Can CEO Craig Barrett Reverse The Slide?

Cliff Edwards in Santa Clara with Ira Sager in New York and bureau reports–BusinessWeek

Intel Corp’s chief executive Craig Barrett gulps down an orange soda. After

folding his 6-foot, 2-inch frame into a chair in a cramped conference room, it’s

clear he is uncomfortable with more than the tight quarters. The topic of

discussion is his legacy–or what it will be. Halfway through his tenure as

Intel’s fourth CEO, the 62-year-old Barrett has three more years until he hits

mandatory retirement age.

Emblazoned on the awards, plaques, and framed articles crowding the walls,

the accomplishments of Barrett’s predecessors are daunting reminders of the

short time he has left to satisfy his own ambitious goal of reinventing Intel.

Here, more than anywhere else, the word "legacy" smothers Barrett.

The mementos around the room mark the legendary work of Chairman Andrew Grove,

the Midas of microprocessors who, practically by force of will and a vision of

the rapid growth of the personal computer, shaped Intel into one of the world’s

most powerful technology companies. Grove replaced Gordon Moore, the technical

genius who set in motion what became codified as Moore’s Law: that processor

performance will double every 18 months, getting cheaper along the way. Before

Moore came Robert Noyce, an Intel founder who co-invented the integrated

circuit, paving the way for countless technological advances that have formed

the bedrock of the computer industry. And Barrett’s legacy? "My legacy is

not to be the trivia question ‘Who was the fourth CEO at Intel?’" he

says. "I hope not to be ‘I don’t know, who was it’"

There’s no doubt Barrett is having a hard time earning his place on the

wall. After launching a bold strategy three years ago to move Intel beyond PCs

and into such markets as communications, information appliances, and Internet

services, the chipmaker is in its worst shape in more than 15 years. Oh sure,

there isn’t a tech exec on the planet who isn’t having a crummy year because

of a souring economy and the threat of war in the wake of the terrorist attacks.

But Intel’s problems run deeper than these events. For the past three years,

Intel has seesawed between product shortages and product delays in its core

computer-chip business. Piled on top of that have been embarrassing bugs,

recalls, and overpriced processors that opened the door for rivals. By year-end,

analysts expect Intel’s share of the PC chip market to drop to 78%–nine

percentage points below what it had when Barrett took over.

Barrett’s invasion into new markets has been even more dismal. So far, some

$4 billion of Intel’s more than $10 billion in new investments have produced

little. This year, Intel stopped making network servers and routers after some

of its biggest chip customers, including Dell Computer and Cisco Systems,

slapped Barrett’s hands for competing against them. In February, Barrett shut

down a service for broadcasting shareholder meetings and training sessions over

the Web. He shuttered iCat, an e-commerce and hosting service for small and

midsize businesses. And he has retreated so far in the information-appliance

business that Intel now markets its Web-surfing devices only in Spain.

Earnings drop

What went wrong? Critics say Barrett has been trying to move Intel into too

many new markets, fracturing the company’s focus on its core business. To

execute on so many fronts, he has decentralized the organization and delegated a

lot of decision-making. But getting a workable structure in place has been a

challenge. Barrett has restructured the business groups at least three times in

as many years, shuffling execs like cards in a deck. Even in the core

microprocessor group, a startling 80% of the unit’s staff were given new roles

in a March shakeup.

Now, Intel is bracing for its worst financial results since it fled the

memory-chip business in 1985. Sure, the entire semiconductor industry is in its

worst slump in a decade, suffering from overcapacity and weak demand that will

cause global chip sales to tumble 34% this year, according to researcher IC

Insights. But Intel will take a bigger hit, because it has failed so far to wean

itself from dependence on a slowing PC business. Intel’s revenue is expected

to decline 52%, from $33.7 billion in 2000 to $25.5 billion this year–the

chipmaker’s first revenue drop since the 1985-86 tech recession. Profits are

falling off a cliff, too, plummeting from $10.5 billion in 2000 to $773 million

this year, estimates Merrill Lynch. And it’s likely to get worse. In the week

following the September 11 attack, UBS Warburg analyst Don Young says retail PC

sales tanked 50% year-over-year at a time when most were expecting a pickup in

demand. And the news from corporate America isn’t any better. Consider Frank

Fanzilli Jr, Chief Information Officer of Credit Suisse First Boston, and what

he has to say about buying new PCs under current economic conditions: "I

will only be looking to replace PCs that are really crawling, and you’re going

to have to prove to me that they’re crawling on all fours before I replace

them." On October 1, Merrill Lynch cut its fourth-quarter revenue estimate

for Intel by 2%, to $6.15 billion.

