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Commentary: Intel gears up in consumer electronics push

The company's plans to unveil a digital music player and new handheld devices are part of a push to expand its presence in the consumer electronics market.

Intel's plans to unveil a digital music player and highlight other Intel-branded consumer handheld devices at the Consumer Electronics Show in Las Vegas this week are part of a push to expand the company's presence in the consumer electronics market on several levels.

The push comes as Intel

See news story:
Intel delves deeper into consumer electronics
struggles to drive demand for the Pentium 4 chip and deal with a modest 10 percent revenue growth in its core microprocessor business. The underlying question is, where does Intel really want to play, and can its brand drive the consumer electronics market?

Intel's core business has always been microprocessors and other electronic components (including flash memory). Its various architectural and product packaging initiatives have all been designed to drive demand for this business. Intel has invested millions of dollars to promote its products as the "guts" of machines sold by other companies.

As a result, while Intel is a major manufacturer of PC motherboards and systems, the computers are sold under other brand names with the "Intel Inside" logo prominently displayed. Intel's research, development, manufacturing, and distribution models are all geared toward driving the highly profitable core business--either directly or indirectly.

As Intel looks to the future, it is faced with two critical challenges to its microprocessor business: Unit growth will increasingly be driven by the consumer electronics side of the PC electronics convergence. And consumer demand for increasingly powerful CPUs is waning--at least in the near term. In response to these challenges, Intel is pushing into "new businesses" as exemplified by its participation in the CES show.

But does this really signal a change in Intel's direction, or is it just another strategy to drive the core business?

From PCs to peripherals
While consumers know Intel's brand, it is currently associated with the PC, not consumer electronics. However, the consumer market has gone through a major upgrade cycle over the past two years, and we expect consumer spending to shift from the PC to peripherals--particularly in digital media--as the worlds of consumer electronics and the PC converge.

Intel is seeking to translate its powerful brand into this expanding market, where consumers will be increasing purchases over the next few years. More importantly, by playing in this market, Intel is seeking to ensure that the PC remains relevant--if not central--to the digital media revolution.

Another issue facing Intel is the changing nature of applications. The Internet is driving more applications onto servers, reducing the need for powerful desktops. This lowers demand for the leading edge of the Intel product family and makes lower-cost commodity chips more appealing. However, Intel's business model is predicated on driving demand for increasing levels of microprocessor performance, which in turn forces system upgrades and purchases of its more expensive (and higher-margin) products.

Intel's move into peripherals, networking and communications, and consumer electronics devices is designed to address both of these issues. If Intel can succeed in translating its brand message into consumer electronics, it can drive enormous demand for its DSP (digital signal processing), flash memory, Xscale (formerly StrongArm) microprocessors and other components used in these devices. In addition, if Intel can accelerate the integration, or at least coordination, of traditional PC technologies and consumer electronics, it can generate new demand for high-end microprocessors, which increasingly will act as a "PC server" to multimedia peripherals.

Introducing its own digital music player at the Consumer Electronics Show is a dramatic way to build on Intel's current position in the consumer market and introduce a reference model based on Intel technologies that consumer electronics makers can use as a basis for designing their own products with Intel Inside. We also see the Intel ChatPad, an instant messaging and email device, and the WebTablet, a wireless handheld device for "couch surfing" the Internet, aimed at accelerating the handheld PC peripheral market.

What consumers want
From a technical standpoint, consumers don't really care which companies' chips are in these devices. They just want devices that work together so that they can download their music from the Web and import it into their player without problems. And they want a brand name they recognize, trust and associate with this market.

We believe Intel probably has the best chance of success selling Web pads and similar products that are closer to its traditional PC market. The Web pads that have been introduced so far are too bulky and too expensive to capture a potentially large consumer market. Intel may be able to prove the viability of this form factor, seed the market, and get the PC manufacturers, which have been very slow to move into these new markets, into gear.

In the PC-related markets, Intel can benefit some from its strong brand recognition. However, it will have less advantage in pure consumer markets. Intel's problem in the price-sensitive consumer marketplace is that it is not typically a low-cost provider. In the PC market, computers with "Intel Inside" can command a small premium because of the strong brand identity Intel has created.

In the consumer electronics market, however, Intel will have problems selling a high-priced item against less expensive products from other manufacturers, which have their own strong brand identities. Intel's digital music device is priced for the high end of that market at $360. The company is hoping to sell it by providing twice the memory of competitors, but that will be hard to maintain as the competition boosts the memory in their systems.

However, if component supply problems persist, Intel may have the advantage in having its own internal supply channel. We see this as a short-term phenomenon, as many suppliers will come online in the next one to two years.

Going against the giants
The question is just how serious Intel is about selling its own consumer products--particularly an MP3 player that would compete with consumer industry giants Sony, Panasonic and Toshiba. Besides the cost of translating its brand into the new market, Intel has a new distribution channel it must address. In fact, the big expense is not actually building the product--of course Intel can make a digital music player--it is creating the distribution channel.

Intel does have some channels already established, mainly with office supply and the more PC-oriented electronics outlets, such as CompUSA. Intel plans to sell its MP3 player mainly through office supply chains, but these do not reach a large segment of the consumer market.

While we believe Intel is unlikely to become one of the top players in consumer electronics, it can still create a viable business. However, we believe its primary aim is to sell its higher-margin components and services to consumer products manufacturers.

Intel's strategy is to use the convergence of computers with communications, consumer electronics and toys to drive its core microprocessor and component business. Intel's digital camera products, for instance, have been a success and, like the new digital music player, drive demand for storage and processor power.

One product per month
We expect Intel to expand aggressively into the digital video market with editing, storage and playback devices. Indeed, we expect Intel to add new consumer-related products about once a month through 2001. While each of these businesses is usually profitable, the more important impact is to prove the viability of the unified PC and consumer electronics market and create a huge new market for Intel components.

The critical next step for Intel is to translate its efforts into OEM agreements with the major PC and consumer electronics players to expand these markets. In the long run, Intel can succeed even if the Intel-branded devices go away.

The ultimate question here is how much traction Intel can gain with the big consumer electronics manufacturers and the PC vendors attempting to enter the consumer electronics business. If it can succeed in this respect, Intel will enjoy a position in the new market similar to the position it has enjoyed in the PC market.

Whether or not Intel succeeds with its bid in the consumer electronics market, it clearly has signaled its intention to become one of the innovators in consumer electronics and expand its market share into that area. Overall, this is good news for consumers, signaling an increase in competition that will help drive capabilities of these products up and prices down and drive new consumer products--such as Web pads--into the marketplace.

Meta Group analysts David Cearley, Peter Burris, Jack Gold, Steve Kleynhans, Dale Kutnick and William Zachmann contributed to this report.

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