Why AMD Still Doesn't Scare Intel
It builds some of the world's most sophisticated chips, but it's not yet turning a consistent profit. To get there, it needs to be strong where its larger rival is weak.
By Om Malik

(Business 2.0) – This summer, when a group of independent computing researchers compiled a list of the world's top 500 supercomputers, 25 of those on the list--including a Cray system that ranked 10th--were powered by 64-bit Opteron chips manufactured by Advanced Micro Devices. Widely regarded as the Porsche of microprocessors, Opteron more than holds its own against chips offered by much larger competitors like Hewlett-Packard, IBM, and Intel.

Opteron's success has given AMD a shot in the arm, burnishing the reputation of a company that was previously known for producing cheap clones used in desktop PCs. But it's not just techies giving the company a second look: Wall Street was also surprised by AMD's performance during the second quarter of this year, as the company turned in a net profit of $11.3 million on sales of $1.3 billion despite analysts' predictions that it would report a loss. During the past three months, AMD's stock has appreciated by more than 40 percent. Is an AMD renaissance under way at last?

Don't count on it. Despite its recent high-profile triumphs, AMD, which had 2004 revenue of $5 billion, is still dwarfed by $34 billion Intel, which commands 80 percent of unit sales and 90 percent of revenue in the global PC processor business. Moreover, Silicon Valley-based AMD has had trouble staying in the black--losing money in three of the past four years. Even the recent spate of good news was illusory; after posting a $43.8 million profit in the third quarter of 2004, AMD lost $47.4 million during the next six months, only to surprise everyone with its modest profit in the most recent quarter.

At $934 million, AMD's R&D budget is only a fifth the size of Intel's, and AMD operates just a single factory, compared with Intel's 12. Still, the rivalry has grown so bitter that AMD filed an antitrust suit in June accusing Intel of using bully tactics to deter PC manufacturers like Dell, Sony, and Toshiba from offering AMD chips in their machines.

Litigation may be one way to get out from under Intel's shadow, but sharper focus would also help. AMD competes in many of the industry's most cutthroat market segments, and some observers believe that rather than trying to compete head-to-head with Intel, AMD would be better off concentrating on a few strategic markets where it has a clear technological advantage. "For a company like AMD, you really have only two options: play the low-cost commodity game or develop chips that beat Intel by a wide margin," says David Wu, who tracks the chip industry for investment advisory firm Global Crown Capital. "With me-too products, AMD will continue to have a tough time."

Spread Too Thin?

A breakdown of AMD's revenue shows how many markets the company targets. It produces microprocessors used in PCs. It makes flash memory chips found in consumer devices. It manufactures high-performance chips like Opteron for use in servers and smaller mobile processors for laptops. In 2004, 37 percent of AMD's income came from the sale of flash memory. Nearly 60 percent came from microprocessors--half of which are low-margin chips destined for use in low-cost PCs. The rest came from basic chips used in consumer electronics and telecom equipment.

Flash memory production is a commoditized business dominated by very large competitors (such as Intel and Samsung) that sell chips at wafer-thin margins to keep their factories running at full capacity. AMD's flash memory business has been operating at a loss, burning through $199 million in the first six months of this year. AMD says it plans to spin off its flash division, Spansion, which operates as a joint venture with Fujitsu. But Wu warns that there might be few interested buyers, pointing to the fact that phone makers are embracing a new kind of memory chip called Nand flash, while AMD's flash is based on older Nor technology.

Unloading the flash memory business is nothing compared with the challenges AMD faces as it attempts to make money by producing processors. Chip-fabrication facilities cost billions, so it's essential to produce in high volumes. AMD's fab facility in Dresden, Germany, uses 200-millimeter wafer technology and can produce as many as 50 million processors a year, but "at the current demand level, AMD cannot make chips cheap enough to raise its margins," says Manoj Nadkarni of Chip Investor, an industry research firm.

Yet to keep pace with Intel, AMD is spending billions more to build a second Dresden facility--this one with state-of-the-art 300-millimeter manufacturing technology--which will help double its capacity to 100 million chips a year by 2008. With worldwide PC microprocessor demand hovering around 200 million units, however, it's hard to see how AMD will achieve the economies of scale required to make the investment in new machinery pay off.

Fattening Up the Margins

On a technical basis, AMD's low-end Sempron chips are good enough to match Intel's Celerons. But they're not as profitable, because AMD's Semprons sell for an average of about $60, and most are installed in cheap machines sold in India and China. To earn Intel's 30 percent operating margins, AMD would have to sell such processors for about $100 per chip. That means moving upmarket.

"You just can't beat Intel unless you have a better product," Wu says. That's exactly what AMD has in its Opteron chips, which are designed for use in servers and high-end workstations. Opterons sell for $200 to $2,600 apiece and are said to be superior to Intel's competing Itanium 2, Xeon, and Pentium D processors. Most important, Opteron has provided AMD with the windfall it so desperately needs, with Opteron sales up a whopping 89 percent since March--enough to offset the losses incurred in AMD's other businesses.

The challenge now is to repeat that success in other segments. Focusing exclusively on narrow, high-margin markets isn't an option because PC makers prefer to buy from firms that offer a full array of processors that can be used in a variety of machines. "No one wants to do business with a niche chipmaker," says Ben Williams, AMD's VP for commercial business.

Key to boosting AMD's profit margins, Williams says, is the company's new Turion 64, designed for use in laptops. While a typical desktop chip sells for about $110, high-end laptop chips like Intel's Pentium M sell for twice as much. Moreover, laptop sales are booming--a report by Current Analysis shows that in the second quarter of 2005, notebook sales accounted for 53 percent of the total U.S. personal computer market, up from 46 percent last year. Although AMD holds just 11 percent of this business, the new Turion 64 chip has found a home inside 60 laptop models from manufacturers including Acer, Fujitsu Siemens, and HP.

"The Turion 64 processor matches Intel's chips and gives AMD a good fighting chance," says Kevin Krewell, editor of the industry journal Microprocessor Report. That's essential, because to make money consistently in an industry dominated by a giant like Intel, AMD needs every advantage it can get.