It’s now unlikely Barrett will reach his goal of 20% revenue growth in the

overall business next year. For fiscal 2002, Merrill Lynch figures Intel’s

revenues will rise only 13%, to $28.8 billion, while net income is expected to

rebound 147%, to $1.9 billion. Next year’s profit growth sounds good, save the

fact it will be Intel’s third-worst showing since 1986. Barrett made his

growth predictions before September 11, and even though he has not revised his

goals, he is hinting at more job cuts. So far this year, he has cut 5,000 jobs

through attrition, bringing the workforce to 80,000. In a speech to employees

late September, the CEO pointed out that Intel’s head count is 20,000

employees higher than it was two years ago, even though revenues are the same.

The message wasn’t lost on his audience, nor on his shareholders. Before the

terrorist attack, Intel’s stock was hovering at $26–more than 60% off its

52-week high. Today, the stock is around $20, amid fears that shaken consumer

confidence will hurt PC sales. Says a top executive at a major PC maker: "I

have never seen them at a weaker moment in the history of Intel."

That’s raising questions about Barrett’s leadership. No one is calling

for him to step down, but a chorus of former executives, analysts, customers,

and partners say Grove should return as Intel’s big strategic thinker. For

years, Grove and Barrett had been the chip industry’s dynamic duo–Grove was

the visionary and Barrett was the nuts-and-bolts operations chief. "They

complemented each other. In the old days, Andy was like Batman, and Craig was

Robin," says one former top executive. "But everyone knows, when you

want to figure out how to beat the bad guy, you don’t call Robin."

Yet Grove’s booming voice is heard less and less frequently at company

headquarters. As chairman, he remains a force at Intel, but he says his role is

mostly as an observer when it comes to decision-making. Always a cautious,

methodical planner, Grove says he has been uncomfortable with Barrett’s bold

actions, but he defends the current CEO. "If he was equally as cautious, we

would be destined to remain a niche player," Grove says. Still,

"Not guilty"

Indeed, Barrett isn’t the least chastened by Intel’s flagging performance

or criticism of his many-pronged strategy. With a temper at times as prickly as

the cactus towering over his 9-by-9 cubicle, Barrett says his strategy has not

created a company without focus. "Guilty as charged, we had product

screwups," he says curtly. "Not guilty as charged that we can’t do

more than one thing at a time." The product shortages, bugs, and recalls,

he says, were "side effects" of pushing forward into many markets at a

breakneck pace. Microsoft Chairman William Gates III, who also steered his giant

software company into new turf while building his core Windows business, agrees.

"You can’t do this without sometimes hitting a bump in the road,"

says Gates. "But Intel is making a lot of smart bets on the future."

Barrett says he’s not backing off those bets. Three years

ago, he vowed to branch out into communications, info appliances, and Internet

services. His original vision not only called for making chips for networking

gear, cell phones, and handheld computers but also for churning out Intel

hardware–network servers, Web-surfing devices, and routers to guide data over

networks. At the same time, Barrett tried to build a services business, with

Intel running e-commerce operations for others or dishing up business software

to corporate customers over the Net. The full scope of his vision has been far

from realized. Intel has retreated from most of the Intel-branded product

offerings to rely on what Intel knows best–making chips. Now, his

beyond-the-PC plans translate into producing tiny slivers of silicon to go into

wireless and other communications products.

Intel’s problems, Barrett says, are largely the result of

the economic downturn. Still, he maintains, he’s turning that to his advantage

by plowing gobs of money into research and manufacturing advances–$11.5

billion, a staggering 45% of revenues–at a time when rivals can ill afford

such lavish spending. With a $10 billion cash reserve and a seasoned team, Intel

is positioning itself to come out of the downturn in better shape than rivals

both old and new. The downturn, Barrett argues, is giving Intel time to hone its

next-generation products in all the markets he has targeted. "We’ve got

the technology, we’ve got the strategy," he says.

