Cloud Service Ecosystems Pose Inflection Point Risk for Intel
By Tony Clark, 2-Dooz Inc. – October 22, 2012 (Original Publication Date)
The computing world was once dominated by vertically oriented, proprietary host systems and network architectures. Example iconic vertically oriented systems include IBM’s 370 host and Systems Network Architecture (SNA) and Digital Equipment Corporation’s PDP-11 mini-computers and DEC-NET. The list of advantages afforded through vertical orientation included the ability of developers to exercise more control over their respective supply chains, which, in turn, yielded a larger share of the available product margin. On the host side, this situation changed with the ascent of the so called WinTel industry-wide PC architecture, which was characterized by a horizontal system orientation; whereby Microsoft provided the operating system and Intel provided the microprocessor (and other hardware). One result of WinTel was a redistribution of the available product margin to the side of the major suppliers. For example, during the past three decades, Intel—primarily fueled by the success of its Intel Inside program, design expertise and manufacturing leadership—was able to wrestle the lion share of the hardware margin away from the PC manufacturers, e.g., Dell, HP, etc. Fast forward to the present day and the dominance and influence of the WinTel architecture is now waning in the face of more proprietary, vertically oriented, cloud based service ecosystems from the likes of Apple, Amazon, Google, and others. It is the emergence of these cloud service ecosystems that pose the most pressing inflection point risk for Intel.
Intel reported its third quarter earnings on October 16, 2012. Revenue for the quarter came in at $13.5B (down 5% year-over-year), and margins were flat relative to the previous quarter at 63.3%. Margins are expected to decline to between 57% and 58% in the fourth quarter. Storage revenues were up 27%; cloud revenues were up 50%; but PC sales were slower than expected. Still, the real color in the commentary was regarding the state of the industry. CEO Paul Otellini noted, “The world of computing is in the midst of a period of breakthrough innovation and creativity.” Adding, “The level of innovation there is unbounded. I haven’t seen this [level of design creativity] in a long time.”
In a sense, Mr. Otellini was articulating what many in high tech have been observing; namely, the computing industry is going through another major transformation. The industry has come full circle with respect to the dominant architectural orientation—from the starting point of the vertically oriented systems offered by the likes of IBM and DEC through the 1970s timeframe, to the horizontal orientation of the WinTel platform in the 1980s through the early 2000s, and now back to the vertical orientation of the cloud service ecosystems today.
And contrary to popular opinion, it is the cloud service ecosystems trend, and not specifically the growth of smart phones and tablet computers, that is Intel’s greatest challenge. My reasoning for this position is as follows. Though the ARM architecture currently enjoys a lead in smart phone and tablet computer designs, I fully expect that Intel will ultimately leverage its design and manufacturing leadership to successfully counter ARM by targeting and implementing major energy conservation and performance improvements in its Atom processor. So, even though it is possible that ARM might replace AMD in the number two position, Intel will ultimately do to ARM what it did to AMD. In other words, Intel can and will take the necessary steps to ensure that ARM remains nothing more than a distant number two.
In previous Strategy Talk articles, I explained that the new customer engagement model in high tech is all about experiences creation. As it turns out, cloud based service ecosystems are a natural way of delivering these experiences. And, moreover, the ecosystems are allowing the Apples, Amazons, and Googles of the world to once again pursue vertically oriented architectures. The result is a gradual, but accelerating swing of the control pendulum to the side of the cloud service ecosystem providers. This has broad implications for Intel’s business model.
Proof of this claim was provided during Intel’s third quarter 2012 conference call. Mr. Otellini offered that revenues were light in part due to a mix change between cloud data center customers and enterprise data center customers. He noted that enterprises mostly use 4-way systems, while clouds mostly use 2-way systems. Clouds are able to use the 2-way systems because they are using them in the context of more sophisticated (and increasingly proprietary) data center configurations that allow for the use of such servers without compromising service performance and availability. Since the 2-way systems are less expensive than the 4-way systems, the growth in cloud demand is resulting in more 2-way systems sales, relative to 4-way system sales, which means less revenue for Intel. Thus, the cloud service ecosystems pose an inflection point risk for Intel.
Those are my thoughts. As always, I invite and look forward to learning what you think.