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Success did not spoil me; I've always been insufferable. -- Fran Lebowitz

Keeping One Step Ahead
by Jim Surowiecki (Surowiecki)

NEW YORK, N.Y. (May 8, 1997) - The newspaper ad in major papers on Monday seemed better suited to the premiere of a hot new film or CD than it did to the introduction of a new microprocessor. "At 12:01 a.m.," the ad suggested, everything would be different. The image the ad conjured up was of hungry computer geeks waiting patiently in line outside COMP USA (Nasdaq: ) stores and clogging DELL (Nasdaq: DELL) phone lines in their quest to be the first with a computer containing the new Pentium II chip.

The strange thing, of course, is that the ad could not have been more on the mark. The arrival of the Pentium II is a real event in the world of personal computing, and it is an event that people have been awaiting -- if not breathlessly, then at least with great interest -- for months now. Once again, INTEL (Nasdaq: INTC) has stayed ahead of the curve. Or, rather, once again Intel has determined the shape of the curve. And the relentless pace with which the new arrives has not slowed. Like rust, Intel's growth machine never sleeps.

The Pentium II microprocessor is not a new generation of chip, but rather contains a faster and more refined version of the technology in the Pentium Pro processor, Intel's last high-end chip. Pentium II will offer MMX capability and greater versatility than Pentium Pro, as well as faster speed. One major difference, intriguingly, has to do with the new processor's packaging. While previous chips fit into ceramic containers that could simply snap into the so-called "motherboards" of PCs -- which meant that one chip was interchangeable with another -- Intel has chosen to encase the Pentium II chip in an entirely new cartridge that plugs into a slot on the motherboard. Since the cartridge contains memory chips that will improve the speed with the Pentium II processes data, it has the virtue of improving performance. And since the cartridge is patented, it has the even more important virtue of making Intel the only company that can fill those slots on the motherboards.

It's become more important for Intel to establish the distinctiveness of its product -- as opposed merely to the authority of its brand name -- because for the first time in a long time the company is facing something of a challenge to its core business. ADVANCED MICRO DEVICES (NYSE: AMD), the small company that for years has tried in vain to deliver chips that outperform Intel's, finally succeeded in early April, introducing a 233 MHz processor called the K6 that was faster and cheaper than the Pentium Pro. AMD has backed up its technological success with an elaborate print and television advertising campaign which has sought to position the K6 as the chip of choice for hip, edgy, upstart individuals.

While it's unlikely that AMD will make real inroads into the heart of Intel's business, some analysts have speculated that the company could ship more than 4 million units this year. And it's almost certain that AMD's newfound strength will keep pressure on Intel to keep prices down. Still, Intel priced both the 233 MHz and 266 MHz Pentium IIs slightly higher than expected, with the 233 chip going off at $636 and the 266 MHz sold for $775. That may suggest that the company sees the cartridge design as innovative enough and competition-killing enough to exempt them from any need to compete initially on price.

Intel also introduced a 300 MHz chip, priced at $1981, but all indications are that very few computers will be built with that chip until its price drops, which in turn won't happen until production is ramped up. It seems clear that Intel introduced the 300 MHz chip was done primarily as a way of reasserting technological dominance, of demonstrating that once again it is the market leader.

All of the key computer manufacturers -- IBM (NYSE: IBM), COMPAQ (Nasdaq:), Dell, HEWLETT-PACKARD (NYSE: HP) -- are now producing Pentium II systems, the vast majority of which will cost between $3000 and $4000. That's good both for the manufacturers, who will reap higher margins, and for Intel. The "12:01 a.m." ad, in fact, was a joint production of Intel and GATEWAY 2000 (Nasdaq: GATE), further testimony to the way in which Intel has been able to fuse marketing, sales, and production into one coherent vision. It's also testimony to the difficulties that AMD will face in attempting to get major PC makers to put the K6 in their computers.

Indeed, at this point only DIGITAL (NYSE: DEC) has committed itself to using the K6. And the total number of K6 processors AMD should ship this year will represent not even a third of Intel's Pentium II shipments, to say nothing of all its older Pentium and Pentium Pro shipments. While AMD does represent the first serious external challenge to Intel since it decided to concentrate on microprocessors, competing with a company that dominates more than 80 percent of the market -- and that has little compunction about withdrawing products from customers who won't play ball -- is a monumental task.

Part of what has made that task so difficult, of course, is the improbable success Intel has enjoyed in making a microprocessor a household name. The "Intel Inside" campaign, which originally many believed to be a hopeless project, has worked to make consumers seek out a product that they never actually purchase. Ten years ago, if you had suggested that consumers would care who made microprocessor in their computers, you would have been mocked. Who, after all, cares who made their memory chips? But "Intel Inside" has changed all that, and the hoopla that has surrounded the release of the Pentium II is striking evidence of the company's success in making itself a brand name in a business where the very concept of brand seemed alien.

The importance of the Pentium II also testifies to Intel's continued ability -- along with companies like MICROSOFT (Nasdaq: MSFT) -- to foster permanent demand for more and more speed. The most astonishing characteristic of Intel's performance over the last two years has been its willingness to invest in companies whose sole business is making products that require faster microprocessors. By keeping the public in a perpetual state of wanting more than they have, Intel has been able to continue to grow at a nearly unprecedented pace. Bear Stearns, for one, is projecting that profits for 1997 could be up 50% over the previous year, a year that was, it goes without saying, brilliant. That Intel's stock trades at a P/E of just 23 may soon be seen as a legacy of an era that the company had left behind long before investors did.

Still, making oneself into a brand name also means opening oneself up to the kind of scrutiny that only the most highly regarded -- or loathed -- companies receive. And on Monday, that scrutiny resulted in a report posted on the Web site Intel Secrets that the Pentium II chip contains a bug similar to the one that caused so much trouble when the original Pentium chip was introduced. According to Robert Collins, who runs the site, calculations with the chip that involve negative numbers with many digits to the right of the decimal point may end up giving the wrong answer. As minor as the problem sounds, it was no more minor a problem that in 1994 forced Intel to take a $475 million charge, recall chips, and revamp its entire corporate approach to potential bugs.

While preliminary indications are that the problem will affect few, if any, people using the Pentium II, Intel is expected to issue a report on the bug Friday. If it does exist, a general recall will not happen. What's important, from Intel's perspective, is that a mechanism exist that will allow people to return the chip if they want and that the company make clear exactly what the implications of the bug are. That doesn't mean that the problem will necessarily be fixed any time soon -- if ever. It means simply that the possible limitations of the product will be known.

Intel's quick response to the Intel Secrets report says much about the company's new understanding of itself and its place in the consumer market, as does the Gateway 2000/Intel ad. The launch of the Pentium II was like the premiere of the biggest movie of the year. Even if you didn't get to see it, you wanted to hear what it was like to be there. Speed has become the byword for more than just hardcore computer nerds now. If, as Andy Grove of Intel has it, only the paranoid survive, they survive in one simple way: by going faster and faster.

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