Will The Chip War Be Lost In The Margins?

In the week following the second-quarter earnings reports from chip rivals Advanced Micro Devices and Intel, the market has seen fit to mildly punish Intel despite impressive net income, while giving AMD a slight bump despite an operating loss of $457 million. How could this be?

The answer, analysts say, is in the margins. Intel reported 2Q gross margin of 46.9 percent, more than a point lower than the chip giant's projected figure and three points lower than the 50 percent rate that the market seems to consider a crucial jumping off point. Meanwhile, even as AMD's gross margin came in at an unimpressive 33 percent, that figure was a marked increase over the first quarter's 28 percent -- even if it was a far cry from the heady days of 2006, when the vendor reported 57 percent margins in the second quarter.

Going forward, one has to think that hitting the mark on margins has to be a major concern for Intel and AMD as the chip rivals head into the second half of the year. In last week's earnings call, Intel projected 52 percent gross margin, plus or minus a couple of points, for the third quarter. With a much steeper path to the magic 50 percent figure, AMD nevertheless targeted that number for some point in 2008 during its call.

"The 50 percent kind of gross margins are still what we're focused on as a corporation. That's still what we're aiming for. We're still focused on that, but realities do have to play into those equations, though. But we're demonstrating that we're working our way out of that hole," said AMD CFO Robert Rivet recently.

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For AMD and Intel channel partners, the question becomes: What is the emphasis on hitting lofty gross margin targets going to mean for the price of chips? In July, the rivals each had a round of price cuts on certain products, leading some to wonder if another price war was in the offing.

But a repeat of last year's chaos seems unlikely, at least for now, according to Gartner analyst Martin Reynolds.

"It's maybe not going to be the price war people are looking for. There aren't really price cuts in this business. So there's always this slope of continuous price drops, but sometimes they're more aggressive on moving forward with those cuts faster than they would normally," said Reynolds.

"But at the same time, it's not as much of a price pressure story as you might think. This time last year, they were still having to cut profits," he added, pointing out that Intel's 2Q margin woes were in no small part due to problems selling its Flash products, meaning that the vendor's ability to play pricing hardball in increasingly profitable segments might remain very potent.

"Intel, to put it bluntly, isn't good at Flash," Reynolds said.

The analyst was wary of AMD's chances to gain ground on Intel any time soon.

"There was bad news in AMD's court, because Barcelona is late and will be shipping at a reduced performance level. Across the broad market Intel has the technology advantage and they can drop rocks on AMD's head," Reynolds said.

Nevertheless, AMD's saving grace might just be its track record of surprising the market with innovative technology, he said.

"I think it's going to be an interesting year as we go forward. Will AMD be able to pull another rabbit out of the hat? Although it looks like AMD isn't doing well, they are in one of the most competitive markets in the world. And those low-price notebook markets are going to keep the PC industry going for a long time."