(This article originally appeared in the Mercury News on August 17, 1998.)

Chip maker Advanced Micro Devices Inc. has made dramatic inroads against Intel Corp. in selling the microprocessors that power budget PCs — taking the lion’s share of that market for much of the first half of this year, and fostering competition that will continue to provide low prices even as performance rises.

San Jose-based AMD sold more than half of the microprocessors for computers priced under $1,000 for four of the first six months of this year — a gigantic leap from just 4 percent a year ago. Microprocessors serve as the brains for computers. Intel’s miscalculation of the rising popularity of cheap PCs enabled AMD to reach 51 percent of the sub-$1,000 market and 34 percent of the general consumer market in June, the latest date for which figures were available, said research firm PC Data.

Intel’s stake in the sub-$1,000 market, meanwhile, nose-dived to 35 percent in June from 72 percent a year ago. It now holds 60 percent of the overall consumer market, down from 91 percent last year.

AMD’s rise is a barometer of what the fledging company is doing right, as much as what’s ailing Intel. But despite its startling rise in the low-cost computer niche, questions linger as to AMD’s ability to sustain the competition.

AMD has grabbed market share at the expense of its bottom line — a losing long-term proposition. The company has lost money for four consecutive quarters. What’s more, the behemoth that is Intel has been roused, and next Monday releases a revamped and more powerful Celeron chip dubbed Mendocino for the low-end PC market.

Intel remains the dominant force in computing, with its microprocessors running more than four out of five of all personal computers sold. The under-$1,000 market, though growing more rapidly than any other segment, represents little more than 10 percent of overall PC sales and the larger consumer market just one-fourth of all sales.

But AMD hopes to use the growing acceptance among manufacturers and users of its chips to press into more profitable, higher-end markets, creating further competition at higher levels — a cross-over analysts say may indeed be easier to make from the base AMD has created.

Price moves buyers

Customers aren’t so concerned that Intel’s inside anymore, said Santa Clara MicroCenter store manager Red Calub. “They want the latest technology at the best prices, ” Calub said. “With technology changing on a day to day basis, whoever is offering the best price and the best value will win the market that day.”

And the business market, long an Intel stronghold, may not be as difficult to infiltrate as previously believed. More businesses are realizing less-costly systems can now meet many of their demands. Thirty-four percent of 2,600 companies recently said they would be interested in purchasing non-Intel systems while 27 percent said they were “highly motivated” to buy either AMD or Cyrix-powered computers, according to a report released two weeks ago by ZD Market Intelligence.

“That wouldn’t have been true a year ago, ” said ZD Market’s analyst Matt Sargent, who headed the survey.

AMD’s rise has not just been confined to the U.S. consumer market. AMD held more than 40 percent of the low-end retail desktop market in Japan in the first quarter of the year while Intel slumped to 60 percent, according to Dataquest Inc. A year ago, Intel’s share was 98 percent while AMD had virtually none.

“This isn’t just a blip, ” said Steve Baker, a senior hardware analyst at PC Data. “It can’t be good news for Intel.”

Intel executives declined to comment on the numbers. But executives there, including former Chief Executive Andy Grove, have publicly said that Intel misread the popularity of the budget PC segment — and that they intend to make up for lost ground.

“It was a surprise to us that it did take off so strong, ” said Mike Aymar, Intel vice president and general manager of product launch operations. “It’s not a one-size-fits-all market anymore. It’s an important segment and we’re committed to continuing to improve the Celeron line, reduce our cost and price. “

Budget computers are nothing new. But traditionally, products sold in that price range were older systems on their way to being phased out or were bare-bones machines. It’s only been in the last 18 months that manufacturers have been designing complete systems with the latest technology specifically targeted at price-conscious consumers. Compaq last February ushered in the current sub-$1,000 craze with Presario models using chips from Cyrix, a unit of National Semiconductor Corp., while other manufacturers such as IBM plugged AMD’s processors into consumer PCs.

Until this spring, Intel competed at the low-end of the market by rolling-over its older technology. Systems with Intel chips, however, were priced no lower than $999, and were suddenly being overrun by systems powered by lower-cost, high-performing AMD and Cyrix chips. Intel made its first real foray into the budget consumer market with the Celeron microprocessor — basically a weaker version of the Pentium II — which drew bad reviews and yawns.

