The limits of Moore’s Law
Challenged by increasing competition and changing consumer demands, Intel’s CEO Paul Otellini led a major reorganisation of the world’s largest chipmaker. Will his effort bear fruit?
When Gordon Moore, one of the co-founders of Intel, predicted in 1965 that the number of transistors on a microprocessor would double every 18 months, he could not know that speed would seize to be the most important feature of a chip.
Moore’s Law, as his prediction became known, ruled the industry for years. Although technically it did not reach its limits yet, the accompanying marketing message that more megahertz, and later gigahertz, is better did. In 2004 consumer purchases of computers exceeded those by business, and consumers care more about features such as design, reliability, communication functions, and price, than how computers work inside.[1]
However, Intel’s long-time ensured place as market leader might have caused the company to loose sight of customer demands. Intel’s chips are still inside 80 percent of every computer sold, but disappointing results and the rise of its smaller rival Advanced Micro Devices shocked its confidence.
This insecurity is reflected in Intel’s share price, which has moved in extremes since 2001 (see chart 1). After a quick rise to $36 in the last two months of 2001, the share price suffered a decline of 50 percent during 2002. Intel managed to recover from this loss in the following year, ending 2003 with a doubled share price of $32.
However, from 2004 the number one chipmaker started to experience serious competition from AMD. While AMD’s share price made a spectacular jump throughout 2004 and 2005, Intel’s share price fell more than 25 percent.
In May 2005 Paul Otellini was appointed to succeed Craig Barrett as the new chief executive officer. Otellini, the first CEO with a background in marketing rather than engineering, recognised the need for change as early as 2001. In 2005 Otellini reorganised Intel according to ‘Platformisation’, which means the bundling of groups of chips on different branded platforms.[2]
So far, this new focus on marketing has not paid off. Intel’s share price saw a small increase during 2005, but fell back by one third in the first half of 2006. The share price recently started a cautious rise, but it is still around $21. While the average of technology stocks is back on 2002’s level, Intel’s share price decreased almost 40 percent in five years. The coming period will determine whether Intel’s shareholders can be convinced that Otellini’s strategy is a plausible replacement of Moore’s Law.
Intel’s latest earnings release show that the chip maker is not by far back on its old level. Intel’s revenue increased between 2002 and 2005. However, the growth rates slowed down and in 2006, at the end of all three quarters revenue was lower than in the previous year (see chart 2).
A possible reason is Intel’s high dependence on the sales of computers, while the growth of this market has stagnated.[3] Intel’s revenue comes for 65 percent from the Digital Enterprise Group, which produces PCs and servers for businesses, and 29 percent from the Mobility Group, which largely produces for laptops. In the overall semiconductor industry, on the other hand, just 45 percent of the revenue comes from computers (see chart 3). So far, Intel has failed to infiltrate rapid growing markets such as home entertainment and mobile phones, which is now the second largest user of semiconductors.[4]
Remarkable is that the growth rates were much higher for Intel’s income and earnings per share than for revenue. This suggests that changes in income were largely due to a reduction or increase in costs rather than to rising or falling sales. The difference was most extreme in 2002, when revenue increased with just 1 percent, while net income and EPS both went up by 140 percent, respectively from $1.3m to $3.1m and from $0,19 to $0,47. Such reduction of costs while revenue stagnates indicates that Intel was investing in short rather than long term results. This might partly explain why its spectacular growth did not continue and reversed in 2006.
However less spectacular, Intel’s gross income changed faster than its revenue as well. Between 2002 and 2005, its gross margin went up from 50 to 59 percent and fell back to 49 percent in the third quarter of 2006.
While Intel presented continuous growth rates between 2002 and 2005, its share price fell. This suggests that other negative factors had a dominant influence on Intel’s image and shareholders’ expectations.
Indeed, Intel made several internal missteps in recent years. Design problems, cancellation or delay of new products, and aborted strategies have cost sales and caused an inventory build-up.[5] As a result, Intel had to announce a 10 percent cut of its global workforce, from 102,500 to 92,000 by the middle of 2007.[6]
Furthermore, a major challenge to Intel’s market leadership has been AMD. In the last few years, AMD was ahead of Intel in launching innovations. AMD’s chips have been faster while using less power, and above these benefits they cost less than Intel’s.[7]
A further blow to Intel’s image has been caused by several investigations following antitrust complaints by AMD. In 2005, the Japan Fair Trade Commission concluded that Intel had violated antitrust laws in Japan since 2002. The JFTC said Intel offered rebates to PC makers if they would limit their purchases from AMD.[8] An investigation into similar practices by the European Commission continues, as investigations in South Korea and a lawsuit launched by AMD in the United States. However, in September of this year the judge dismissed major parts of the lawsuit in favour of Intel and postponed the trial date till 2009.[9]
Following these problems, as well as competition in the PC industry, both Microsoft and Dell decided to stop there exclusive deals with Intel. Microsoft is using IBM chips in its Xbox since 2004 and this year, Dell agreed to use AMD chips in a server product.[10]
Despite of the many difficulties, there are several indications that not all is lost for Intel.
