In light of chip giant Intel's (INTC +7.97%) prolonged struggle to bring its 10-nanometer chip manufacturing technology into volume production, I have grown increasingly concerned about the company's current business model.
In the past, when Intel's manufacturing group executed extremely well, the company's in-house chip manufacturing efforts were a genuine asset to the company. Today, however, Intel's manufacturing struggles have not only hurt its competitive positioning with respect to chip manufacturing technology, but those struggles have kept Intel's innovations in chip design from coming to market as well.
Image source: Intel.
Today, I'd like to go over three reasons Intel should stop manufacturing its own chips and outsource production to third parties.
1. Even playing field
It seems quite likely that over the next year or two, Intel will go from having manufacturing technology that's at rough parity with what the other contract chip manufacturers are offering to a position that's clearly behind the competition. This development would likely put Intel at a competitive disadvantage to other chip designers that utilize the contract chip manufacturers' latest technology, possibly hurting Intel's gross profit margin and revenue performance in the coming years.
If Intel were to start building its chips elsewhere, it could, at a bare minimum, ensure that it isn't operating at a competitive disadvantage to its peers. The playing field with respect to chip manufacturing technology would be leveled, improving Intel's potential competitive positioning in the years ahead.
2. Significant cost reductions
Intel spends substantially on research and development to develop new generations of chip manufacturing technologies. That spending is entirely worth it if it yields technologies that give Intel a leg up in the marketplace in either product performance/efficiency or in cost structure.
However, given that the company's internal chip manufacturing teams are executing so poorly that Intel's product competitiveness could soon take a large hit as a result, the money that it spends developing these new technologies, quite frankly, appears to be wasted.
Back in 2012, Intel indicated that it spent over $2 billion per year in research and development related to chip manufacturing technology -- a number that has likely only grown over the last six years. If Intel were to completely end development of its technologies internally, I'd estimate that the company would save between $3 billion and $4 billion per year.
Now, the trade-off here would be that Intel would have to pay a markup for silicon wafers produced by a third party, potentially meaning a drop in Intel's gross profit margin. However, if Intel's products are much more competitive as a result of having more reliable access to cutting-edge chip manufacturing technology, then Intel could more than make up the difference through improved market share and potentially even higher average selling prices (thanks to more competitive products).
3. Lower risk
If Intel were to get rid of its chip manufacturing operations, it would have at least two credible contract chip manufacturers to choose from: Taiwan Semiconductor Manufacturing Company and Samsung. Both companies have been flawlessly delivering new manufacturing technologies to the market on time for years now.
By having multiple potential sources for chip production, Intel would be able to hedge its bets -- if one chip manufacturer is having difficulties ramping up a next-generation technology, then Intel would be able to shift its orders to another player. If both third-party contract manufacturers are having issues, then at the very least Intel's competitors will be in the same boat.
Moreover, by building its chips at arguably more reliable contract chip manufacturers, Intel's customers may be more confident in the company's future product plans, making them less likely to be on the lookout for alternative suppliers.
