magazine articles, scanned the Web, endured the TV commercials, and now you just can't wait to buy that new Pentium III computer.

Don't do it.

The P-III, with a $300 million marketing campaign behind it, is going to be everywhere we look soon enough, but I heartily recommend you NOT buy one. The chip is faster, sure, but it is also more expensive. And with Intel showing versions running at one gigahertz, today's 450 MHz model will drop like a stone in price almost immediately, especially when AMD introduces its K6-3 chip. Besides, there isn't any software that yet supports those 70 extra P-III instructions, and there probably won't be for months or years, a la Intel's thinly supported MMX instructions or AMD's even more thinly supported 3D-Now. So wait a few months, let the AMD chip appear, then see what happens to prices. But no matter how you look at it, Intel's star is fading, if slowly. Poor Intel.

Poor Intel ? It's hard to imagine in this, the Intel Decade, that the world's largest chip company could be in decline, but by traditional Intel standards it is. The stock is strong and the company still has bales of cash and almost no debt, but revenue is a little lower, and profit margins are down. For a company that has grown by a factor of eight this decade, lower is not good. Blame the Japanese, the Koreans, blame the Thais, but it's not the Asian economic crisis that's to blame for the worried looks at Intel's Silicon Valley HQ. Rather, the company — like any other 30 year-old business success at the end of an expansion cycle — is feeling its age. To understand its current identity crisis, let's look at Intel inside.

They invented the microprocessor, and despite passing on the invention of the personal computer (it didn't look like a good business at the time), Intel processors now power more than 80 percent of the world's PCs. But it just isn't as easy anymore being the market leader. Intel's amazing success began with IBM's decision to use its 8088 microprocessor in the original IBM PC, but the real boom began when Intel cut off the other companies that were making its chips. There was a time when the major customer for these expensive gizmos was the U.S. military, and for its own peace of mind, the military demanded more than one supplier for each part. So Intel licensed the right to manufacture its parts to other companies, many of which undercut Intel prices. With the PC bonanza, suddenly the military was an insignificant buyer, so Intel cancelled its so-called second-source contracts following the 80386 processor. Boom times followed.

But nothing lasts forever. The companies that had built Intel chips under license eventually reverse-engineered the chips and built them license-free. Intel copycats including Advanced Micro Devices (AMD) and Cyrix (a division of National Semiconductor) used the courts to validate their right to copy Intel's chip architectures. And PC manufacturers like Compaq and IBM used these clone chips as a weapon to force Intel prices down. Now the best way for Intel to stay ahead is to simply run faster. Running faster means shrinking product cycles from three years to 18 months by running parallel product development teams and spending more money faster than the other guys. Since Intel has more money to spend, this keeps them in command, but shorter product cycles mean less time to recoup R&D expenses. Hence, those lower margins.

This explains why new PCs seem to appear more frequently than they ever did before. Intel is pushing the pace.

Another way to stay ahead of the competition is by branding. This wasn't necessary when a 486 or Pentium chip came from Intel alone, but the advent of Pentium clones changed all that. The hugely successful "Intel Inside" campaign, with its dancing bunny suits, was the answer. This is an advertising campaign in every sense, since Intel pays PC makers to slap that Intel Inside sticker on the box. Loyalty comes at a price in PC-land.

Unable to defend its X86 processor technology in court, Intel used another time-honored computer industry technique, and instead decided to defend the box that the technology came in. Look inside a computer with a Pentium II processor, and it appears different than earlier Intel processors. The processor doesn't look like a chip at all, so much as dark box that stands edge-up on the circuit board. This is by design. Where earlier Pentium chips and Pentium clones generally plugged-in what's called a "Socket 7," the Pentium II module (it contains some very high-speed memory in addition to the processor chip) requires a "Slot I" — an Intel exclusive. For the first time, Intel protected its socket specification as intellectual property with the idea of being the only Socket II player in town.

This technique never really works the way companies expect it to. Intel is doing well selling Slot I processors, but its competitors have now defined a Super Socket 7 specification that is cheaper, backward-compatible, and looks to have just as good performance. So much for Slot I.

But Intel's biggest current headache comes from an unexpected direction — Microsoft. The other half of the "Wintel" juggernaut has been making some serious trouble for its ostensible partner. As shown in recent Intel testimony at the Microsoft anti-trust trial, Microsoft has made some pretty serious threats in an effort to keep Intel out of the software business. But the rivalry goes much further than that. The very success of AMD in the Pentium clone business is probably due more to Microsoft than anything else. At a time when it still wasn't clear that AMD would even be allowed to sell its Pentium-class chips, AMD decided to try an end-run around Intel and claim compatibility not with Intel's X86 technology, but with Microsoft Windows. And Microsoft was happy to help, since it validated in the marketplace that being "Windows compatible" was more important than being Intel compatible.

Then there is always the problem of earnings growth. With shortened product cycles making the downward price curve for processors steeper than ever, and competition from AMD and Cyrix pushing prices down, Intel has to expand into new areas like networking and microcontrollers (the digital brains inside car engines and dishwashers) and building more parts of the PC. But new businesses generally aren't as profitable as old businesses, at least at first, something investors don't always understand. The same is true for all that cash Intel has on hand. Cash looks good until it becomes an obvious drag on earnings. With more than $7 billion in the bank, Intel has a hard time making more than a 10-15 percent return compared to more than 30 percent if they plowed it back in the business. But sometimes there is no field that needs plowing.

So Intel has become the biggest maker not only of microprocessors, but also of the main computer boards in which those processors are installed. They'll gladly build the whole PC. This systems business was devised as a way to make more revenue from each processor. When processor supplies were limited, Intel hoped to force PC makers to buy chips already installed in motherboards or entire systems. But that was before Cyrix and AMD. Now Intel is in many cases forced to work with its rivals. When Intel wanted to get software developers to write programs using the MMX multimedia instructions added to later Pentium chips — so the chips would run games and graphical applications faster — the only way to guarantee such cooperation was with the help of AMD and Cyrix. Both companies added MMX instructions in their chips thanks to royalty-free licenses from Intel.

And Intel is far from the top dog in what appears to be the next big microprocessor market — digital TVs. With the analog TV system scheduled by the FCC for a shutdown in 2006, there are more than 200 million televisions in America that need replacing. What they'll be replaced with is a digital TV, which looks from the inside a heck of a lot like a PC. This is the next big growth market, but neither Intel nor Microsoft have a lock on it yet.

In Intel's case, though, there is one saving grace — the incredible cost of building new chip plants. Each new generation of hardware requires more advanced chip-building equipment that comes at double the price of the generation before. The current cost of entry is $2.5 billion, with the $5 billion chip plant not far behind. There are only three U.S. high-tech companies with both the money and the vested interest to make such an investment — IBM, Lucent Technologies, and Intel. So maybe there's a reason after all for keeping all that cash.

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