That may not be enough. Now more than ever, flawless

execution in Intel’s core microprocessor business is essential to overcome

weak results in the new businesses and the plunge in the economy. Rival Advanced

Micro Devices, however, hopes to throw a monkey wrench into that plan. The

scrappy upstart, locked in a bitter battle with Intel, has made major inroads

since 1999, when it introduced its Athlon processor. The chip, which was faster

than Intel’s Pentium III, was quickly snapped up by PC makers, especially when

Intel couldn’t make enough processors to meet sizzling demand during the

Internet heyday. AMD, after nearly two decades, finally put a dent in Intel’s

market share.

No sweat

This year, Intel counter-punched. It slashed prices on its

Pentium 4 chips by 84%, dragging AMD into a savage price war. And in the past

month, Intel has released a speedy, 2-gigahertz Pentium 4 chip that outguns AMD’s

top processor. AMD is expected to strike back by mid-October with faster Athlon

chips. The only problem is, the PC market isn’t traveling at the same speed.

This year, for the first time, PC sales are expected to decline. Even when the

economy crawls back, few expect buyers will return to their habits of the past.

Barrett shouldn’t expect help from his scramble into

powerful, high-margin chips for servers either. Selling for up to 40 times the

price of a PC chip, analysts say Intel’s new Itanium server processors will

take at least five years to gain traction. Customers will need to test each new

chip and rewrite software to take advantage of processing in massive 64-bit

chunks instead of the more common 32 bits. That’s painful news for Barrett,

considering Intel has staked so much on Itanium. This year, says an IDC analyst,

sales of Intel-based servers will decline nearly 10%, to $23 billion, from $25.3

billion a year ago. After the terrorist attacks, IDC revised its 2002

projections downward from 9% growth to a 1% decline.

And the new businesses won’t be much help any time soon. In

three years, Barrett has pumped more than $10 billion into 34 acquisitions to

bolster efforts in new markets, betting that those deals would help such units

as the Communications Group and the Wireless Communications & Computing

Group grow 50% annually. Revenue did rise sharply, to $6.4 billion last year

from $3.9 billion a year earlier, and now amount to nearly one-fifth of Intel’s

total. But that’s mostly thanks to Intel’s flash-memory chips, which are

used in cellular phones.

It hasn’t helped Intel’s cause that Barrett has been

shuffling management and reorganizing business units nearly as often as the

company trots out new processors. First, Barrett formed a new wireless unit in

December, 1999, combining Intel’s flash-memory business and new acquisitions,

such as DSP Communications, a leading supplier of chipsets and software for

digital cellular communications. A year later, Barrett combined the

manufacturing and development groups working on its core processors into the

Architecture Group. This year, Intel’s networking and communications

businesses were merged into a new unit, and the architecture unit was revamped

for a second time in two years.

Barrett and Grove say the moves were necessary to clean out

organizational cobwebs and to reflect the realities of a more segmented

marketplace. The reorganizations were designed to make Intel more fleet-footed

and to avoid duplication of efforts in various units, such as the networking and

communications operations each pitching similar products to customers with no

coordination. Barrett explains that in the past three years he has moved four

executive vice-presidents into new positions to give them experience in sales,

marketing, and operations, in preparation for choosing his eventual successor.

Those on the up-and-comer list: Otellini; Sean Maloney, Communications Group;

and Michael Splinter, Sales & Marketing Group. Barrett also says the

reorganizations were key to pushing decision-making down into the executive

ranks and making Intel nimble.

Broadband blues

Too bad Intel has been anything but nimble. Customers,

analysts, and former executives say many of Intel’s execution problems have

been the result of putting chip experts in charge of new businesses. "They

keep putting chipheads in positions they know nothing about," grumbles one

former employee. Nonsense, says Barrett. He insists that Intel’s managers are

more than capable of tackling new challenges.

