Do technology companies possess a sustainable competitive advantage? Warren Buffett doesn’t think so, primarily because of the heavy R&D budgets that weigh down profits and require them to remain competitive. But with the right synergies, tech firms definitely can achieve massive gains.
A Capital Intensive Business
According to a Booz & Company report, six of the top 10 most innovative companies in the world operate in the technology sector. Among them is Intel Corporation (NASDAQ:INTC), which spent $10.1 billion on R&D in 2012. Such large costs likely will not dwindle anytime soon.
According to Intel’s CTO Justin Rattner, “…fifty cents of every dollar goes into exploratory stuff and the other fifty cents of every dollar goes into tech that serves the business unit that makes the money.” For a firm that generates 60% of its revenue from the declining PC industry, this formula is perplexing.
Just what does Rattner have in mind? The future.
Inside Intel
During the first quarter, Intel Corporation (NASDAQ:INTC) generated $4.3 billion in cash, paid $1.1 billion in dividends, and repurchased stock valued at $533 million. These are all phenomenal indicators that Intel is healthy — especially the cash generated.
If Intel wants to stay on top of its game, though, it must accomplish three objectives:
1. Expand into the mobile market by partnering with firms that can utilize its technology and products
2. Diversify income streams by decrease its 60% dependence on revenue from the PC market
3. Monetize R&D initiatives by bringing ideas to market
How Google Inc (NASDAQ:GOOG) could wreck Intel
Research and development giant Google Inc (NASDAQ:GOOG) poses a large threat to Intel Corporation (NASDAQ:INTC) on two fronts. First, Google is entrenched in markets Intel desires to enter, notably the mobile industry. Second, some of Google’s groundbreaking products, like Google Glass, utilize products from ARM Holdings plc (ADR) (NASDAQ:ARMH), Intel’s direct competitor. If Google is continually pleased with ARM’s technology, the partnership between the firms could quickly become a piercing thorn in Intel’s side.
While Google Glass was under development, Intel Corporation (NASDAQ:INTC) endured an identity crises. During this time, Intel’s management decided to transition from designing chips, processors, and technology for the PC market to offering products and services applicable to the mobile industry. All the while, ARM continued to focus on its niche market — designing technology for electronics and technology companies.
Seemingly at Intel’s expense, ARM grew rapidly.
Then everything changed. Intel had enough.
ARM’s worst nightmare became reality. Intel waged war. Samsung announced that it chose Intel’s chip for its new tablets. Intel’s Clover Trail + Atom system-on-chip is less expensive than ARM’s equivalent. Moreover, Intel Corporation (NASDAQ:INTC)’s next-generation core processors based on the Haswell architecture will result in significant battery power savings for tablets, further pressuring ARM to produce better technology.
Why Microsoft Corporation (NASDAQ:MSFT) cares
From cloud computing to operating systems to gaming, Microsoft Corporation (NASDAQ:MSFT) is literally everywhere in the technology industry. One of the goals for its Windows RT platform, a mobile variant of its Windows 8 operating system, is to enable ARM to gain more market share in the mobile tablet market. Why? Because ARM is the exclusive technology architecture platform for Microsoft’s Windows Phones. Fortunately for Intel, the Windows RT platform seems to be on its last leg.
Ultimately, Microsoft’s mission is to “help people and businesses throughout the world realize their full potential.” It focuses on improving its existing products and services, but, as shown by its added business segments, Microsoft moves wherever customers flock. It engages customers, competitors, and creativity. Therefore, if Intel’s mobile chips continue to be more cost- and power-efficient for consumers, Microsoft could pursue a partnership with Intel to design its mobile application processors, modem solutions, and graphics processors. If such a deal occurs, ARM may be in trouble.
Moving Forward
Rattner believes that the future of technology is in wearable devices and that Intel can be a primary player in the market. To remain competitive, though, Intel must grow within the mobile market, diversify income streams, and monetize R&D projects. If Intel meets these marks, investors are in for the ride of their lives.
When it comes to dominating markets, it doesn’t get much better than Intel’s position in the PC microprocessor arena. However, that market is maturing, and Intel Corporation (NASDAQ:INTC) finds itself in a precarious situation longer term if it doesn’t find new avenues for growth.
Brendan Marasco has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google and Microsoft.
The article Intel Is Fueling for the Ride of Its Life originally appeared on Fool.com.
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