There's been plenty of talk about alternative chip technologies threatening Intel's (NASDAQ:INTC) dominance in the data center, but so far, there's been very little real progress. Companies like Advanced Micro Devices and Qualcomm are bringing the ARM architecture to the server market, for example, but those efforts are still in the very early stages.
A bigger threat to Intel may in fact be the Power architecture from International Business Machines (NYSE:IBM). IBM opened up the Power architecture to partners of the OpenPOWER foundation about a year ago, including Google, NVIDIA, and many others, with the goal of creating an ecosystem around Power that could provide a viable alternative to Intel in the data center.
IBM and NVIDIA recently secured a major supercomputer contract thanks to this collaboration, but that deal turned out to be just the tip of the iceberg. Rackspace Hosting (NYSE:RAX), one of the smaller cloud computing companies, recently announced it will be reducing its dependence on Intel by using Power chips in thousands of its servers in the future. This decision comes after years of testing the technology, and it represents the first major crack in Intel's near-monopoly of the data center.
Why is this important?
Intel is essentially the only option when it comes to server CPUs. The company controls somewhere around 98% of the market, and companies like Google and Rackspace have little choice but to spend enormous sums on Intel chips as they build out and upgrade their cloud computing data centers. Intel's x86 architecture has become the standard, so it's not just a matter of offering alternative hardware; an entire software ecosystem needs to be built around any competing processor technology.
This presents a significant barrier to entry into the server chip market, one that is unlikely to be successfully scaled by a single company. Before OpenPOWER, the only way to buy a Power-based system was directly through IBM, a model that doesn't work well with the way companies like Google, Microsoft, and Rackspace build out their data centers. Google, for example, designs its own server systems, with the company able to optimize specifically for certain tasks.
OpenPOWER allows companies to do this type of custom design work with the Power architecture, and with about 80 different hardware and software companies now part of the foundation, the momentum is building. Rackspace, which is now officially a member of OpenPOWER, is the first major cloud computing company to commit to actually using Power chips, and with Google also an OpenPOWER member, it seems likely that more companies will eventually follow suit.
Already, OpenPOWER has made more progress in the server market than those pushing the ARM architecture, and one key reason is that the Power architecture is specifically designed for high-performance applications. Rackspace found that Power chips offered efficiency and performance benefits in various applications during its testing, and the company ultimately passed on ARM chips because they simply didn't perform well in tests.
What it means for Intel and IBM
Intel has managed to earn incredible profits from its server business thanks to its complete dominance of the industry. The company's data center segment recorded a 50% operating margin during the third quarter of this year, a higher margin than even the PC CPU segment.
That there is now a viable alternative to Intel's chips represents a significant threat to Intel's bottom line. With companies like Google now having a non-Intel option, Intel may be forced to cut prices in order to prevent OpenPOWER from gaining ground. Intel doesn't need to lose much market share to feel the negative effects of this newfound competition, and the move by Rackspace could ultimately mark a top for Intel's server chip profitability.
OpenPOWER isn't the end of proprietary hardware at IBM; the company still has a very lucrative mainframe business that isn't going anywhere. It does, however, mark a significant shift in IBM's strategy, and the progress so far has been impressive. Intel still has a stranglehold on the server market, but OpenPOWER represents a very serious threat to that dominance.
IBM needs to get a reasonable rate of return on all of the R&D work it does on the Power architecture, and it's now clear that selling proprietary systems alone is no longer working. OpenPOWER allows IBM to not only sell more chips, but also to license the designs to other companies. All of this lowers the cost of entry into the Power ecosystem, creating a viable alternative to Intel. Rackspace is the first domino to fall, and given OpenPOWER's momentum so far, it's unlikely to be the last.
Timothy Green owns shares of International Business Machines and Nvidia. The Motley Fool recommends Google (A shares), Google (C shares), Intel, Nvidia, and Rackspace Hosting. The Motley Fool owns shares of Google (A shares), Google (C shares), Intel, International Business Machines, Microsoft, and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.