In its latest forecast, the Semiconductor Industry Association predicted a further rise in global sales of semiconductors. The SIA said that the Asia-Pacific is the fastest-growing region and is expected to be 48.2% of the worldwide chip market in 2009.[11] In this respect, Intel is ahead of the market with 50% of its revenue coming from the Asia-Pacific area.[12]
However, according to the SIA the sales increase is mainly driven by consumer purchases, while Intel just recently recognised the specific demands of this group. The newest PCs are designed for high quality multimedia rather than for corporate use and the technical possibilities of Moore’s Law are irrelevant for these needs. Moreover, the sales growth of PCs, Intel’s core market, is small compared to the rapid rise of mobile phones and home entertainment products.
Intel is behind other chipmakers in producing for these growing markets, but Paul Otellini has created new possibilities for the company. Under his platform strategy Intel has been divided in five platforms in January 2005. The two divisions with Intel’s largest market share are Digital Enterprise for business computers and Mobility for laptops and wireless communication. With this last division Intel also seeks to gain share in the mobile phone sector, which is now dominated by its rival Texas Instruments.[13] To infiltrate the home entertainment market, by contributing to the ongoing convergence of consumer computers and electronics, Intel created the Digital Home platform.[14] Furthermore, the platforms Digital Health and Channel Products were created for emerging markets. In November 2005 the Flash Memory division was added. About the potential of ‘platformism’ Otellini said: “The new organisation will help address growth and opportunities by better anticipating and addressing market needs.”[15]
Another advantage of the strategy is that AMD cannot do it. Intel’s rival is too small for such an organisation and they would need third parties to make platforms.[16]
A further opportunity for Intel came last year, when the chipmaker established a partnership with Apple. The importance of this deal lies in Apple’s innovative place in the PC industry, especially in mobility and home entertainment, exactly those two markets Intel is planning to conquer.[17] For example, Intel is investing in the production of the Nand flash memory, which can be used in Apple’s iPod.[18]
Recent results suggest a comeback for Intel. In September of this year, Intel announced a new product, a quad-core chip, ahead of AMD for the first time in two years. Paul Otellini said: “I believe very much that with this new set of dual and quad-core microprocessors we’ve now regained our leadership.”[19]
Patrick Gelsinger, head of the Digital Enterprise division, said: “We are more focused and more angry. That we can go through downturns and come out stronger is the mark of a great company.”[20] Intel has recaptured its confidence, and it seems the market has renewed its trust in the chipmaker too. Although Intel’s latest quarter report presented declined revenue and income compared to last year, the results were higher than Wall Street expected, and Intel’s share price started a cautious rise.[21]
Intel’s future success depends on whether the chipmaker will gain share in growing markets. Paul Otellini seems to be the right man for this job. He realised early that it is time for Intel to look further than the traditional PC market. Moore’s Law might have reached its limits, but Intel has not. New inspiration comes from Robert Noyce, another co-founder of Intel, who said: “Do not be encumbered by history. Go off and do something wonderful.”
[1] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[2] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[3] ‘Intel’s right-hand turn’, The Economist, 14 May 2006.
[4] ‘Intel’s right-hand turn’, The Economist, 14 May 2006.
[5] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[6] Chris Nuttall, Financial Times, 6 September 2006.
[7] ‘Not paranoid enough’, The Economist, 27 May 2006, p.74.
[8] Chris Nuttall, Financial Times, 2 April 2005, p.8.
[9] Tobias Buck, Financial Times, 4 October 2006, p.26; Chris Nuttall, Financial Times, 28 September 2006, p.29; Roger Parloff, Fortune, 9 April 2006.
[10] Kevin Allison and Chris Nuttall, Financial Times, 19 May 2006, pp. 1, 16.
[11] Semiconductor Industry Association’s annual forecast, 16 November 2006, www.sia-online.org [11 December 2006].
[12] Intel’s annual report 2005, www.intel.com [12 December 2006].
[13] Gene G. Marcial, Business Week, 14 February 2005, p.98.
[14] Cliff Edwards, Business Week, 9 January 2006, p.46.
[15] Chris Nuttall, Financial Times, 18 January 2005, p.29.
[16] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[17] ‘New best friends’, The Economist, 6 November 2005; Cliff Edwards, Business Week, 9 January 2006, p.46.
[18] David Whelan, Forbes, 4 October 2006.
[19] Chris Nuttall, Financial Times, 27 September 2006, p.22.
[20] David Whelan, Forbes, 4 October 2006.
