Intel Takes A Bullet And Barely Breaks Stride

Not a terrific way to start the year. On Jan. 17, Intel Corp. detailed the damage from the public-relations nightmare surrounding an obscure bug in its flagship Pentium chip: a $475 million charge to fourth-quarter earnings to account for the costs of replacing and writing off flawed chips. A few days before, Intel abandoned an eight-year legal battle with archrival Advanced Micro Devices Inc.--a surprise win for AMD.

Is Intel losing its edge? Don't bet on it. The hit from its Pentium fiasco was unexpectedly big--at least 15% higher than analysts had anticipated--and the charge drove fourth-quarter profits down 37% from a year earlier, to $372 million. But virtually in the same breath, Intel reported that Pentium sales had doubled from the third to the fourth quarter, helping lift 1994 revenues 31%, to $11.5 billion. In coming weeks, the world's largest chipmaker will unleash a barrage of price cuts and new chips. And it is spending considerably more than ever to build new factories. Says John Bourgoin, AMD's vice-president for microprocessor products: "I don't see Intel becoming any less tough or less aggressive."

On Feb. 1, sources say, Intel will drop prices on some Pentium chips by as much as 45%. That, it hopes, will spur more PC buyers to choose the proprietary Pentium over older 486 chips, which six other companies also make. And on Feb. 16, Intel will up the ante by unveiling technical details of its next-generation microprocessor, code-named P6. The P6 aims to leapfrog Pentium wannabes due out around the same time this summer. Vows Intel Chief Operating Officer Craig R. Barrett: "We plan to be just as aggressive on the technical front as we've always been."

They have to be. For many rivals and customers, the Pentium-bug debacle exposed Intel's vulnerability. More than ever before, "the Pentium issue indicates that system vendors need an alternative source," says Ronald Chwang, president of PC maker Acer America Corp., which uses Intel and AMD chips. Intel alienated big customers such as Compaq Computer Corp. and IBM last year, partly by refusing to grant price cuts on its chips; now, those companies may move to buy more of their supplies from Intel competitors such as AMD, NexGen, and Cyrix.

EMERGING RIVAL. Intel also faces more competition from outside the traditional IBM-style PC market, which it has long dominated. IBM's and Motorola Inc.'s PowerPC chip, used in Apple Computer Inc.'s Power Macintoshes, threatens to become a strong rival. And emerging markets for cable-TV set-top boxes and video-game machines--which mostly use other chips--could draw consumer dollars away from PCs.

That's why Intel, which still owns over 75% of the $11 billion microprocessor market, plans to spend a record $2.9 billion on new plants and equipment, up 20% from 1994. That dwarfs AMD's planned $700 million. Those new plants will have plenty of chips to churn out. This spring, Intel is expected to introduce new, faster Pentiums. And they're 30% cheaper to produce, thanks to a more advanced manufacturing process. That will allow Intel to keep cutting prices while maintaining high profit margins.

Intel's next big weapon: the P6. With 6 million transistors--twice as many as Pentium--it's likely to be big and expensive at first, so it won't sell in quantity until 1996. But by borrowing speed-enhancing tricks from rival chips such as the PowerPC, the P6 runs nearly twice as fast as the swiftest Pentium. That will keep PC makers in the Intel camp, says Linley Gwennap, a consultant and editor of the industry newsletter

Microprocessor Report.

Even though rivals gradually are gaining on its microprocessor technology, the Pentium is keeping Intel firmly in the lead. By the end of December, 42% of PCs sold at retail were Pentium machines, says market watcher ARS Inc. in Irving, Tex. (chart). "Our sales are through the roof," says Jack Wahrman, director of merchandising for J&R Computer World, a New York retailer. Now, with the prime consumer-PC buying season mver, Intel will have to persuade corporate buyers to trade up to Pentium.

So far, they've held off because of the higher prices. Indeed, some observers, such as Compaq, think Intel is trying to move PC buyers to Pentium too fast. After all, the 486 still has legs: It will continue to outsell Pentium in 1995. AMD's triple-speed version of the 486 actually outperforms low-end Pentiums for most applications, at a much lower price. Says AMD Chairman W.J. "Jerry" Sanders III: "Intel is trying to push the market before the market is ready."

Ready or not, though, the market still is willing to let Intel call the shots. Says Robertson, Stephens & Co. analyst Daniel L. Klesken: "Even through all this brouhaha, the Pentium has missed barely a heartbeat." With bugs and lawsuits put to rest, it's Intel that's likely to give rivals palpitations from now on.

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