Intel UnboundRobert D. Hof
Tap-tap-tap-tap-tap-tap-tap. David House, a senior vice-president at chip giant Intel Corp., raps out a precise staccato beat with his knuckles. What you're hearing, he says, is the racing heartbeat of an industry. "Twice a second," House explains, "somebody buys an Intel-based computer."
As astonishing as that pace is--some 55 million Intel-powered personal computers will be sold this year, a 30% leap over 1994 shipments--it's not good enough for House's demanding boss. Chief Executive Andrew S. Grove has already built Intel into an $11.5 billion powerhouse: the biggest and richest chipmaker in the world. Its microprocessors now chug away in 150 million PCs, and, because Intel chips are being designed into all sorts of systems, "80% of all computing in the year 2000 could be done using Intel technology," predicts Gartner Group analyst Mark Specker. Still, Intel's hard-charging CEO is pushing to create even greater demand.
Grove's motivation is simple, and the voluble executive has been perfectly up-front about it: To support the huge--and growing--costs of developing and building microprocessors, Intel needs to generate huge profits. The company now spends approximately $1 billion to design a microprocessor and then plows $1 billion into each plant that builds it. There are two ways to cover that nut: One is to create new demand for PCs. The other is to preserve high profit margins by accelerating the shift from one generation of microprocessors to the next. That makes it harder for clonemakers to catch up and force Intel to cut prices ahead of its schedule.
PENTIUM JITTERS. About four years ago, Grove hit on a formula to achieve his goals. While the Pentium was in development, his long-simmering frustration with the slow evolution of the IBM-compatible PC "platform" boiled over. The guts of most PC clones--aside from the microprocessor--had not advanced far beyond the 1984 IBM PC/AT. Grove worried about losing ground to other platforms, such as Apple Computer Inc.'s Macintosh or even Sun Microsystems Inc.'s SPARC designs. Sluggish development was also helping Intel cloners grab market share. Grove feared for the success of the Pentium generation--on which he was betting $5 billion in development and production costs.
So he put Intel into the business of designing computers. Instead of launching the Pentium chip and then getting computer makers to design machines around it, a process that could take a year, Intel began doing the job itself. It figured out the "chip set"--a collection of logic semiconductor chips that surround the microprocessor and perform functions such as synchronizing the actions of various components. And it greatly stepped up efforts to design and build entire motherboards, the circuit cards at the heart of PCs. When Pentium went into production, Intel also started selling chip sets and motherboards. Soon, dozens of PC makers were selling Pentium machines.
For Intel, the formula is working beyond all expectations. Not only is it pushing its own chips out faster--Pentium's successor is due out in November, before Pentium clones have appeared in volume--it is also using its motherboards and chip sets to speed to market a host of improvements to the PC, including a faster "bus" for moving data in and out of the computer. That has helped push PC demand beyond analysts' forecasts and has put Intel on course to exceed $20 billion in sales by 2000.
It has also made Intel arguably the most powerful force in industry--a mixed blessing at best for PC makers. Much as they enjoy the current PC boom, they worry that their industry is being hollowed out and that they are ceding unprecedented power--and riches--to Intel. While the chip giant gobbles up more pieces of the PC, computer makers are finding fewer ways to keep differentiating their products and relieve the margin squeeze that has barely let up since the price wars of the early 1990s (charts). "Everybody has been hassling Gates about Microsoft's monopoly," says the chairman of a big computer maker. "Microsoft doesn't have half the leverage that Intel has today."
How strong is Intel's influence? One sign is the reluctance of computer executives to talk about the chipmaker's power on the record. A year ago, Compaq Computer Chief Executive Eckhard Pfeiffer blasted Intel's strategy at a conference. He railed against Intel's growing power and, in particular, its motherboard business, which helped rivals Gateway 2000 Inc. and Dell Computer Corp. bring out Pentium-based machines ahead of the Houston-based giant.
