Intel Wants to Help Cook Up Custom Chips

In late September, Intel Corp. (INTC ) took the wraps off a new venture aimed at helping other chip designers turn their ideas into silicon and get them to market quickly. It was a remarkable moment. Here was the industry's global brand leader announcing to the world that the future--or at least a big part of it--lies in becoming a supplier of outsourcing services.

Until now, that has been a less-than-glamorous branch of the semi business. Accordingly, few analysts gave the announcement a second thought. Yet for Intel, this is the latest in a series of admissions that its world-beating microprocessors must share center stage with many other types of chips and services. And for other established players in the contract-manufacturing business--including IBM (IBM ) and Agere Systems Inc. (AGR.A )--Intel's announcement amounts to a warning shot over the bow.

Intel is targeting, among others, a growing army of small custom-chip designers, all of which are scrambling to find ways to reduce costs and respond to ever-shortening product life cycles. These "fabless" outfits design their own chips, then contract out the manufacturing and testing--an approach that lets them sell chips for everything from set-top boxes to communications gear without too much investment up front. Specialty chip companies should pull in $7.7 billion in sales this year, and then grow at a 20% annual clip--substantially above that of the chip market as a whole--says Needham & Co. semiconductor analyst Dan K. Scovel.

The fabless model isn't new, of course. Many specialty chipmakers already design their own products, then turn to an Asian foundry like Taiwan Semiconductor Manufacturing Co. (TSM ) to make the chips. But under the terms that Intel envisions, customers would need only to provide some basic specifications for a chip and Intel would handle the details of design, as well as the manufacturing contract with the Asian foundries.

By contrast, IBM and Agere offer to help their customers on design work--but then fabricate the chips in-house. A minor distinction, perhaps, but some analysts believe it increases the comfort factor for the design shops. These analysts question whether little guys will surrender so much added value to a giant like Intel. "There's some value in not having to incur all the headaches," says Needham's Scovel. "But having someone else handle your business cradle-to-grave is a model that has yet to be proven."

BIG DECISION. Indeed, chipmakers that own fabs have fought for decades to protect the secret recipes they concoct for shaping silicon into key parts of electronic devices. But times have changed. Small and mid-tier players are being forced to decide whether they want to invest hundreds of millions, or more, in a fab to make specialized chips that sell in relatively low volumes. Intel, IBM, and others make a good case that their years of engineering expertise can speed up the process for small fry.

Even with Intel's superb pedigree, the new venture won't be a cake-walk. Customer service skills are just as important as technical expertise in the emerging market, says Goldman, Sachs & Co. semiconductor analyst Terry Ragsdale. That means companies in the outsourcing business must be available around-the-clock for updates on where a product stands, and must deliver it on time--without glitches.

Moreover, what constitutes a huge contract for a small company will amount to a trivial tidbit of business for Intel. "There's the huge issue of gaining credibility with customers," Ragsdale says. Still, with few competitors in the market and so much money on the table, Intel and other large semiconductor makers are more than willing to give it a try.

By Cliff Edwards in Santa Clara, Calif.

    Before it's here, it's on the Bloomberg Terminal.