Shortly after pre-announcing dismal Q3 results, reports have surfaced that Advanced Micro Devices (NYSE:AMD) is planning a round of layoffs that could reduce the headcount of the struggling chip designer by 20-30%. The layoffs are expected to hit engineering and sales, and according to a report, "could be deep enough to scale back some products". The question, now, is whether these layoffs will serve to make AMD leaner and meaner, or if it will simply cripple the talent pool to the point where the company no longer has any chance of being remotely effective?
Excessive Cost Cutting
AMD's last two earnings reports have seemingly been proud of the continued drops in operating expenses, despite weakening revenue and gross margins. Cutting unnecessary operating expenses by limiting PCard usage, laying off dead-weight employees, and cutting administrative overhead is generally a good thing. However, in a fiercely competitive, technologically driven space such as high performance microprocessors and graphics processors, there's no room to blink.
See, I think the problem is that AMD's CEO is attempting to leverage his experience at Lenovo by applying the same cost-cutting tactics to what is fundamentally an R&D-driven business. While the PC OEM business is all about cutting operating expenses and costs to the bare-minimum since the barrier-to-entry is low and the margins even lower, the chip business is different. There is clear differentiation between products based on performance, power consumption, die sizes, and so on. Simply put, the better and cheaper your mouse trap is, the stronger the business is likely to be going forward.
Engineering Cuts Are A Bad Idea
The problem with the purported job cuts is that they will reportedly be hitting the engineering staff. While I am not privy to the exact details of who exactly will be laid off, any material cuts in the engineering staff will likely signal a death knell for the company. Why?
Well, first off, with less engineering talent, the remaining individuals will be put under more severe strain as per-capita the workload will increase quite heavily. Next, if talented engineers are being let go (and not just the dead weight), they will find homes at other semiconductor companies that would love to have that expertise. Nvidia (NASDAQ:NVDA), Qualcomm (NASDAQ:QCOM), and Intel (NASDAQ:INTC) would love to have that extra talent to give themselves an even bigger competitive advantage over AMD, especially as these firms are all much better capitalized.
Finally, without top engineering talent and resources, the products simply won't be competitive. Unfortunately for the company, it seems that Intel managed to yet-again take share in the most recent quarter on the CPU side. Given the implied weaknesses in the discrete GPU space, it stands to reason that Nvidia managed to take share in the discrete GPU space (since the company has been doing so even in a supply-constrained environment). And in the tablet space, while AMD finally announced a decent solution, it is still measurably behind its competitors on a power consumption and system-on-chip integration level. Without the technical chops to drive the next generation, it is hard to see the company becoming a more viable competitor in the future.
Could Layoffs Improve Focus?
The good news is that AMD still has a lot of good technology. The bad news is that it's really spreading itself far too thin. On the CPU space, it's going up against Intel - a behemoth with a sizable gross margin advantage due to its design and manufacturing advantages, allowing it to command high ASPs whilst keeping costs to a minimum. On the GPU side, it is competing with Nvidia, whose latest generation "Kepler" parts are generally considered more efficient than AMD's parts (although the delta is not anywhere near as wide as that between AMD's and Intel's CPUs).
It is absolutely time for AMD to find a high margin area and focus on it, and it seems that the layoffs may be in service to that goal. However, reports say that these cuts and outsourcing will apparently hit AMD's graphics division the most - it's most profitable, highest margin segment. Now, AMD has been losing market share to Nvidia over the last several quarters, and if the company's technology suffers as a result of headcount reduction or outsourcing, then it will accelerate the share loss in this successful area.
Right now, AMD is in a tough spot - the general weakness of the PC space and the strength of its competitors have proven to be much more significant headwinds than anticipated. As a result, management is trying to maintain profitability by aggressively cutting operating expenses via layoffs. If the company is able to cut "dead weight" and become a leaner, meaner execution machine, then it will thrive going forward. If the company is cutting key engineering talent, then it is in effect undergoing a lobotomy and putting itself out of the running for anything but Nvidia's and Intel's low margin scraps.
Clarity will hopefully be given at the upcoming earnings call scheduled for October 18th.
Disclosure: I am long INTC, AMD, NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.