Will Intel keep rolling?

Intel is on a roll. They just reported 2009 Q4 revenue of $10.6 billion with net income of $2.3 billion – not bad indeed! (See NY Times, 1/14/20).  The success is attributed to their recent investment in new plants ($7 billion), a resurgence in PC demand,  and their move to make chips for netbook and smartphones (their Atom chip targeted to those markets brought in $1.4 billion in revenue). Kudos to Intel, but will the fun last? How long can Intel succeed with its strategy to heavily invest in new manufacturing technology so that it can stay ahead of rivals?

There are reasons to believe that this strategy will work for at least another 5 years. This is based on the premise that the need for new, smaller, more energy efficient chips will continue. And in particular, the premise that the latest investment is necessary to make improvements in performance that generate real value for which people are willing to pay for.  As we continue to push towards the “Dick Tracy” era (everything can be done on something the size of a wristwatch), there is reason to believe that this will be the case.

The economics of chip manufacturing is well known. Invest a huge sum of money to build a clean plant with very advanced equipment. Then you start to make chips and most don’t work, so continuous refinements of the production process are necessary to increase the yield of good chips.  The faster the yield curve increases, the better the return on investment.  The more sophisticated the chip, the lower you start on the yield curve and the hard it is to increase your yield. 

There are plenty of companies that can make chips in the world. But these chips are not as complex as the ones Intel makes. Hence, they are satisfied to let Intel take the lead. Intel bears the risks and earns the reward. And it is important to recognize that the risk is significant. At some point Intel will follow this strategy and it will fall flat – the new chips they will make won’t be sufficiently better than existing, simpler chips, meaning that they won’t be able to charge a premium price and recover their investment.

It is interesting to compare Intel’s situation to two other companies, Microsoft and Dell.  Microsoft earned a huge amount because it had its hands around everybody’s neck (the operating system), not because they were particularly good at making software. (Or, maybe they were particularly efficient at writing code, but the technology has changed and they no longer appear to have that advantage. Plus, the fixed cost to write code is much lower than the cost to build a chip plant.) Dell’s advantage came from declining component prices. As long as they were dropping really fast (40% a year), Dell had a commanding lead over its rivals becuase it carried less inventory. Once the cost of components stopped declining at a torrid pace, Dell lost is advantage – having very little inventory buys you little if prices are not dropping.  Plus, its product design was not sufficient to command a premium price.

So Dell and Microsoft were victims of changing technology. At some point Intel will be too… just probably not in the immediate future.

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2 Responses to Will Intel keep rolling?

  1. Ahmet Yükseltürk says:

    This is the situation wih silicon chips. Intel is trying to produce chips with carbon nanotube, nanowire, graphene etc. right now.

    Silicon chip performance will not get better, because as size of a gate decreases further, silicon’s properties change and become unsuitable. It will be interesting to see if the next chip company will be Intel or somebody else?

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