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No quick fixes for chipmakers

Price has become an issue because that's the only innovation computer vendors are providing.

The causes are many and the cures don't look easy.

That's the consensus among analysts examining yesterday's announcements from Intel and Advanced Micro Devices that revenue and earnings would be lower than expected for the first quarter.

Overall, the main culprit appears to be the sub-$1,000 computer. For both companies, customer preference for lower-priced computers with cheaper processors have led to lower profits, and sales volume has failed to offset the declines.

But the popularity of these cheap computers appears to extend far beyond the desire to keep within a budget, and that's the root of the problem. Market saturation, a worldwide economic slowdown, and the failure of computer vendors to innovate have together shaped a market that is both intensely competitive market for PC makers and stultifyingly dull for consumers. In other words, price has become an issue because that's the only innovation computer vendors are providing.

PC sales will likely rebound, but maybe not until 1999.

"The PC market has run into a fundamental problem in that these systems are not as easy to use as consumers expect them to be. All of the low-hanging fruit has been picked," said Michael Slater, founder of MicroDesign Resources.

"Getting into that other 60 percent of the households is going to be tough," he added, referring to the PC's presence in about 40 percent of American households.

"It's temporary if your view is long term. I don't know if its the same if your view is this year," Slater concluded.

From a financial perspective, yesterday's announcements come as the logical result of the sub-$1,000 revolution.

"Intel is selling more chips at the lower end, for $100 or $80, than they'd like and they have been selling fewer chips at the high end, for $500 and $600," said Nathan Brookwood, semiconductor analyst at Dataquest. The same is true of AMD, and as a result, revenue has dipped at both companies.

High-end chips are important to Intel because they cost about the same to make as low-cost processors, Brookwood explained. A low-end Pentium MMX that sells for around $80 costs $50 to build. A 300-MHz Pentium II, however, sells for more than $600 and only costs $85.

Whether the revenue dip was accompanied by contracting demand for semiconductors and computers remains an open question. Brookwood, for one, believes demand has stayed relatively stable. Extrapolating from the limited data provided by Intel, Brookwood said that Intel's cost of goods for the quarter was equal to the company's cost of goods in the fourth quarter, which means semiconductor sales stayed even.

Others, however, believe a downturn has occurred. Inventories of notebooks and desktop computers increased during the quarter, which has likely depressed sales, said Bruce Stephen, a computer analyst with International Data Corporation. In the end, Intel will likely ship 21 million processors for the quarter, roughly 2 to 2.5 million less than earlier projections, said Wall Street analysts.

Partially as a result, and partially as a result of broader economic trends, computer demand will be slower this year than last, Stephen said. Worldwide demand will grow 13 percent this year and 15 percent in the United States, according to IDC. In 1997, worldwide growth came to 15.2 percent while the U.S. market exceeded expectations with 19 percent growth.

Those demand figures, however, seem to mask a greater problem in the market. Customers have changed how they approach computer buying and what they expect from computers, most said, and the industry has not kept up.

"There are two remedies, neither of which unfortunately are an instant fix," said Brookwood. To recover, the industry will have to develop a hardware-intensive application that will excite users. Intel also has to bring out the new generation of a high-cost Pentium II for servers. Sales of these $2,000 and $3,000 chips would offset low-end sales.

Stephen speculated that technological saturation may have set in to a certain degree. Corporate America went on a buying binge over the past two years. The economy may have entered an era in which these customers are merely trying to get a grasp on what they own.

"Second, people know low-end features will improve, so they wait a quarter," he said.

A lack of innovation has become a problem as well, said Slater, who says PC makers are more than partially responsible for the decline. "PC makers are scared to spend $5 on something that improves ease of use," he said. To get the market moving again, these makers will have to start adopting innovations such as the "plug-and-play" USB bus or 3D graphics to interest consumers.

Intel is an investor in CNET: The Computer Network.