Intel and TSMC: What are they thinking?

Don't get me wrong-- I think the Intel-TSMC alliance announced earlier this week is a good thing for both companies.

But the official explanation, that Intel wants TSMC's help to make Atom processor cores more widely available to the industry, just doesn't strike me as a sufficient reason for the deal.

Intel hardly needs TSMC's help to make SoCs (systems on a chip). Intel has been making highly integrated devices for the embedded market, as well as PC chipsets for a long time. It already has enough of the building blocks and enough experienced engineers to make Atom-based SoC products.

And it isn't as if Intel needs better process technology, or more fabrication capacity. Intel already has more of the best fabs in the world than any other company.

What's the one thing TSMC can do that Intel can't? Operate with low gross margins. In its most recent quarter, TSMC's gross margin was only 31.3 percent, while Intel's gross margin is still an industry benchmark at 53 percent. The difference is more than Intel's net profit--that is, if Intel had TSMC's gross margins, it would be losing money.

Low-margin component suppliers are a critical element of the embedded-systems market, which Intel identified as one of its target markets for this deal. Cost is king in consumer electronics, so high-margin suppliers like Intel rarely get a chance to participate.

Similarly, as average PC-selling prices decline, a growing share of the demand for processors and chipsets drops into price ranges in which Intel just can't afford to play.

The TSMC deal is Intel's way of taking a piece of these businesses without spending much money or taking much risk. For example, TSMC is already accustomed to helping its customers make SoCs for embedded systems. Intel could build such a business itself, but not at the margins it's used to.

Intel said in its press release that it will be porting its Atom cores to TSMC's technology. This is the sort of work that can get expensive in engineering time, but it's possible that the work will be made easier by a convergence between TSMC's processes and Intel's.

Last May, Intel agreed to cooperate with TSMC and Samsung in the transition to larger 450-millimeter silicon wafers (a little less than 18 inches across, up from the 12-inch wafers used today).

This doesn't necessarily mean that the three companies will co-develop fully compatible manufacturing processes, but with the 450mm transition being slated for 2012, there's still plenty of time left to drop that other shoe.

Anyway, this new TSMC deal is merely at the earliest official stage. The companies have signed a memorandum of understanding, but they have yet to work out the details. That could take a year, and it could be another year or two before Atom-based chips are ready to start rolling through the TSMC factory.

All in all, Atom SoCs might not become available from TSMC until 2012, at which point, they could, in principle, be made on a common Intel-TSMC process.

Not that Intel would provide its really good process technology to TSMC. In chips, as in other things, quality is expensive. Intel's best process technology, which it uses primarily for microprocessors, is at the leading edge of semiconductor manufacturing, with features such as a metal electrode acting as the transistor's gate, a hafnium-based insulation between the gate and the channel, and strained silicon in the transistor channel itself (where the current flows when the transistor is on). (See this Intel presentation for more details. Incidentally, did Intel ever announce which metal it's using? If so, I can't find it.)

TSMC may not need or want any of these features, and it would make sense for Intel to keep its best process technology to itself, anyway, if only to protect its high profit margins.

Even without a leading-edge process, TSMC can still make good money from Atom-based SoCs in the embedded market. That's enough to justify TSMC's participation in the deal.

But I'm not sure that explains Intel's motivation. Sure, Intel will make money it wouldn't have made otherwise, but it will also have costs it wouldn't have had otherwise. Intel may make a few bucks per chip in intellectual-property licensing fees, and perhaps this could amount to hundreds of millions of dollars a year, but that isn't a whole lot of money to a company like Intel, which makes tens of billions of dollars a year in gross revenue.

Why else would Intel be doing this deal?

Well, I think that the chipmaker could be setting itself up to kill off three of its biggest rivals.

There's already an x86 processor company using TSMC to make (some of) its chips: Via Technologies. Via isn't a big player, but it's been a thorn in Intel's side ever since it purchased the x86 processor operations of IDT (WinChip) and National Semiconductor (Cyrix) in 1999.

Via specializes in exactly the kind of processors that Intel can't afford to sell: low-cost, highly efficient designs aimed at low-cost PCs and embedded systems. Today's Atom is better than Via's best chips, but it's also more expensive. A cheaper TSMC-sourced alternative will hurt Via badly.

Most of the same reasoning applies to ARM, which licenses its processor cores to be used in SoCs made at TSMC, among other fabs. That's almost the same business model Intel is adopting with its own TSMC deal.

ARM dominates the market for microprocessors in cell phones. Intel's current Atom processors are too expensive and too power-hungry for that market. But remember, it'll be a couple of years at least before Atom-based chips start shipping from TSMC. The Atom cores of 2011 or 2012 will be more directly competitive with ARM's cores.

So put ARM on the endangered-species list too.

There's one other company that ought to be worried by this deal, and it probably isn't one you'd expect: Nvidia.

Nvidia is generally thought to be TSMC's biggest customer. It doesn't make x86 processors (though there are persistent rumors that the company is developing one), but it does make the ARM-based Tegra family, which would run up against these future Atom chips.

It's Nvidia's graphics chips that I'm worried about, however.

Intel is developing graphics chips of its own under the Larrabee code name. I wrote about Larrabee last August, and it seemed like a bad idea to me at the time. One of my key objections, however, was that graphics chips are inherently a low-margin business due to the strong competition between AMD and Nvidia, and I didn't think that Intel could afford to drag down its margins just to compete in that market.

The TSMC deal changes all that.

Larrabee's cores aren't Atom cores, per se, but they're similar enough that Intel might consider them to be covered by the language in the TSMC partnership announcement. Or if not, agreements can always be expanded later.

Making Larrabee chips at TSMC would solve the margin problem, putting Intel's graphics chips on a level playing field with Nvidia's. Larrabee would still be at a significant disadvantage because its x86-based design isn't as well-suited to graphics acceleration as Nvidia's chips, but Intel has a special ability to sell inferior products along with other chips its customers need--especially processors. That's reportedly how Intel's slow integrated-graphics chipsets ended up in so many systems during the Windows Vista transition, leading to many disappointed customers.

Or it's possible that Intel will not allow the TSMC deal to harm these companies, if only because Intel may still be in court defending itself against AMD's antitrust lawsuit.

But I wouldn't make that assumption, and I bet that ARM, Nvidia, and Via won't either. Intel isn't the only paranoid company in this industry.