Intel Corporation (NASDAQ:INTC) has dominated the microprocessor industry since the mid-1980s. It has held about a 90% share of the market throughout the last two decades thanks in large part to its partnership with Microsoft Corporation (NASDAQ:MSFT). Many competitors have come and gone, but only one competitor, Advanced Micro Devices, Inc. (NYSE:AMD), has been stubborn enough to stick around despite a long history of value destruction.
However, the moody Mr. Market is not satisfied with Intel’s dominance of CPUs for the maturing PC market. Instead, the market has grown concerned over the emergence of ARM Holdings plc (ADR) (NASDAQ:ARMH) — a chipmaker for mobile phones and tablets. ARM is head and shoulders above the rest of the market — including Intel.
To understand the threat that ARM poses to Intel Corporation (NASDAQ:INTC), investors must first understand the nature of Intel’s dominance.
Market dominance
For microprocessors — or almost any product, for that matter — the two main considerations of buyers are price and quality. Ever since International Business Machines Corp. (NYSE:IBM) licensed Intel Corporation (NASDAQ:INTC)’s microprocessor, Intel has had an advantage in both price and quality.
Although various well-funded challengers have attempted to break into the market, only AMD has stuck around long enough to make a good illustration of why Intel has been able to maintain market dominance for so many years.
Upon first glance, AMD appears likely to have a higher rate of innovation than Intel because it spends a greater percentage of sales on research & development.
In reality, AMD’s R&D spending is dwarfed by Intel’s. This is because Intel has an enormous share of the market, and thus, much more revenue.
No matter how much AMD spends, Intel Corporation (NASDAQ:INTC) can always spend more. This gives it an advantage in both price — because it has higher margins, Intel can lower prices and still earn a profit — and quality — because it spends more developing its product.
Even if AMD were to come up with an innovative new chip — which it has done before — it still couldn’t gain much market share from Intel Corporation (NASDAQ:INTC). This is because Intel’s customers are somewhat sticky. For instance, Microsoft is not going to jump ship and switch to AMD because of some incremental improvement in the microprocessor. Instead, it gives Intel the chance to catch back up so that Microsoft does not have to switch all of its products over to a new device. The same is true with most of Intel’s customers.
AMD’s existence is futile; it will never earn its cost of capital as long as it competes directly with Intel.
A new challenger?
But as we enter the era of smartphones and tablets, Intel’s dominance is coming into question. In the same way that Intel dominates the PC market, ARM’s chips dominate the handsets and tablets market.
Intel’s Atom chips compete with ARM’s chips, but ARM’s are much more energy efficient than Intel’s. This drastically prolongs the battery life of the device — which is usually more important than performance.
It is possible that many consumers view low-end PCs and tablet devices as substitutes, which means that Intel must capture part of the tablet market in order to avoid losing sales.
While Intel is clearly behind in the race, one chart gives me confidence that it will soon catch up:
It will not be long before Intel Corporation (NASDAQ:INTC)’s better-performing (i.e., faster) microprocessor will become energy-efficient enough to make ARM’s chips an afterthought.
Bottom line
In most industries where economies of scale provide a competitive advantage, many firms share near-equal scale — creating a competitive environment among current players. However, no other chipmaker even comes close to matching Intel’s scale. Thus, Intel will always have a larger R&D budget and will always dominate the industry.
The article Is Intel Doomed? originally appeared on Fool.com and is written by Ted Cooper.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