ON THE BANDWAGON. This year, Pfeiffer has changed his tune. When the next-generation Pentium Pro chip (code-named P6) comes out in November, Compaq will be among the PC makers racing to market with machines based on Intel motherboards. He'll be in good company: IBM, Digital Equipment, Hewlett-Packard, and a host of others will do the same. "If you want a system in the fall, you have one choice," grouses a PC executive at a major computer maker. "You buy the Intel box because they're doing the chip, the board, the mechanicals, everything."
Intel's new game plan is shaking up the entire PC industry, toppling some leaders and crowning new ones. Hewlett-Packard Co. has made a smash reentry into the PC market, vaulting into the top 10 in only two years, partly by using Intel motherboards. Its first consumer PCs, which came out last spring, were built entirely by Intel. Digital, another comeback kid, relies on Intel motherboards for a quarter of its machines, and home-PC giant Packard Bell Electronics Inc. relies on Intel for most everything it sells.
AST Research Inc. is the latest major PC maker to get with the program. The Irvine (Calif.) company announced on Sept. 11 that it will post a larger-than-expected loss this quarter because Packard Bell, Gateway 2000, and other Intel motherboard customers had beaten it to market with new models. "Intel has changed the business," says Safi U. Qureshey, the chastened chairman of AST. "A few years ago, our focus was the addition of unique [hardware] features as differentiators. But getting to market fast with the right configuration is better than showing up three to six months later with our own gee-whiz feature."
The solution: join the growing ranks of Intel motherboard customers--then scramble to come up with a marketing message, package design, or software that will make your product stand out in a sea of identical hardware. The sad reality, says Leslie Fiering, vice-president of market researcher Gartner Group: With an Intel motherboard, "even the mom-and-pop store down the road can do a PC that rivals Compaq's."
No wonder, then, that in just three years, Intel has become the world's largest producer of motherboards. It's expected to sell 10 million boards this year and twice that next year. This makes Intel a huge buyer of components such as chips, further complicating the lives of PC makers who want to build their own boards. One reason for AST's nosedive, Qureshey says, is that it was waiting 16 months for components that it could get almost immediately if it bought them on boards from Intel. The growing Intel motherboard empire is also wreaking havoc in Taiwan.
BULLETPROOF MARGINS. By controlling the motherboard business, Intel not only sets the pace of technology, it also can set prices--while still protecting the margins on its cash-cow Pentium chips. If it cuts prices on motherboards, the whole industry has to follow, reducing PC prices and making them more attractive to buyers. Intel reaps the benefit of those higher sales without slashing prices of Pentiums, which carry 70%-plus gross margins.
It's not surprising that PC makers have the willies over what Intel might do next. Their biggest worry: The chip giant will follow its massive Intel Inside brand-identity campaign with an Intel Outside offensive. That means building Intel-brand computers. Grove swears he'll never do that because his customers know how to sell finished PCs better. But he doesn't rule out making more complete systems for others to sell if that proves the best way to move chips. On Sept. 15, Intel tilted that way, announcing plans to spend at least $100 million on a plant in DuPont, Wash., that will crank out complete systems for PC makers to resell. "Intel could flip a switch and become the largest system vendor in the world," says Robert N. Gunn, sales and marketing vice-president at Micronics Computers Inc., a motherboard maker.
Meanwhile, the chipmaker is expanding its design work beyond desktops. When it brings out the Pentium Pro, it will also trot out a design for a network server based on the new chip. Servers, the computers that anchor local-area networks, have been among the few remaining high-profit niches for PC makers and have helped server leader Compaq make up for slim margins in home PCs. Come November, however, Compaq will be selling a Pentium Pro server designed by Intel.
The more Intel does, the less PC makers can do themselves. It's a vicious cycle: Unable to differentiate their hardware, PC makers will compete on price, leaving less to invest in new technology and rendering them even more reliant on Intel. Even Compaq, which still strives for hardware differentiation, has scaled back its R&D budget from as much as 6% of revenue to around 1.8%. "We still see an ability for us to do value engineering," says Ross Cooley, a Compaq senior vice-president.