[21] Don Clark, Wall Street Journal, 18 October 2006, p.2.
When Gordon Moore, one of the co-founders of Intel, predicted in 1965 that the number of transistors on a microprocessor would double every 18 months, he could not know that speed would seize to be the most important feature of a chip.
Moore’s Law, as his prediction became known, ruled the industry for years. Although technically it did not reach its limits yet, the accompanying marketing message that more megahertz, and later gigahertz, is better did. In 2004 consumer purchases of computers exceeded those by business, and consumers care more about features such as design, reliability, communication functions, and price, than how computers work inside.[1]
However, Intel’s long-time ensured place as market leader might have caused the company to loose sight of customer demands. Intel’s chips are still inside 80 percent of every computer sold, but disappointing results and the rise of its smaller rival Advanced Micro Devices shocked its confidence.
This insecurity is reflected in Intel’s share price, which has moved in extremes since 2001 (see chart 1). After a quick rise to $36 in the last two months of 2001, the share price suffered a decline of 50 percent during 2002. Intel managed to recover from this loss in the following year, ending 2003 with a doubled share price of $32.
However, from 2004 the number one chipmaker started to experience serious competition from AMD. While AMD’s share price made a spectacular jump throughout 2004 and 2005, Intel’s share price fell more than 25 percent.
In May 2005 Paul Otellini was appointed to succeed Craig Barrett as the new chief executive officer. Otellini, the first CEO with a background in marketing rather than engineering, recognised the need for change as early as 2001. In 2005 Otellini reorganised Intel according to ‘Platformisation’, which means the bundling of groups of chips on different branded platforms.[2]
So far, this new focus on marketing has not paid off. Intel’s share price saw a small increase during 2005, but fell back by one third in the first half of 2006. The share price recently started a cautious rise, but it is still around $21. While the average of technology stocks is back on 2002’s level, Intel’s share price decreased almost 40 percent in five years. The coming period will determine whether Intel’s shareholders can be convinced that Otellini’s strategy is a plausible replacement of Moore’s Law.
Intel’s latest earnings release show that the chip maker is not by far back on its old level. Intel’s revenue increased between 2002 and 2005. However, the growth rates slowed down and in 2006, at the end of all three quarters revenue was lower than in the previous year (see chart 2).
A possible reason is Intel’s high dependence on the sales of computers, while the growth of this market has stagnated.[3] Intel’s revenue comes for 65 percent from the Digital Enterprise Group, which produces PCs and servers for businesses, and 29 percent from the Mobility Group, which largely produces for laptops. In the overall semiconductor industry, on the other hand, just 45 percent of the revenue comes from computers (see chart 3). So far, Intel has failed to infiltrate rapid growing markets such as home entertainment and mobile phones, which is now the second largest user of semiconductors.[4]
Remarkable is that the growth rates were much higher for Intel’s income and earnings per share than for revenue. This suggests that changes in income were largely due to a reduction or increase in costs rather than to rising or falling sales. The difference was most extreme in 2002, when revenue increased with just 1 percent, while net income and EPS both went up by 140 percent, respectively from $1.3m to $3.1m and from $0,19 to $0,47. Such reduction of costs while revenue stagnates indicates that Intel was investing in short rather than long term results. This might partly explain why its spectacular growth did not continue and reversed in 2006.
However less spectacular, Intel’s gross income changed faster than its revenue as well. Between 2002 and 2005, its gross margin went up from 50 to 59 percent and fell back to 49 percent in the third quarter of 2006.
While Intel presented continuous growth rates between 2002 and 2005, its share price fell. This suggests that other negative factors had a dominant influence on Intel’s image and shareholders’ expectations.
Indeed, Intel made several internal missteps in recent years. Design problems, cancellation or delay of new products, and aborted strategies have cost sales and caused an inventory build-up.[5] As a result, Intel had to announce a 10 percent cut of its global workforce, from 102,500 to 92,000 by the middle of 2007.[6]
Furthermore, a major challenge to Intel’s market leadership has been AMD. In the last few years, AMD was ahead of Intel in launching innovations. AMD’s chips have been faster while using less power, and above these benefits they cost less than Intel’s.[7]
A further blow to Intel’s image has been caused by several investigations following antitrust complaints by AMD. In 2005, the Japan Fair Trade Commission concluded that Intel had violated antitrust laws in Japan since 2002. The JFTC said Intel offered rebates to PC makers if they would limit their purchases from AMD.[8] An investigation into similar practices by the European Commission continues, as investigations in South Korea and a lawsuit launched by AMD in the United States. However, in September of this year the judge dismissed major parts of the lawsuit in favour of Intel and postponed the trial date till 2009.[9]
Following these problems, as well as competition in the PC industry, both Microsoft and Dell decided to stop there exclusive deals with Intel. Microsoft is using IBM chips in its Xbox since 2004 and this year, Dell agreed to use AMD chips in a server product.[10]
Despite of the many difficulties, there are several indications that not all is lost for Intel.
