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Intel faces up to ARM

|Includes:ARM Holdings, plc (ARMH), INTC

Who today remembers Little Giant, Link Belt, DEC, Wang, ICL, and who in a decade will remember Sun? I could go on. 
Innovation is not a safety razor, it cuts two ways. Clayton M. Christensen’s celebrated study, The Innovator’s Dilemma - When New Technologies Cause Great Firms To Fail, clearly illustrated the painful side of innovation. Chips, software and the internet now influence most of the economy and so creative destruction will accelerate. Take a peek at the advertising, newspapers, music, financial services and the automotive industries if you are in doubt. 

Christensen looked at steel mills, mechanical diggers, motor bikes, cars and information technology and saw the same pattern, killer products inevitably begin life as devices built with a low specification that initially address a limited market. If the technology has legs these devices will improve and eventually topple the entrenched giants. Like evolution the march of disruptive technologies does not stop. This week we will take a closer look at a range of global companies that could win or lose from the latest disruptive technologies. We also revisit another of our themes, rare earths, which are used in a range of electrical goods, such as hybrid cars like the Prius. China controls 97% of the supply of these materials and there are fears that it might restrict their sale. 

ARM vs Intel 
Christensen’s key idea was what he termed ‘disruptive technologies’. As he described them, disruptive technologies ’are typically cheaper, simpler, smaller, and, frequently, more convenient to use.’ My favorite example from the book is hydraulic diggers. These were introduced after the Second World War, at a time when the excavator market was dominated by firms such as Insley, Koehring, Little Giant and Link Belt. Their wire enabled diggers specialized in shifting large payloads. By contrast, the new generation of hydraulic diggers were not as powerful. Therefore, they were used to dig ditches and other small scale work. Over time, as the hydraulics became 
work. Over time, as the hydraulics became more powerful they were able to undercut the old cable actuated diggers, having first achieved scale and economy in their niche market. New companies, such as JCB, John Deere and Caterpillar successfully used hydraulic systems to over run the excavation market. 
The rise of 3G 
Today there are 830 m 3G subscribers, a number that is expected to treble by 2013, which is just over three years away! Phones are small, simple to use and thanks to the subsidies given by operators in some countries, they are cheap. This year roughly 200 m smartphones will be sold and this number is expected to triple by 2012. Over the last five years smartphone sales have increased more than eight times. By 2011 - but I wouldn’t be surprised if it were next year - there will be more smartphones sold than personal computers. 
A smartphone however, is not a personal computer - right? At this point I have to dust off one of my favorite quotes. In the 1980s Digital Equipment Corp was the world’s second largest computer company and its founder, Ken Olsen, was widely feted as an industry seer and brilliant engineer. As personal computers boomed Olsen opined that the craze wouldn’t last. The trouble, he said, was that you couldn’t network a PC! That was how Ken Olsen went from seer to sap. DEC fortunes plummeted as PC sales soared and eventually it was bought by Compaq, which later itself was swallowed by HP. 
Olsen, like the engineers at GM who couldn’t see what Lithium-ion was capable of (see quote in box above), correctly identified the shortcomings of the first generation of PCs, but failed to anticipate that it would only be a matter of time before the networking weakness was solved. The future for Olsen and DEC was too horrible to contemplate in a world dominated by networked PCs, so no surprise he had a blind spot. Technology is all about Black Swans.. Just like stock market crashes and earthquakes, Black Swans usually give many warnings before they arrive but most of us ignore the clues. 

Like hydraulic diggers and personal computers, smartphones cannot compete directly with the incumbent - you are not likely to write an entire word document on a smartphone, or a spreadsheet and neither are smartphones particularly good at surfing the net. Like all disruptive technologies before them smartphones have created their own market and this is the problem for Intel, while being an advantage for ARM. 
The processors inside smartphones are as powerful as those that powered the PC about five years ago. PC’s will always be more powerful and Intel will probably always dominate the PC business - but is that business worth dominating? 

Today’s ARM processors are the size of a large spec of dust, In fact they are so small up to five at a time can sometimes be found within a smartphone. This is the key to ARM’s success as well as being the problem for Intel.
Arm was founded in 1985, and from the beginning the company focused on designing Reduced Instruction Set Chips -RISC- that were ideal for battery powered devices that were only required to do a limited number of tasks. By comparison, Intel built its dominance on Complex Instruction Set Chips -CISC-good for general purpose computers where energy consumption and space were less of a problem. 
ARM earns 70% of its revenue from mobile phones and by now you will have realized that the new generation of mobile phones are taking powerful computing into areas that desk top computers and CISC chips cannot follow. ARM’s RISC processors have all the makings of a disruptive technology: they began as simple devices but can now achieve all that is required to build a device that consumers love. By 2013, according to Ericsson and others, nearly 70% of the 3 billion or so devices that will be connected to the internet will be mobile. Welcome to the world of Arm. 

Intel’s recent announcement that it is to buy Wind River, a producer of ‘embedded computers’ ( which means the user cannot program them), and 
the development of its Atom family of microprocessors, are attempts to win in the new world of embedded, mobile devices. Success will be limited because ARM has, over the last twenty years, built an unrivaled library of tools and developers that not even Intel can rival. 
In addition, ARM’s business model is better suited to the new world. Unlike Intel, Arm does not manufacture chips, instead it licenses them to other producers, including Intel itself. By contrast, Intel’s model is a throw back to a previous age where chip companies both built and designed their own devices. 

Intel will continue to dominate the personal computer world but will find it difficult to challenge the dominance of ARM in the embedded universe. Intel’s problem is that ARM processor designs are spreading from its heartland of mobile phones into netbook computers and consumer electronic devices, such as the new generation of high definition, flat screen TVs. Like phones, TVs are embedded devices and increasingly power consumption is becoming an issue. The great advantage that ARM has is that there are more developers and product designers behind it than Intel, when it comes to embedded devices. The future will be dominated by the Internet and mobile devices, not desk top PCs. Intel can play in this market but because it does not own the logic design it cannot achieve the same margins that it did in the PC business. Imagine ARM as Switzerland, it can supply all other producers who can then go to Taiwan Semiconductor, or UMC, to have their devices made. Therefore, ARM in combination with TSMC is, in our view, a better way of playing the move to a content centric age.

This is an excerpt from a longer piece that appeared in Cykepartners Research dated 3rd September

Stocks: ARMH, INTC