The future looks bleak for AMD

It's almost an annual ritual: PC chip maker Advanced Micro Devices suffering from manufacturing problems, gets whacked by price pressure from its rival Intel.

Last year, AMD recovered, but at the cost of three losing quarters in a row. This year could be worse. Both AMD (NYSE:AMD) and Intel (Nasdaq:INTC) cut prices on Monday. "They are clearly having problems attaining a profitable business model," said Linley Gwennap, analyst at chip-technology follower MicroDesign Resources. "They are really counting on K6-3 and then the K7 to save them."

Those chips are due at the end of Q1 and Q2, respectively. And Intel's not willing to wait around. Despite an impending appearance in front of the Federal Trade Commission for alleged antitrust practices, the chip giant is not slipping on the kid gloves. "It is a competitive market -- there is absolutely no doubt about it," said Seth Walker, an Intel spokesman. "The reality is that we only cut prices on our low-cost PC parts."

That means a potential profit hit to an already beleaguered AMD. While the company's K6-2 is a hit with low-cost PC manufacturers, AMD's single chip makes it an all-or-nothing bet in the processor market. Where Intel's broad line of products -- from server-level Xeon processors to low-cost Celeron processors -- gives the company room to boost prices on Xeon processors to subsidise the Celeron, AMD has little room for missteps.

And AMD has stumbled. Last quarter, a manufacturing glitch meant fewer of its top-end 400MHz processors coming off the production line closing a window for AMD to maximise profits. "They introduced the 400MHz part at $283 (£173), so it looked that they were going to finally make some money," said analyst Gwennap. "Then the chips failed to come, and now Intel has come in with price cuts." The 400MHZ K6-2 has now dropped in price to $134 (£82), less than half the price at its introduction.

AMD has also lost an important image battle with Intel. Despite the company's attempt to set the K6-2 in the same league as Pentium II, Intel's counter-marketing efforts have successfully put the K6-2 permanently in the ring with the company's low-end Celeron. "AMD used to promise to keep prices 25 percent below Intel's comparable products," said an executive at one PC maker -- an AMD customer -- who asked to remain anonymous. "Now I see them shooting for pricing parity. They are trying not to be priced lower than the Celeron, and I don't know if they will be able to do that."

This is despite little performance difference in any of the chips under business benchmarks, according to MDR's Gwennap. "It is interesting to see that plus or minus 2 percent in (benchmark) performance can make a difference of $200 (£122) in price," said Gwennap, who estimates that a Pentium II may outperform a Celeron by little as 2 percent, for certain applications.

Still, Intel's hard-ball price cuts are nothing new. "We have some pretty standard moves," said Intel's Walker. A year ago, Intel cut the price on its Pentium MMX chips by up to 42 percent, putting pressure on a then-struggling AMD's K6 margins. At that time, AMD's white knight was its K6-2, which came out in May.

Like Intel, AMD also knows what it has to do this time around as well. "Enrich the mix. Every quarter," said Scott Allen, spokesman for AMD. "The name of the game is quite simple. But it is not easy, we learned that the hard way last year."

A year ago, AMD was in the midst of a manufacturing crisis, unable to get its processors out the door and to its customers. In contrast, the company made more than 5.5 million processors in the fourth quarter of 1998. Still, Intel's price slashing has had its intended effect: AMD's average selling price for its processor was $89 (£54)-- well short of its goal of $100 (£61).

This quarter, Allen said the company expects the average price and volume to remain the same, but higher R&D costs will sink the company's slight profit in the previous quarter.

Not all the news is bad, however. For the low-cost PC makers, the battle over the bottom end means better profits and more powerful products. "This is driven by Intel's decision to be aggressive in the (low-end) market," said Steve Dukker, president and CEO of low-cost PC maker Emachines, who added that he expected more powerful machines to appear that much sooner thanks to the Intel/AMD rivalry.

For the long term, the news could be less rosy, stated Matt Sargent, analyst with computer-industry watcher ZD Market Intelligence. "It is obvious that Intel is trying to shut out Cyrix and AMD so that they can go back to collecting their huge margins on their products," he said.

If so, the low-cost PC renaissance could be a short one. For AMD, the remedy is clear: Deliver a 450MHz version of the K6-2 by the end of March, manufacture its K6-3 in volume by Q2 and, ultimately, make good on its promise to deliver its high-end K7 processor by the end of June. A fine plan, said Sargent. "The question is can AMD tough it out long enough to get to the K7?"