Intel: Stepchild of Wintel?

Unlike software ally Microsoft, Intel is engaged in far more trench warfare in a rapidly changing battlefield. The processor giant still commands more than 85 percent of the market for chips used in today's desktop computers, but faces increasing challenges in emerging mainstream markets.

Competition from rivals such as Advanced Micro Devices and National Semiconductor's Cyrix arm, a paucity of power-hungry applications, and a steep decline in PC prices have driven Intel to cut prices at an accelerating rate.

As if that weren't enough, Intel may have come under some "friendly fire" as well. Internal memos which came to light today allege that Microsoft pressured Intel to drop certain Internet-related projects that conflicted with the software giant's own agenda. The disclosures have raised new questions about the dynamics of the Wintel relationship and how it has affected the fortunes of both companies. (See related coverage)

But the most insidious threat to Intel may very well be an enemy within: Its newest chip, the "Mendocino" Celeron, could end up cannibalizing business from other Intel processors--including some of its most profitable lines.

Released this week into a fiercely competitive consumer PC market, the higher-performance version of the Celeron chip--"integrated" secondary cache memory makes it speedier than its predecessor--presents a classic catch-22 situation. While Intel needs to offer a high-performance processor to compete with rivals in this critical market, the same chip threatens to compete with the company's higher-end processors.

"It's a huge, huge, huge danger for them," said Dean McCarron, principal analyst at Mercury Research. "There isn't any question that there is great concern at Intel that system prices are going down."

In short, Intel has begun to lap itself in its development cycles. The new Mendocino performs almost as well as existing 300-MHz and 333-MHz Pentium II chips, but sells for a much lower price.

Intel seems to have suffered from too much of a good thing, at least where technology is concerned. Processors have continued to double in performance every 18 to 24 months at ever lower prices, jading users to highly touted performance advantages.

"Mendocino is a great chip," McCarron said. "It's so good you have to question why you would buy a Pentium II."

Many financial analysts continue to rate the company's stock as a strong buy: Intel pulls in more than $1 billion in profits per quarter while its main rivals have been posting successive losses. Still, some have begun to question whether the company can sustain its historical profit margins with lower-priced products.

The other half of the Wintel marriage is a markedly different story. During the last few years, Microsoft's operating system competitors have virtually disappeared. Mainstream systems such as OS/2 and DR-DOS faded with the appearance of Windows 95. As a result, even in an era when PC and component makers are cutting prices almost monthly, the cost of Windows operating systems has barely dipped at all. (See related story)

The difference between the Wintel businesses can be explained through simple laws of supply and demand. The ability to make higher-powered processors is outpacing the need for it, according to an article by Nick Tredennick in a recent issue of the Microprocessor Report.

Software companies have simply not developed applications with mass appeal that need the processing might of the most powerful chips on the market. A larger customer base also dilutes the number of users who demand performance.

The gap between ability and demand has fundamentally changed the competitive landscape. With performance less of an issue, manufacturers have had to compete more strongly on price. Put another way, the lull in performance demand means that the tangible differences between lower- and higher-end chips and PCs is shrinking.

Looking at the current lineup of Intel chips, Tredennick wrote, "There is a 2-to-1 ratio in performance, but almost a 7-to-1 ratio in price."

The emphasis on cost has definitely had an impact on Intel's bottom line, McCarron said. In the first half of 1997, Intel's average selling price for its microprocessors was $260, a high water mark for the company. For the first half of 1998, it dropped to $210.

In the end, however, Mendocino is probably a necessary evil. Without it, the company was ceding the growing low end of the market to AMD.

"It answers a fundamental hole they had in the market," said Richard Belgard, a microprocessor consultant.