In its latest forecast, the Semiconductor Industry Association predicted a further rise in global sales of semiconductors. The SIA said that the Asia-Pacific is the fastest-growing region and is expected to be 48.2% of the worldwide chip market in 2009.[11] In this respect, Intel is ahead of the market with 50% of its revenue coming from the Asia-Pacific area.[12]
However, according to the SIA the sales increase is mainly driven by consumer purchases, while Intel just recently recognised the specific demands of this group. The newest PCs are designed for high quality multimedia rather than for corporate use and the technical possibilities of Moore’s Law are irrelevant for these needs. Moreover, the sales growth of PCs, Intel’s core market, is small compared to the rapid rise of mobile phones and home entertainment products.
Intel is behind other chipmakers in producing for these growing markets, but Paul Otellini has created new possibilities for the company. Under his platform strategy Intel has been divided in five platforms in January 2005. The two divisions with Intel’s largest market share are Digital Enterprise for business computers and Mobility for laptops and wireless communication. With this last division Intel also seeks to gain share in the mobile phone sector, which is now dominated by its rival Texas Instruments.[13] To infiltrate the home entertainment market, by contributing to the ongoing convergence of consumer computers and electronics, Intel created the Digital Home platform.[14] Furthermore, the platforms Digital Health and Channel Products were created for emerging markets. In November 2005 the Flash Memory division was added. About the potential of ‘platformism’ Otellini said: “The new organisation will help address growth and opportunities by better anticipating and addressing market needs.”[15]
Another advantage of the strategy is that AMD cannot do it. Intel’s rival is too small for such an organisation and they would need third parties to make platforms.[16]
A further opportunity for Intel came last year, when the chipmaker established a partnership with Apple. The importance of this deal lies in Apple’s innovative place in the PC industry, especially in mobility and home entertainment, exactly those two markets Intel is planning to conquer.[17] For example, Intel is investing in the production of the Nand flash memory, which can be used in Apple’s iPod.[18]
Recent results suggest a comeback for Intel. In September of this year, Intel announced a new product, a quad-core chip, ahead of AMD for the first time in two years. Paul Otellini said: “I believe very much that with this new set of dual and quad-core microprocessors we’ve now regained our leadership.”[19]
Patrick Gelsinger, head of the Digital Enterprise division, said: “We are more focused and more angry. That we can go through downturns and come out stronger is the mark of a great company.”[20] Intel has recaptured its confidence, and it seems the market has renewed its trust in the chipmaker too. Although Intel’s latest quarter report presented declined revenue and income compared to last year, the results were higher than Wall Street expected, and Intel’s share price started a cautious rise.[21]
Intel’s future success depends on whether the chipmaker will gain share in growing markets. Paul Otellini seems to be the right man for this job. He realised early that it is time for Intel to look further than the traditional PC market. Moore’s Law might have reached its limits, but Intel has not. New inspiration comes from Robert Noyce, another co-founder of Intel, who said: “Do not be encumbered by history. Go off and do something wonderful.”
[1] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[2] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[3] ‘Intel’s right-hand turn’, The Economist, 14 May 2006.
[4] ‘Intel’s right-hand turn’, The Economist, 14 May 2006.
[5] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[6] Chris Nuttall, Financial Times, 6 September 2006.
[7] ‘Not paranoid enough’, The Economist, 27 May 2006, p.74.
[8] Chris Nuttall, Financial Times, 2 April 2005, p.8.
[9] Tobias Buck, Financial Times, 4 October 2006, p.26; Chris Nuttall, Financial Times, 28 September 2006, p.29; Roger Parloff, Fortune, 9 April 2006.
[10] Kevin Allison and Chris Nuttall, Financial Times, 19 May 2006, pp. 1, 16.
[11] Semiconductor Industry Association’s annual forecast, 16 November 2006, www.sia-online.org [11 December 2006].
[12] Intel’s annual report 2005, www.intel.com [12 December 2006].
[13] Gene G. Marcial, Business Week, 14 February 2005, p.98.
[14] Cliff Edwards, Business Week, 9 January 2006, p.46.
[15] Chris Nuttall, Financial Times, 18 January 2005, p.29.
[16] Chris Nuttall, Financial Times, 9 February 2005, p.15.
[17] ‘New best friends’, The Economist, 6 November 2005; Cliff Edwards, Business Week, 9 January 2006, p.46.
[18] David Whelan, Forbes, 4 October 2006.
[19] Chris Nuttall, Financial Times, 27 September 2006, p.22.
[20] David Whelan, Forbes, 4 October 2006.
[21] Don Clark, Wall Street Journal, 18 October 2006, p.2.
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