I started this post with just thoughts on my  pathetic AMD stock. Mainly, it’s become clear that everyone in the world right now seems to hate AMD (at least its stock). AMD is around its 52 week-low of $13 declining from ~$40 in the past year. This post, however is instead a far longer ramble on the two monopolies of the PC industry. Disclosure: I own AMD, GOOG, YHOO, and have recently begun selling MSFT stock.

THE TWIN-MONOPOLIES

Currently, computer makers earn pennies on the dollar for every system they sell. Yet, two companies continue to reap massive profits from each and every sale. These two companies hold the most powerful monopolies in the PC business: Microsoft and Intel.

Microsoft is obvious. Once Windows became the default for any computer shipped, MSFT had a stranglehold on every PC sale. After all, what good is a computer if you don’t think you’d be able to use most programs and file formats, etc. A PC=Windows to most users.

Intel is slightly more complicated. Despite the billions spent in branding “Intel Inside”, the average PC users still doesn’t really care what’s inside their computer. We just want it to work; to do everything we want. The microprocessor inside as visible as Windows is. Yet Intel was still able to create a monopoly, because:

a) Capacity/Production Ability: producing micro-processors has tremendous infrastructure costs. In the face of an entrenched competitor who dominates the market (Intel), building out the manufacturing capability to compete is a highly questionable decision. Further, as the creators of the industry standard, x86, they own key patents.

b) Performance: Intel’s only viable competitor, AMD has been consistently inconsistent. AMD occasionally has a superior product, followed by Intel one-upping them for an extended time. As a monopolist with a superior technology, life is pretty easy and good.

c) Pricing: Here’s where Intel puts their foot to the throat of AMD. In a brilliant  (if not anti-competitive) and diabolical strategy, Intel gives PC makers significant discounts (“rebates”) on processors above a certain threshold. Let’s pretend I make computers and ship 100 units a year. For every chip over 80, that I buy from them Intel would give me a ridiculous discount. So while I might want to give AMD 20 chips worth of business just to diversify my business (and to cultivate a competitor against Intel to prevent them from consolidating too much power), I would have to give AMD this business knowing that I’m throwing away substantial profit. Intel would price my discounts above 80 so highly that the extra chips would basically be free/below cost. For Intel, it’s a brilliant gambit. You avoid the price-war on every sale by only granting discounts when it guarantees you a monopoly with a customer. This in-turn all but guarantees that you won’t have to deal with future price competition. As a business with thin margins, PC makers find it hard to turn down all this “free profit” and so buy much less from AMD.

This is how Microsoft and Intel have become the “ two tolls” of the PC industry (and thus the “Wintel” label). Just like driving on the NJ Turnpike, if you want to get from point A to point B, you have to pay the toll. Want a PC? You got to pay MSFT and INTC. Business has been good for many years.

WHAT’S HAPPENING NOW

Microsoft/Software
Today’s buzzword is: Web 2.0. For our purposes, let’s define it as “the web as a platform.” The previous platform being the desktop computer. Yesterday when I wanted to write a document, I opened MSFT on my Windows desktop and off I went. Tomorrow I might fire up my web browser and visit Google Docs (formerly writely.com) to create that same document. I’d save it to my Google account and could access it from home, work, my parent’s computer, pretty much anywhere w/an Internet connection. Additionally, multiple people could simultaneously edit and collaborate with me on this document while I am working on it. I can’t even do that with MS Word.

How much does this magic cost? Free. MS Word is a hundred bucks or so. Hmm..

Extrapolate that out to almost every program that I use today. If I instead accessed these applications through a web browser, it wouldn’t really matter if I did this on Windows, a Mac, Linux or whatever else?  If this day comes to pass, we might all no longer pay the “Microsoft toll.” If a string of other competitive operating systems pop-up (a Google one maybe?), we’ll have price competition which will significantly bring down the cost of the toll or eliminate it all together.

