Cheap chips now, but will it last?

By Richard Morochove

First published October 30, 1997

We'll see cheaper chips in the short term but less choice in the long run in the wake of two unrelated moves by Intel earlier this week.

Intel's autumn price cuts to its Pentium MMX and Pentium II processor lines average about 20 per cent. The cheaper chip costs should get passed along to consumers within the next two to three weeks in the form of lower personal computer prices.

This is almost certainly Intel's final price reduction for 1997. If you've been waiting for lower prices before you buy a computer ahead of the holidays, you needn't wait any longer.

Intel also acted to settle its patent dispute with Digital Equipment, a move that has longer-term implications. Digital sued Intel in May, claiming the world's biggest chipmaker infringed on patented technology used in its Alpha line of processors.

Caught flatfooted by the suit, Intel hinted that Digital would lose its preferred customer status and be forced to buy Pentium chips on the open market. Then Intel fired back with a countersuit, claiming Digital had infringed on 14 of its processor patents.

Rumours of an out-of-court settlement had circulated for weeks. The deal works out well for both parties, but isn't so good for computer buyers.

Intel and Digital entered into a ten-year patent cross-licensing agreement. Intel agreed to purchase a chip manufacturing plant and two development facilities from Digital. Intel will also hire the design engineers and purchase rights to Digital's StrongARM chip, a low-power processor used in handheld devices, including the latest members of Apple's Newton family.

Digital dumps a money-losing manufacturing plant running at only a fraction of capacity. Intel rids itself of a potentially troublesome lawsuit for $700 million (U.S.), a price that amounts to less than two week's revenues. This tells me there must have been some merit to Digital's suit, otherwise Intel wouldn't have agreed to purchase the facilities.

While Alpha is a fast processor, it never caught on with computer buyers. The chip has less than one per cent of the worldwide market for microprocessors. It's expensive and requires a special version of operating systems, such as MS Windows NT.

The sophisticated technology required to make new processors requires expensive equipment. It costs upwards of $1 billion to build a processor manufacturing plant today. You can recover that investment only if you run the plant at full capacity, which means you need several large computer makers to base their machines on your chip.

IBM joined forces with Apple Computer and Motorola in the PowerPC Alliance. DEC's arch-rival Hewlett-Packard partnered with Intel to design the processor code-named Merced, discussed in last week's column. Digital marketed Alpha almost as an afterthought and never did get the big design wins it needed with other computer manufacturers.

Intel's deal with Digital reminds me of Microsoft's agreement with Apple, announced in August. For an investment of $150 million (U.S.), Microsoft gained Apple's support for its Internet Explorer Web browser and its stance on Java. Microsoft also agreed to make future versions of its Office software for the Mac, propping up its fortunes.

Just as Apple now has too small a market share to effectively compete against Microsoft, Digital's chip sales are just a small faction of Intel's.

Digital says it will continue to design future versions of its Alpha chip, which will be manufactured by Intel. Unloading the money-losing plants means it will cost Digital less to remain in the Alpha business. Yet now it is dependent upon a direct competitor to build the chip.

Digital also promised to produce computers based on Intel's upcoming Merced chip.

How long will Digital remain committed to spending megabucks to develop new versions of its 64-bit Alpha, when it's less than two years away from picking up 64-bit Merced chips for about a grand apiece?

Ultimately, I think the deal provides a graceful way for Digital to leave the processor manufacturing business, assuming it receives U.S. government approval. This would further strengthen Intel's control of the processor market.

Who's left to challenge Intel?

Don't bet on the shaky PowerPC Alliance of IBM, Motorola and Apple continuing much longer. Intel's most effective competition comes at the low end of its processor line from chips made by Cyrix, now owned by National Semiconductor, and Advanced Micro Devices.

Unlike Digital and the PowerPC group, Cyrix and AMD work to clone Intel's processors. They make chips that are compatible with Intel's, yet less expensive. They've achieved some success, particularly in the price-sensitive home computer market. If a PC sells for less than $1,400, there's a good chance there's no Intel inside, yet it will still run MS Windows and all the popular applications.

Let's hope these little chipmakers survive and continue to keep up the pressure on Intel. If they fade away, Intel's Pentium price reductions may not come so often nor cut so deep. CW