Shares of AMD (AMD -1.03%) recently surged after the chipmaker secured Alphabet's (GOOG 0.76%) (GOOGL 0.76%) Google as a new data center customer. This means that all the major public cloud companies -- including Amazon (AMZN -0.54%) and Microsoft (MSFT 0.26%) -- are now using AMD's Epyc processors.

Google, Amazon, and Microsoft will still use Intel's (INTC -0.36%) Xeon CPUs, but these deals with AMD indicates that Intel's iron grip on data centers -- where it once controlled 99% of the market -- is loosening. AMD's share hit 3% at the end of 2018, and it expects that figure to hit 10% by the first half of 2020.

Two IT professionals in a data center.

Image source: Getty Images.

Why are Intel's customers switching to AMD's chips?

Intel's Xeon CPUs dominated the data center market because most customers were reluctant to switch over to untested chips. AMD's Opteron CPUs claimed up to a fifth of the data center market at its peak in 2005 and 2006, but its share eventually plunged to the low single-digits as Intel fought back.

AMD accused Intel of locking in customers with big rebates and penalizing uncooperative customers with delayed chip shipments. Those allegations subsequently supported the EU's antitrust case against Intel, which resulted in a yet-to-be-paid fine of 1.1 billion euros ($1.2 billion).

AMD expanded its Opteron brand to ARM-based chips three years ago and targeted "micro-servers," which consumed less power than full x86 servers. However, demand remained tepid, and Intel continued to rule the market.

AMD then went back to the drawing board and challenged Intel with a new high-end data center chip, Epyc, two years ago. Like the original Opteron, the Epyc went straight for Intel's high-end Xeon chips instead of dabbling in lower-end markets.

Industry benchmarks indicated that the first-gen Epyc offered comparable performance as the Xeon at a much lower price. The second-gen Epyc, codenamed "Rome", also left comparable Xeons "lying in the dirt," according to recent head-to-head benchmarks at Extreme Tech. Simply put, AMD now offers a more powerful server chip than Intel at a significantly lower price.

Two IT professionals walk through a data center.

Image source: Getty Images.

A top-tier Epyc chip currently costs about $7,000, while a comparable Xeon chip costs over $13,000. That difference adds up quickly for cloud customers like Google, Amazon, and Microsoft, which all operate massive data centers with thousands of servers.

Bad news for Intel, great news for AMD

Intel's data center group (DCG), which generated 30% of its revenue last quarter, is struggling with three main headwinds: an ongoing chip shortage, the trade war with China throttling spending from big data center customers, and tougher competition from AMD. That's why the unit's growth slowed to a crawl in the first half of 2019.

YOY growth

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Q2 2019

DCG revenues






Source: Intel quarterly reports.

Most of Intel's headwinds are tailwinds for AMD. AMD doesn't face a chip shortage, and tighter budgets at data centers make Epyc CPUs look more appealing than Xeons. Intel also can't lock in customers with rebates in the aftermath of the EU probe, so the Epyc probably won't suffer the same fate as the Opteron.

AMD sells its Epyc CPUs in its EESC (enterprise, embedded, and semi-custom) unit, which generated 39% of its sales last quarter. That unit generates most of its sales from APUs for gaming consoles like the PS4 and Xbox One, but sales of those chips are fading as the current console cycle matures. However, AMD noted that robust sales of Epyc chips partly offset that slowdown.

AMD's EESC revenue fell 12% annually during the quarter but grew 34% sequentially, which indicates that its declines are bottoming out. Moreover, AMD noted that surging sales of its Epyc chips (which have higher margins than its APUs) boosted the EESC unit's operating profits both sequentially and annually.

The key takeaways

Simply put, Epyc is becoming a major new growth engine for AMD, and its cloud deals with Google, Amazon, and Microsoft could help it achieve its goal of claiming 10% of the data center market by 2020. Intel might eventually strike back after it resolves its chip shortage and development issues, but it's quickly losing its iron grip on the data center market.