Intel/Processors
AMD, the Charlie Brown of processors, appears to have gotten their act together. This is a real life David vs Goliath story. AMD’s market valuation is about $7 billion and Intel’s is $108 billion. That’s partially a reflection of AMD’s stock having been hammered due to its recent ill-fated price war with Intel.

AMD was able to counter Intel’s entrenched position using a technology edge. AMD chose a superior chip architecture, forcing Intel to eventually admit defeat and copy. During this time AMD made heavy inroads in the lucrative server market and with computer manufacturers. Dell, until recently, the world’s largest PC maker, had exclusively utilized Intel chips until this year. Now they  offer AMD products as well. AMD’s rapid share gains triggered a massive shake-up at Intel and kicked off a brutal price war. This resulted in AMD’s stock imploding. Intel, a far better funded rival pursued the cut-throat tactic of forcing AMD to stand down or face bankruptcy. AMD has chosen to not blink in their battle against Intel by matching price-cuts and continuing to heavily build out the production facilities it needs to compete.

On 4/9 AMD announced that their revenue was going to again miss estimates. They attributed this to both lower-prices due to the price-war and lower volume due to the general slow down in hardware sales. Most interestingly, AMD announced that they were going to decrease capital spending by $500 million this year. There were only two ways that the market would believe that AMD would survive: a large equity investment/financing or a big cut to capital-expenditures. Since they didn’t raise money, the question looms as to whether it was because AMD couldn’t raise it or because they felt like they could, but it wouldn’t be worth it. If the latter, AMD is betting that the $500 million investment cut will not hurt their long-term position. This is the major risk– that AMD cuts investment to remain viable in the short-term, but over the long-term Intel out-invests to build huge strategic advantages that AMD can’t match. The stock markets reaction to the investment cut (despite the revenue warning) was to cheer and bidding the stock up 4-5%.

THE FUTURE

The price of computers will continue to fall dramatically. If web-based software comes to become a widespread solution for many users, it is very likely that the day for operating system agnosticism will be upon us. This will obviously take a healthy chunk out of computer prices.

Consumers might eventually benefit from software savings, but they’re already seeing the savings in hardware. The brutal price war between AMD/Intel has dropped the prices in PC’s dramatically. Cheaper prices help sell more PC’s and so I find it hard to believe that computer makers will willingly allow Intel to have such a dominant monopoly over them again. Why would they willingly give Intel back their pricing power?

So I see AMD going in one of these three (now four) directions:

1) AMD will raise enough funding to send Intel (and investors) a clear signal that are here to stay. Nothing answers this question in the long-term other than having strong market share. OUTCOME: Intel will realize that AMD is not going away, and they are depressing their own profits in a scorched earth battle, and vicious price wars will abate. The market share will stabilize (maybe 70/30) with better (but nothing like pre-AMD Intel) margins for both.

2) AMD and Intel remain mired in a vicious price battle for years. AMD will almost certainly be able to raise funding (at least to stay afloat) if for no other reason that too many powerful people have too much at stake. It is Dell, HP, Gateway, Lenovo’s interest to ensure that Intel never has them over a barrel again. Similarly, the Googles of the world building out massive server farms also share this interest. Eventually Intel’s management will have to step down because AMD and Intel have battled so viciously over price that  angry shareholders will have had enough.

3) The most interesting scenario: Could Dell or HP just buy AMD? This would given them a huge cost advantage over all of their competitors due to vertical integration. Also, it would mean Intel would probably return to high pricing margins leaving competitors with an even great cost disadvantage. How about Apple buying AMD? They switched over to x86 recently and use Intel chips. They could swallow AMD whole, have another powerful differentiator from PC’s and save a little dough. How about Microsoft? Yeah, MSFT. What if the king of Redmond also envisions the day when people might become O/S-agnostic and decide that they, like Apple, will own their machine end to end (hardware and software). Why not build an elegant solution running on AMD chips that no one else can match? Does Google really want to eventually put a computer in every home so they can access Google services? Maybe AMD could help with that…