When Barrett moved into the corner office, he vowed to

reinvent Intel’s business and its culture. He brought in consultants to

encourage the troops to tear down the old ways. But Barrett has yet to purge

Intel of a culture that is used to competing in markets where it is the only

choice. Take Intel’s much-hyped broadband effort. In 1998, Intel began pushing

a new standard for a speedy, low-cost, digital subscriber line (DSL) chip

without phone-company input, says Bob Merritt, director of emerging markets for

chip researcher Semico Research. That frustrated phone companies, which then

refused to support Intel. In March, Intel quietly admitted it has no plans to

ship the chip, and the future of that business is now up in the air. Barrett has

worked on improving customer relations, but some say Intel’s take-no-prisoners

culture remains unchanged.

Barrett’s answer is to turn up the heat on what he knows

best: Manufacturing. He has hurriedly ramped up a makeover of Intel’s

manufacturing plants, introducing the latest production technologies to help

slash the costs of making chips and chipsets. He is pumping $7.5 billion, or 29%

of expected annual revenues, into capital development. Intel is in the process

of converting its plants to bring down costs of making chips as much as 50%.

New, 12-inch wafers, about the size of a dinner plate, have 240% more room to

produce chips than the current 8-inch ones. Copper interconnects boost

performance by lowering heat conductivity, and shrinking the size of circuitry

from .18 microns to .13 microns cuts the size of the same chip in half.

Indeed, Intel workers in sterile rooms wearing bunny suits

soon could be a thing of the past, as virtually automated plants use

sophisticated, custom-made equipment to move parts through the manufacturing

process. CIBC World Markets semiconductor analyst Quinn Bolton estimates that

will push the manufacturing costs of a Pentium 4 desktop chip down to just under

$39, from about $60 now. Intel is betting it can use the same technology and

factories to produce chips and chipsets for each market it is pursuing.

Barrett isn’t finished doling out the dough for

manufacturing advances. He’s spending another $4 billion to research promising

new technologies, such as extreme ultraviolet light to draw features for

increasingly complex chips that will run at 10 ghz and beyond, expected in 2005.

Intel also is getting ready to bring out new technology called hyperthreading

that could be a significant boost to the power of its chips by allowing one

processor to perform two heavy computing tasks simultaneously–as if there were

two chips in the machine instead of just one. That technology will be available

for servers and workstations next year and in PCs by 2003. Intel hopes to pull

miles ahead of competitors, making the technical differences in its products

much more pronounced, boosting sales.

Deep pockets and manufacturing prowess, however, may not be

enough to help Intel dominate the communications, wireless, and Web-site hosting

markets. The chipmaker’s best growth prospect outside of servers is in its

wireless group, where it hopes to make inroads with its "wireless Internet

on a chip" strategy. By combining its flash memory with low-power,

high-performance digital and analog chips to make a single piece of silicon,

Intel plans to be a one-stop shop for the guts of cellular phones and handhelds.

Its edge: offering a chip that is two to five times more powerful than those of

its rivals.

Rivals aren’t waiting for Intel to gain a toehold. Industry

leaders Texas Instruments and Motorola also are moving forward with

next-generation offerings in the battle for the digital signal processor market,

one of the key ingredients in cell phones. And they say that Intel, the

interloper, has a lot to learn in a short time. "We have over 20 years of

wireless and cellular knowledge," sniffs Omid Tahernia, general manager of

Motorola’s Wireless & Mobile Systems Division. Tahernia says there’s a

huge learning curve in figuring out pricing and what customers want.

In the market for Internet and networking equipment, Barrett

has tried to buy his way to market leadership. In 1999, he plunked down $2.2

billion–Intel’s biggest acquisition ever–for Level One Communications, a

maker of chips for broadband devices that speed data around the globe. Intel’s

early efforts read like a "How Not To" guide for business, says

analyst Brad Day at Giga Information Group. Day says Intel bet on Level One,

even though it already was late in developing fast ethernet networking products.

The delays, coupled with Level One managers cashing out, gave competitors the

opening to turn out products superior to Level One’s, making the acquisition a

questionable move. Indeed, Intel developed without Level One’s engineers a

router chip that’s selling well, Day says.

