With declining chip prices, Intel emphasizes diversity

Intel, the No. 1 chipmaker, is facing dwindling profits in microprocessors. So the Silicon Valley stalwart has latched onto a grand plan to diversify from a tightly knit family of products to delivering a much broader array of hardware and services.

It's a common theme in high technology today. The Internet economy and uprisings like the recent trend toward free PCs have forced many firms to reinvent themselves seemingly overnight.

Intel is no exception. In the past year, the largest chipmaker has spent more than $3 billion acquiring four communications companies, invested in TV set-top box initiatives, bought an e-commerce software developer, and begun to recruit Web consultants for a new data hosting division.

And more moves are coming, Intel says. "We're far from done with our acquisitions," said Mark Christensen, vice president and general manager of the Network Communications Group, which makes processors for telecom equipment and is perhaps the most closely followed of the new divisions.

Most observers believe the company's track record, huge financial resources, and technical reach give it strong odds to successfully straddle the transition. Nonetheless the shift is prompting underlying changes in how the company will operate, which in turn raises questions on what will happen along the way. The main question: How will they do in markets where they are the small fish?

Under the reorganization, the chipmaker essentially segmented itself into four divisions, complemented by a separate group dedicated to venture investing and worldwide business development. Each division will function with relative degrees of autonomy. The largest by far is the Intel Architecture Business Group, which is the only one directly focused on PC products. The other three are the Network Communications Group, the Communications Products Group, and the data services group known as the New Business Group.

"It's almost a conglomerate," akin conceptually to a General Electric, said Michael Slater, founder of MicroDesign Resources. "The question is whether they can manage to grow in so many different directions."

Effort began in 1997 with Pentium II
The effort to diversify began in earnest in 1997 inside the microprocessor division. That year, Intel decided to first segment the Pentium II line into three separate chip families targeted at different PC and server markets. Intel also bought Chips and Technologies, a graphics chipmaker, to bolster its effort to get into the graphics market.

Although the chipmaker has engaged in side businesses such as videoconferencing in the past, the new structure represents a historic break, executives and analysts say. In the past, lateral efforts generally existed to increase the demand or attractiveness of PCs. Some, such as videoconferencing and graphics, have not been huge successes.

Along the way, Intel has found many opportunities--but capitalizing on them won't be easy.

"Becoming the world's leader in processors for the PC was part of their destiny," said Steve Tobak, vice president of marketing at rival National Semiconductor. "This is different. There is the question whether their heart is truly in it?Networking is not in their blood."

Necessity is the mother of invention
Moreover, Intel will not enjoy the kind of architectural dominance it has in processors. In its new businesses, the company will be one of many competitors and have to rely more heavily on managerial talent, financial strength, strategic alliances, and a host of intangibles. In fact, other than its venture fund, few of Intel's lateral businesses have gone big time.

"Ultimately, it's out of necessity," said Dean McCarron, principal analyst at Mercury Research. "There's not much overlap or integration."

Yet the chipmaker packs some heavy artillery.

"They've got the fattest bankroll in the industry," Slater said, along with a number of long-standing alliances, investments, and cross-license agreements, and a host of former employees now situated at potential allies. Still, he said, "the more focused you are, the easier it is. There is no question that this is a hard transition to make."

Intel executives portray the change as an expansion of the company's core functions.

"We've gone from being the building-block supplier to the computer industry to being the building-block supplier to the new Internet economy," said Paul Otellini, general manager of the Intel Architecture Business Group, which oversees the development of processors, graphics chips, motherboards, and all the other internal PC components. "We sell complementary products that grow with the Internet economy."

Financially, diversification seems inevitable. In the first half of 1999, revenue from the main PC-focused group grew 12.6 percent, from $10.7 billion to $12 billion. The other business groups--which, combined, are half the size of the main group--grew from $1.3 billion to $1.8 billion, a 38 percent increase over the same period. These groups also rose from reporting losses to squeeze out a $15 million profit.

In the new regime, the lateral groups will work to enhance the PC market but also function fairly independently. The Network Communications Group, for instance, will continue to have its chips made by outside foundry firms, not in Intel's existing chip plants, according to Christensen.

The emphasis the company will put on the side businesses has also increased. In the future, there will be a greater attempt to gain market share and fulfill niche product categories, say analysts and executives.

Communications constitutes a logical place to start. The company has been manufacturing networking equipment for a number of years already, albeit with uneven performance, according to many. Under the new regime, the company will put more money into the effort.

Making and selling communications processors, on the other hand, has similarities to the PC microprocessor business. In fact, Nathan Brookwood, principal analyst at Insight 64, said it is analogous to the earlier PC era, when customers were willing to pay for performance.

"These are high margin products," he said. "That's why the Cisco's of the world can sell these boxes with margins of 50 to 60 to 70 percent."

Of all the new businesses, the services division may have the toughest time keeping pace. Unlike the other divisions, the services will not be engaged in manufacturing but rather fee-for-project services. According to Tobak and others, this is an entirely different beast, and it can potentially carry lower margins because of the employee-intensive nature of the operation.

In the chips
Despite diversification, the microprocessor division will remain at the core of the company's fortunes.

"Their crown jewels will continue to be the microprocessor business. They need to participate in these segments to protect the crown jewels," said Ashok Kumar, an analyst with Piper Jaffray.

Nonetheless, the degree of energy Intel is putting into the new divisions indicates a clear shift from business as usual.

"This is a kind of a once-in-20-years thing," Kumar said. "Under traditional metrics, it doesn't make sense. This is being done strategically."