Taking the lead

Intel’s early neglect of the burgeoning low-end consumer market helped AMD move into the lead, analysts say. Key alliances with top-tier computer makers such as Hewlett-Packard, IBM and Compaq within the last nine months played a major role as well.

“It gives them a lot of credibility now that they have big PC names backing their systems, ” said Kelly Henry, an International Data Corp. analyst. “Consumers may not know who AMD is but if it’s being backed by Compaq or HP, they know their machines are going to work — even if it doesn’t have that ‘Intel Inside’ stamp on the box.”

But the same low prices that propelled AMD’s leap to the top may be its unraveling, analysts say. When AMD Chairman and Chief Executive Jerry Sanders unveiled the K6 last spring, he pledged that prices would be 25 percent less than same-performance Intel chips. Analysts suspect that AMD often discounts even higher to woo big-name computer makers away from Intel.

“In order to sell those units and get that market share, AMD has to bomb the prices on their chips, ” said Tony Massimini, chief of technology at Semico Research Corp in Arizona. “The units sound great but at the end of the year, you look at the bottom line. And their bottom line hasn’t been great.”

Earlier this month, AMD announced it lost $64.6 million despite increased sales of its K6 line of processors. Sanders says he expects the company to post a profit next quarter, as production becomes more efficient.

AMD plans to do so by marketing itself as the value-proposition, of high performance at a cheaper price.

“If Intel drops their price, we have to drop our price, ” Sanders said.

And that strategy, some analysts say, may make profits elusive for AMD — particularly when battling a $25 billion corporation.

Intel’s most powerful weapon is its efficiency, and a global sales volume so immense that the company can turn a relatively quick profit on a new chip. Intel also can sustain a pricing war longer than AMD, because its already-high profit margins allow flexibility, analysts said.

“This puts a lot of pressure on AMD, ” said Semico’s Massimini. “Intel has worked very hard to maintain its market share for many, many years. They’re going to fight back hard.”

The next battle

The much-anticipated showdown begins next week when Intel pounces back with its next Celeron processor, code-named Mendocino, aimed at the budget consumer market.

AMD executives won’t say whether they’ll discount K6-2 processors when Mendocino comes out. The 300-megahertz Celeron is expected to cost $149 in volume while the 333-megahertz model will be at $179, said Ashok Kumar, an analyst at Piper Jaffray.

Meanwhile listed prices for the 266-megahertz K6-2 processors have dropped 39 percent since its late-May debut to $112 while the 300-megahertz chips have been cut by 41 percent, to $164.

“They’re not going to make money if they cut prices any more, ” Kumar said.

“Intel is essentially using their manufacturing prowess as a competitive weapon, ” said Mark Edelstone, senior semiconductor analyst at Morgan Stanley Dean Witter. “It’s difficult not to be left in Intel’s wake on a very consistent basis.”

To be viable in the long-term against Intel, AMD must leverage its growth in the consumer market to break into other higher-margin segments such as the business market where Intel dominates, analysts say. Higher-speed processors commonly found in performance and business machines command higher prices and margins.

The bulk of Intel’s chips run high-performance and business machines which earns it, on average, a steep 75 percent margin for its processors, said Dataquest senior analyst Scott Miller. At the low-end market where AMD and other Intel competitors congregate, margins are considerably less.

Chips manufactured by AMD netted an average selling price of $84 last quarter, while Intel, with a higher mix of products, pulled in more than $200 per processor.

AMD processors need to sell for $100 for the company to be profitable, Sanders said. Last quarter’s low average-selling-price for AMD’s K6 chips was due to “fire-sales” of older technology, he said. The next generation of processors — the faster K6-2 — sold above $100 in same time frame. “We’re confident we’ll get at least $100 for K-6 chips this quarter, ” Sanders said.

Average selling prices for AMD chips should also rise when the company releases a 350-megahertz version this quarter and 400-megahertz models in 1999. AMD also announced a collaborative agreement with Motorola earlier this month to develop technology for copper-based semiconductors. The joint venture is part of Sanders’ plan for his company to battle what he calls the “800-pound gorilla that is Intel” by becoming a “virtual gorilla” through partnerships.

Though analysts are waiting to see AMD’s financials for this quarter before making any definitive pronouncements, a good number think the company’s on the right track so far.

“They’re right now building credibility and brand awareness, laying down the foundation, ” Henry of IDC said. “They’re going up against a giant. It’s going to take some foundation building before they can build a castle there.”