Apple and Intel Revisited

Note: This is a guest post from Richard Elkus, a Silicon Valley venture capitalist and executive who is the retired CEO of Prometrics Corp. and Vice Chairman of Tencor, Inc.

My book, Winner Take All: How Competitiveness Shapes the Fate of Nations (2008),was based on my experience in electronic audiovisual recording and the production of equipment used in the manufacturing of semiconductor devices, areas that in one way or another affected every other product and market on earth. The products from these technologies have proliferated exponentially since inception. For example, video recorders in 1970 had a market approximating two hundred million dollars and a unit volume measured in thousands. Today, the cell phone market alone, embodying cameras and displays, is measured in billions of units. At the core of all of this functionality sits one indispensable device that processes the information: the semiconductor. Today you can’t build a car, an airplane, a train or a boat, let alone a television set or a computer, without using electronic audiovisual recording and the semiconductor. These technologies and their respective products and markets are essential to economic growth. For the United States, they are at the core of economic competitiveness, military strength, and political might.

Audiovisual communication products have grown exponentially in technical complexity and function. Yet the cost of those products has dropped precipitously. The first video recorders cost thousands of dollars each. Today a cell phone including a camera can cost under a hundred dollars with better features and performance. The consumer loves the result: great products at ever-decreasing prices. On the other hand, the cost of manufacturing facilities to make those products has risen exponentially. From 1983 to 2008 the cost of a fabrication facility to manufacture semiconductor processors rose from fifty million to five billion dollars. Now, five years later, that facility can cost up to fifteen billion dollars. The economic bet is that the products resulting from this equation (very expensive capital equipment manufacturing millions of technological products at a low price), will create markets large enough to pay for the investment plus a handsome profit.

Innovation, product development, and the commercialization of technology products can produce spectacular results. In 1997, Apple was on the verge of bankruptcy when Steve Jobs returned to the position of CEO. With singular determination to focus on a few products, Jobs set Apple on a fifteen-year course to become the most valuable company on earth, more valuable than the market capitalization of Microsoft and Google combined. Jobs set out to control the integration of software and hardware in a way that the consumer could hardly have imagined. Jobs didn’t just change lives; he altered the course of audiovisual communications.

Apple’s product lines rely on parts from various vendors. One of those vendors, Samsung, provides key components to Apple, including semiconductor processors. This presents a major problem. Samsung, unlike Apple, is vertically integrated. It produces its own semiconductors as well as the products that use them. Samsung’s Galaxy smartphone is the iPhone’s largest competitor. The relationship between Apple and Samsung has become strained as they continue to fight over intellectual property rights. Apple needs another source of supply. But other semiconductor manufacturers are difficult to come by and once chosen require extraordinary investment by all parties to the relationship. A new relationship like the current one with Samsung will be very hard to break.

Intel’s launch of the microprocessor was perfectly timed for the PC market. Coupled with Microsoft’s Windows, Intel established a monopoly in PCs and became the largest semiconductor manufacturer in the world with the highest profit margins. Its manufacturing expertise remains preeminent. Intel’s investment in R&D and capital equipment, unrivaled in the past, now has two competitors of like size: Samsung in Korea and TSMC in Taiwan. Unlike Samsung, Intel produces semiconductors but not end-use products. As the wireless market began to expand it did so without Intel as the market leader. Other cheaper processors suited for the wireless environment took Intel’s place, including Samsung’s processor used in the Galaxy and the iPhone. As the world goes wireless and the PC becomes less  a factor in the marketplace, Intel’s outlook appears less predictable than in years past.

Intel is producing processors for Apple computers but not the iPhone and related wireless products. So here are two major U.S. companies, powerhouses in their respective fields, each, potentially very valuable to the other. Intel’s engineering and manufacturing expertise combined with Apple’s success in wireless communications, in some mutually beneficial way, might be a winning combination. And it’s made in America. Perhaps the relationship of Apple and Intel should be revisited.