The Falcon and the Inchworm

Falcons are said to be the fastest moving creatures on the planet, reaching speeds of over 200 miles an hour when diving on a prey. Inchworms, on the other hand, are among the slowest moving creatures on earth. When disturbed, some species even stand erect and motionless, like twigs on a tree!

THE FALCON
Intel Corp (INTC) was one of the biggest, fastest growing companies in the world.  From 1998 to 1999 the company's market cap increased 39% to $275 billion. That's when Andy Grove retired as CEO. Since then its stock price has been sinking. By March 30, 2005 INTC's market cap had dropped 46% from its peak to $148 billon.

Here's a snapshot of Intel's fall, taken through the lens of the competition for customers and capital:

 

The blue circles are Intel's share of the market value (year-end stock price times number of common shares outstanding) created by the top 23 semiconductor manufacturers from 1991 through 2005. The green diamonds are Intel's share of sales revenues generated by those competitors.

In all but four of the years up to the one where Grove retired, the company posted a positive differential in its share of value over share of revenue. In 1998 that differential reached 18 points with Intel creating 69% of the industry's $286 billion market cap, while it generated just 51% of its $52 billion in revenues. The shareholder value created by Intel was five times greater than its sales revenue. This was a good thing. By December 31, 2005 Intel's fortunes had reversed. Intel's 35% of the industry's $291 billion market cap was 14 points less than its 35% of $80 billion strategic group revenues.  The company was no longer a winner. Its market cap was in steady decline. The falcon was falling.

The slowdown after 1996 and the roller coaster in the years that followed resulted in a fifteen-year enterprise marketing risk of 19.2. This is a big number. Enterprise marketing risk is a measure of volatility calculated by the standard deviation in the difference between a company's share of value and share or sales over time. This volatility suggests that investors can expect further lare swings in Intel's value-sales differential. Can the new CEO and his team change this picture?

A FOCUS ON EVERY MARKET
Paul S. Otellini is the first CEO in the company's history without an engineering degree. Before he joined Intel in 1974 he got an undergraduate degree in economics and a business degree from Berkeley. Now, as CEO he plans to change everything. Business Week's January 9, 2006 cover story was "Inside Intel:"

Under Grove and successor Craig R. Barrett, Intel thrived by concentrating on the microprocessors that power personal computers. By narrowing the company's focus, the duo buried the competition. They invested billions in hyper-productive plants that could crank out more processors in a day than some rivals did in a year. Meanwhile, they helped give life to the Information Age, with ever-faster, more powerful chips. Otellini is tossing out the old model.

Instead of the intense focus that drove Intel under Grove's leadership, Otellini plans to enter a dozen or more new markets ranging from health care to cell phones. And to do it he's given marketing a powerful seat in the board room.

CLEAR OUT THE COBWEBS
Otellini hired Eric B. Kim away from Samsung to be Intel's new CMO in November, 2004. And Kim reported directly to Otellini. At a gathering of senior executives on October 4, 2005 Kim revealed the bones of the company's new marketing strategy. Quoting "Inside Intel" once again:

Kim declared that Intel must "clear out the cobwebs" and kill off many Grove-era creations. Intel Inside? Dump it, he said. The Pentium brand? Stale. The widely recognized dropped "e" in Intel's corporate logo? A relic.

A CONTINUOUS WORLD
Everyone thinks the world has gone digital. In fact, it's a continuous world and always has been. Sounds, images, time, temperature, distance, speed, weight, and height all are continuous dimensions of reality.

So how do you convert all these things to a digital format? With analog integrated chips! An analog chip is needed to convert music to zeros and ones for efficient digital storage on a CD. And to convert it back again so we can hear it. Same thing for DVDs. And cell phones.

THE INCHWORM
A 2006 Forbes article on "America's Best-Managed Companies" calls analog chip design the black art of engineering:

At 25-year-old Linear Technology, where high-performance analog chips are made for 15,000 different products, 250 analog engineers each spend a year and a half to make a new design. … Linear manufactures its own chips and focuses on markets where it can get designed into a machine or product for the long haul …

Linear Technology (LLTC) is the most efficient company in the business with gross margins of 79% compared with Analog Devices Inc. (ADI) of 60%. Intel's gross margin is 52%. In 2006 LLTC sales revenue was $1.13 billion. Its gross profits were $890 million. In that Forbes article the CEO, Lothar Maier said "Linear takes the creativity of our engineers and turns it into cash."

PRICING POWER
Donald Mitchell and Carol Coles provide insight on how Linear Technology does it in the fifth part of their essay on "How to Enhance Your Organization's Business Model." The authors say Robert H. Swanson, Jr., LLTC's previous CEO figured:

… that reducing power usage would make cellular telephones and other portable electronic devices (such as laptop computers, digital still cameras, MP3 players and personal digital assistants) more valuable to end users by increasing how long the equipment could be operated between battery charges and changes … Improvements in battery technology would make the company's power management chips even more valuable by adding new dimensions to what portable devices do.

AN INCHWORM RISING
The blue circles in this chart are LLTC's share of market value created by the same 235 companies in the Intel graph above, along with the company's share of group revenues. In most years the company's share of value was three times its share of revenues. This is a picture of an inchworm rising:

 

Linear Technology's enterprise marketing risk was a small 0.9. This suggests that investors can expect the pattern to continue in the future.

PUT YOUR MONEY DOWN
Well there you have it. Two short stories about the Falcon and the Inchworm charting their future in an industry with a 2005 market value of $2914 billion. Where would you put your money? On the falling Falcon with a billion dollars a month in free cashflow and a strong marketing voice on the board, or the rising Inchworm that turns its engineers into cash? Don't keep your choice a secret. Post it with your comments!

~V

Comments

[Victor Cook]

Intel has been working on combination analog-digital chips for years. Do you think its a good idea focus on lots of new markets? For example, Intel's extensive enthnographic research (undertaken as part of its emphasis on marketing) led to the development of the Classmate PC (http://www.classmatepc.com/) for students in emerging markets. Its currently in pilot testing in Brazil.

[Deaf,Lake,Moon]

I know how the Duo Core burried the competition. My new Gateway PC runs the Core 2. The praise I found on the web for this chip while I was looking into the purchase was absurdly good. Also they started using these Intel chips on HP machines again. As far as the Falcon and the Inchworm are concerned are you saying that Intel hopes to get into the analog chip market? And is that a good or bad idea? Personally I think it is marvelous that these analog chips extend battery life.