Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

The longtime theoretical threat to Intel's cash cow business isn't theoretical anymore. 

Right now, Intel Corp. sells nearly all chips for the mass-market computer servers that handle back-end computing for activity on the web and smartphones. Intel still generates the majority of its annual sales from its better-known personal computer chips, but sales of semiconductors for corporate networks and cloud-computing systems generated two-thirds of its operating income over the last nine months. This data-center segment is the most important business for Intel. 

Chip Star
Intel generates a growing share of its operating income from chips that power computer servers and other data-center equipment
Source: Bloomberg
Note: Fiscal 2016 figures are for the nine months ended Oct. 1.

Qualcomm Inc., whose chips are the brains for the world's smartphones, disclosed Wednesday that it has produced its first server computer chip, the company's first foray into competing with Intel in this area. Put bluntly, Qualcomm's disclosure is bad news for Intel. Qualcomm can absolutely blow its chance in a new market, but the industry dynamics favor a challenger in server chips, and Intel has never faced one as formidable as Qualcomm. 

That's what happens when you have 100 percent market share or close to it, as Intel does in mass market server chips. There is nowhere to go but down.

The key fact to grasp is Intel has some powerful customers: Google, Microsoft, Alibaba and other tech giants that buy server chips by the truckloads. No big customer wants a single supplier for anything, particularly for essential ingredients like server chips.

Qualcomm's entry into server chips at the very least gives those customers leverage to demand price cuts from Intel. It's logical to think they will at least buy small numbers of Qualcomm server chips to evaluate performance and determine whether they are a viable second source of supply. Every chip Qualcomm sells is most likely a lost sale for Intel.

Intel shares didn't reacted much early Wednesday to the potential Qualcomm competition. That's understandable. Qualcomm has already telegraphed its intentions to compete with Intel in server chips. Customers are just starting to test Qualcomm's new product, and it's not clear whether they meet the high bar for server chip performance. Other would-be server chip rivals such as startup Calxeda Inc. and big but struggling chip maker Advanced Micro Devices Inc. have mostly failed to eat into Intel's server chip dominance. Intel is also a fighter, and it won't take this Qualcomm threat lightly.

But there should be a healthy amount of panic at Intel headquarters. Executives definitely do not need to be reminded that Qualcomm's rise over the last decade in smartphone chips came at Intel's expense. Intel was and remains almost nowhere in smartphones, and the company has been trying to come back from that historic misstep ever since. It cannot afford a repeat in losing its lock on the data center. 

The problem is Intel needs its data-center chip business to fire on all cylinders. It's a central plank in the bullish investor thesis for the company. Those server chips are pricey and boast fat profit margins -- an easy task with essentially no competition. Intel's data-center segment had 45 percent operating income margin in the last nine months, compared with 30 percent for the segment that includes Intel's chips for personal computers and smartphones. 

Meh
Intel shares are essentially flat this year as the company raised -- and then dashed -- hopes of fast sales growth in its server chips
Source: Bloomberg

But Intel is not fighting from a position of absolute strength. The company has acknowledged that server chip sales to big companies -- other than those to server-by-the-truckload tech companies -- have not been as strong as expected. Intel has said big companies are delaying server purchases because of economic concerns. But broad changes in computing mean Intel cannot count on those corporations as a significant source of growth in server chips.

Instead, the purchase of servers is going to grow more concentrated among a handful of giant customers. Intel calls them the "Super 7" -- Google, Amazon, Microsoft, Facebook and China's Baidu, Alibaba and Tencent. Now Qualcomm is giving those Super 7 a good reason to try to diversify their supply source away from Intel. That's not super for Intel.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net