Some PC makers are quietly plotting ways to get around Intel's dominance. A secretive group called Sundance, made up of PC makers such as Compaq and IBM and chipmakers such as Cyrix and Advanced Micro Devices, hopes to develop a basic PC design not tied specifically to Intel chips. It's also working on its own bus and multimedia standards. Snaps one angry PC executive: "If I had an alternative, I would run."
Trouble is, there isn't much of any place to go. NexGen Inc. has a Pentium alternative, but it doesn't have the Pentium's built-in math circuitry and requires a special PC design. Cyrix Corp. and AMD are both late with Pentium-class chips, and on Sept. 26, AMD said its K5 won't be out until mid-1996.
Apple's Mac design, based on the Motorola-IBM PowerPC chip, is a possibility. "Intel is stealing the board business, so boardmakers will be happy to go to a different standard," asserts Apple licensing director James S. Gable. But there are few converts, perhaps because an Apple-IBM "common reference platform" board won't be out until next year.
That pretty much leaves Intel in the driver's seat--with its foot on the gas. In Hillsboro, Ore., Intel Architecture Laboratories is busy creating hardware and software to transform the PC into the Swiss Army knife of the Digital Age, an all-purpose multimedia, videoconferencing information appliance. One innovation, the Universal Serial Bus, uses a single type of connector to attach peripherals like printers and modems. The Hillsboro gang also has schemes for running video on computer networks, and they've built lightning-fast modems to grab data sent over cable-TV systems. "We either deliver something that's going to appeal to the next 100 million people who want computers, and to the next 50 million who want to replace their computers with something else, or we won't grow," says Grove.
For all its muscle, Intel doesn't always get its way. Its ProShare videoconferencing setup has been slow to take off because of high pricing and jerky video. And in August, Intel's newest PC initiative, Native Signal Processing, stalled. Intel had hoped to persuade software developers to back the scheme, which would allow PCs to run sound and video on Intel microprocessors. That way, PCs wouldn't need graphics and audio cards but consumers would have more reason to buy models using the fastest, most profitable Intel chips. But Intel didn't write the software to work with Microsoft's new Windows 95 operating system, so Microsoft warned software developers to avoid it. Result: Intel will relaunch the initiative next year.
NSP revealed a hubris that has long plagued Intel. The scheme would have inserted a layer of software that at times would allow video and audio signals to preempt Windows. "NSP's an Intel thing," says Carl Stork, director of Microsoft's Windows hardware programs. "It doesn't mean it's on Microsoft's road map." Concedes Grove, "We screwed up on NSP. At times, we advocate more than we listen."
More and more, however, the industry listens--and follows. And, privately, PC makers concede that while Grove's strategy may have given Intel immense new power, it has also produced a market boom that is helping all of them.
Can Grove's speedup last indefinitely? Can PC makers figure out how to prosper under the conditions that the chip giant is imposing? Grove says the two issues are inextricably linked: As long as he can keep the industry humming, PC makers will find ways to make hay. Of course, not everybody buys the scenario. Wall Street, for example, discounts Intel's prospects. Although the stock has more than doubled since last October, at around $60 it is more than 20% off its 52-week high and trades at only 14 times projected earnings. The chief worry: Intel won't maintain its margins and earnings momentum.
Grove's answer is to keep up the relentless pace. "If the end-user gets dissatisfied with the PC that the industry produces," he says, "we are going to be in Hurt City." Little chance of that--as long as Andy Grove is keeping the beat.
Making More PCs Now, But Enjoying It Less
A decade ago, major PC makers designed and built much of the guts of their machines. They bought disk drives, monitors, power supplies, and chips from outside suppliers. But they usually designed their own motherboards, graphic chip sets, disk-drive controllers, and BIOS (key software to make a PC IBM-compatible). Intel's contribution: chips, mainly microprocessors.
Only a few major PC makers, such as IBM and Compaq, still make motherboards. But because they can't produce a motherboard design as quickly as Intel, even these giants are relying on the chipmaker for their first Pentium Pro-based machines. Intel's contribution: microprocessors, motherboards, chip sets, complete PCs, software.
DATA: BUSINESS WEEK, INDUSTRY ESTIMATES
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