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Intel’s chip making for rivals a double-edged sword

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Intel faces a quandary in making chips for rivals. Offering this service on a limited basis to companies like Altera is close to a free lunch. It helps Intel maximize manufacturing capacity and defray costs: building a semiconductor plant costs $10-billion. Expanding this business too far, however, could threaten margins.

Many firms used to both design and manufacture chips. That has changed. It's getting harder to cram more transistors onto each chip. The cost of a state-of-the-art plant has gone up about 10-fold since the 1990s and the pace isn't slowing. Only Intel, Samsung and a few other firms are able to afford the investment and research. The top five chip makers' share of the industry's total capital expenditure has increased from 30 per cent in 2004 to more than 65 per cent, estimates Gartner.

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Intel has been investing heavily to keep its manufacturing edge in making the smallest chips. That has historically led to higher margins. And since smaller chips drink less power, Intel hopes its manufacturing prowess will make it a major player in the mobile device market. It hasn't yet – and the PC market is maturing. So sales have not kept pace with investment. That's a problem. Semiconductor factories mint money when they run around the clock, but chalk up big losses when idle.

Producing chips for others offers a nice way out of this dilemma. Intel has about a one-year lead on rivals in technology, so it can charge a premium for access. Moreover, Altera doesn't make processors so isn't a direct rival. Such deals help keep the company's factories humming while reducing dependence on the PC market. Moreover, the best outsourcing companies, such as Taiwan Semiconductor, are extremely profitable.

Taking on bigger clients such as Cisco or Apple , however, may mean Intel has to invest in new plants. That's because most mobile chips run on a competing standard championed by ARM Holdings. Doing so will require splashing out so much cash that it could whack the 60 per cent gross margin it earns from its control of the x86 standard for microprocessors. The legendarily paranoid company will have to step carefully.

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