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Intel's Xeon to tip price scales

The expensive price tag on Intel's upcoming Xeon processors should boost the chip giant's bottom line.

The expensive price tag on Intel's upcoming Xeon processors should boost the chip giant's bottom line as it faces sagging margins due to the growing use of cheap chips in popular sub-$1,200 PCs.

The top-of-the-line 400-MHz Xeon Pentium II processor will cost

Xeon pricing
Chip speed Cache size Price
400 MHz 2MB $4,489
400 MHz 1MB $2,836
400-MHz 512K $1,124
computer vendors an unprecedented $4,489 in volume when it is released toward the middle of the year, close to $2,000 more than the most costly Pentium Pro chip and over five times the price of the most expensive Pentium II, according to industry sources familiar with the pricing. The chip includes a performance-boosting two megabytes (MB) of extra "cache" memory.

Less powerful Xeon processors will be costly as well. A 400-MHz chip containing 1MB of cache memory, which is due around the same time, will sell for $2,836. Another chip containing 512K (half the amount of a 1MB cache chip) will cost $1,124 in volume.

As a result, many Xeon servers will be priced between $10,000 and $25,000--and possibly more for the most powerful servers.

Although increased manufacturing costs contribute to the price hike, market positioning appears to be the greatest factor. In the desktop arena, where the company faces more competition, the latest Pentium II-based processors are priced between $150 to $824 and discounted quarterly. In the server arena, where Intel faces virtually no competition from other x86 processor vendors, Pentium Pro chips from an earlier generation of technology sell for $1,035 and $2,675 and are rarely discounted.

Xeon chips will cost "a couple of hundred bucks, tops," to manufacture, according to Drew Peck, computing analyst with Cowen & Company. "Xeon is overpriced, but so are the products that will come with it," he added.

"The server market isn't as price sensitive as the desktop market," Dataquest analyst Nathan Brookwood noted in an earlier NEWS.COM interview. "If you cut the processor price, you don't really change the dynamics of the [server] market."

Xeon chips will be more expensive to manufacture, Intel says. The processors will come in a "Slot 2" package, which is approximately twice as large as the current "Slot 1" Pentium II package used for desktops. Intel will also use pricey, custom-made memory chips for the cache memory.

Analysts state that the sudden jolt in pricing comes as part of an Intel plan to increase its profit margins. Desktop processor price wars and the rise of the sub-$1,000 computer have drastically curtailed the profit associated with mainstream PC processors.

Intel's gross margins during the first quarter, for instance, shrank from above 60 percent in 1997 to 54 percent in 1998 while the average selling price (ASP) for processors similarly also went down. The declines partially owe to cheap computers, according to Intel.

By charging more for Xeon in markets that are less sensitive to price increases, Intel can maintain its outstanding financial track record. Intel executives have also said that they expect server and workstation processors to help increase margins. (Intel is an investor in CNET: The Computer Network).

"If they sell one Xeon processor for every 30 [low-margin] Celeron processors, they can maintain their average selling prices above $200," said Ashok Kumar, semiconductor analyst with Piper Jaffray.

The Xeon strategy will also allow Intel to cash in on the rise of Intel-based workstations and severs, said Cowen & Company's Peck. Until now, Intel charged a single price for processors running at a particular speed, regardless of where in the PC lineup the computer vendor placed the chip, he pointed out. Compaq, for example, pays the same price for desktop Pentium II chips as it does for Pentium IIs that end up in more costly and profitable servers.

By branding Xeon as a separate product line, Intel can price these chips without regard to the desktop prices and take a portion of the incremental profit associated with these more expensive machines.

"In the face of unprecedented price erosion, Dell has seen its average selling price [for computers] rise. A big part of it can be attributed to workstations and servers," he said. "Intel has so far not been able to exploit this. Xeon is an effort by Intel to cash in on [this marketing strategy]," he added.

While Brookwood, Peck, and Kumar did not confirm exact pricing on the Xeon chips, all three said the prices were in line with their projections.

Will consumers and computer vendors go along with this? Most likely yes, say Peck and others. The server and workstation markets are far more resistant to pricing pressures than the desktop market. Further, Intel's hardware vendors will mostly be going up against Unix vendors such as Sun Microsystems and Digital, which already charge about the same or more for competing products.

A 450-MHz version of the chip will appear later in the year, while versions running at 500-MHz and higher will come out in 1999.