Web woes

And the outlook for Intel’s Web-hosting venture is even

more bleak. Indeed, analysts say that even though Intel has poured $2 billion

into this business, it should exit the market. Demand from companies wanting

others to run their Web operations has fallen dramatically since the dot-com

meltdown. Few Web hosters are making money. And on September 26, Web-hosting

leader Exodus Communications filed for bankruptcy. Barrett says he is staying

the course because the market will once again boom. In the past six months,

Intel has forged Web-hosting and partnership deals with the BBC, Sony, and

Commerce One. Still, competitors say Intel’s data centers are virtually empty.

Such tales bode ill for Barrett’s legacy. Still, he has

three years to reverse Intel’s slide–and that can be an eternity in the

computer industry. "People will remember him for what he did last, how the

stock did last," says a Lehman Brothers analyst. Grove agrees that the wild

cards will be the economy and how well Intel executes. In the next two months,

Intel’s executive team will sit down and review the strategic plan that will

help determine the course of Barrett’s future. They probably won’t be able

to squeeze into that cramped conference room, but wherever they go to map out

future plans, Intel’s legacy will loom large.

Cliff Edwards in Santa Clara with Ira Sager in New York and bureau reports–BusinessWeek

Barrett’s Big Bets

After

disastrous forays into making everything from Internet routers to

information appliances, Barrett has settled on what Intel does best–silicon

chips

Manufacturing:

Spending $7.5 billion to convert plants worldwide to the latest

technologies in a bid to make chips at costs below rivals.

• Benefits: New factories will use larger,
  
  12-inch wafers that pack in more circuits, copper wiring for faster
  
  speeds, and ultra-efficient production equipment to slash per-processor
  
  manufacturing costs as much as 50%.

• Challenges: Balancing manufacturing for
  
  a variety of chip lines, while preventing technical glitches. Prolonged
  
  downturn could mean the company bet on an expensive transition at the
  
  wrong time.

High-End

Servers: McKinley, the next Itanium server processor expected to handle

information in large chunks, is scheduled to begin rolling out in early

2002, doubling performance and lowering power requirements.

• Benefits: Shows most promise for juicy
  
  profit margins, with high-end server chips estimated to bring in between
  
  $1,200 and $4,000 per processor. That’s crucial for making up for the
  
  slimmer margins on Intel’s high-volume Pentium 4 chips, which sell for
  
  $133 and $562.

• Challenges: The $2 billion Itanium
  
  effort is two years behind schedule, giving rivals AMD and IBM time to
  
  match Intel’s offerings.

Wireless:

The big play: wireless Internet on a chip. Announced in May, the chip

bundles all the previously separate pieces needed to build handheld

devices or cell phones.

• Benefits: Intel has an advantage being a
  
  one-stop shop, offering blueprints for quickly getting new products such
  
  as cellular phones and personal digital assistants to market.

• Challenges: Getting top manufacturers
  
  such as Nokia, Ericsson, Motorola, and Palm to switch from established
  
  suppliers such as Texas Instruments and Advanced Micro Devices.

Communications:

Moving into chips, chipsets, and equipment for ethernet and optical

networking for large phone carriers, home networking, and

voice-over-Internet technologies.

• Benefits: Few established suppliers
  
  means the field is wide open when the telecom recession ends and companies
  
  begin buying next-generation broadband gear. The $1.2 billion acquisition
  
  of Giga, a maker of chips for fiber-optic switches, has produced solid
  
  sales so far.

• Challenges: Intel may have a tough time
  
  keeping up with the rapid pace of change in the ethernet and optical space–not
  
  its core market.

Web Hosting: Intel hopes to dominate this market for setting up, testing, and

managing websites when e-commerce begins to boom again.

• Benefits: Small and mid-tier businesses
  
  increasingly want a third party to host and manage their website. Intel is
  
  hoping to crack this market that is now stalled but expected to boom
  
  again. Forrester Research predicts the overall business will hit $14
  
  billion by 2004, up from $4 billion in 2000.

• Challenges: Intel has yet to make any
  
  profit on the business, after announcing it would invest nearly $2 billion
  
  to build data centers around the globe. As other Web hosters flame out,
  
  Barrett says he’ll stay the course, although he’s cutting back
  
  funding.