4) AMD cuts capital spending and invests only in what’s critical to keep up with INTC. Strategically, they could also be doing this to gain more favorable financing terms by signaling options. In this case, they could announce next quarter an investment infusion and ramp capital expenditures. If this does not come to be, AMD likely hopes to succeed in cutting investment in very long-term areas that won’t cripple the company in the next 2-5 years. They would then hope to be able to ramp up investment when financial conditions improve. Otherwise, AMD is blinking. Basically, INTC was able to play the killing stroke that AMD won’t feel until a few years from now. At that point they’ll  find themselves at such a position of cost or technological inferiority that actively competing with INTC is an impossibility. Obviously if you believe this to be the case, you should be selling!

Previously, I thought the scenarios were ranked in probability order. Although if I was Dell or HP, $10 billion isn’t a lot of cash to gain such a potentially key strategic advantage. However, given today’s announcement it’s clear that AMD has chosen #4, to cut spending. This puts to rest immediate liquidity and viability questions, but raises new long-term ones. It will be interesting to hear on their earnings call next week a) where the cost cuts will be coming from b) whether AMD is closing the door on raising more capital this year for further capital investments.

I didn’t discuss a few other factors which I’ll sweep in here:

1) AMD is currently suing Intel for anti-competitive practices. If the way I described Inte’s tactics sounded a little monopolistic, it’s probably because they seem to be. Fortune has written some excellent articles profiling Intel behavior and the lawsuit over the past couple of years. Intel was just in the news because they announced they “lost” critical emails. All of this news combined with the whispers you hear from manufacturers, tell the story of a ruthless Intel doing everything in its power to kill AMD. If this comes to light, a substantial settlement (billions) would not be surprising. The irony is this settlement could cement AMD’s long-term position by giving it the funds to invest in R&D and facilities needed to compete.  Strategically though, Intel would delay until the very end, so this is unlikely. If AMD doesn’t last, Intel might be happy to pay their creditors or a shell of their former arch-enemy billions. The death of their only competition is worth tens of billions.

2) AMD is scrappy and quite brilliant. Despite having an R&D budget less than a quarter of Intel’s, AMD has frequently out-innovated them. This is very impressive and speaks to the power of the talent at AMD. If one were to browse message boards and blogs, AMD also seems to have won the PR battle of the better company to work for. A quick glance reveals that former INTC employees and partners are quite scathing, whereas AMD has won the hearts of those in the computer industry. INTC is (nearly) in the same boat as MSFT in this way.

3) Dell has been pushing AMD hard lately. Dell went from zero AMD, to very quietly featuring AMD in most of their print advertisements. This could be due to ridiculous prices that AMD is offering or it could be due to Dell wanting to break INTC’s stranglehold on the market. Either way, getting AMD out there as a component in most PC’s does more than any advertising ever could, because it positions them as a clear alternative. Dell is as main-stream as it gets, when they start pushing AMD processors, consumers start to ignore the fact they had gotten used to buying Intel processors all those years. While Intel has built great brand awareness, it has failed to stand for anything. All of their marketing spending through has gotten them nothing but the equity of “being inside of people’s computers”. That’s not a defensible marketing positioning. In fact, as a brand manager let me tell you: that positioning really, really sucks.

So I’m betting on AMD. For now. If they’re cutting into the future for the sake of the short-term, I’ll get out. I also believe that the PC manufacturers should have their heads examined if this is the case: they’re handing back over monopolistic pricing control to Intel. If they do that, when the chickens come home to roost, you don’t want to be holding Dell, HP or any of those other stocks. But Intel would look pretty good again– after all, monopolies always do.

3/11/13 – I lost a ton of money on AMD. The trends were right. Microsoft is under assault from the web and Apple. Mobile has absolutely battered Intel as they’re not in these devices. iPhone, anyone?