Why Intel is sharing its secret sauce

March 3, 2009: 9:30 AM ET

Since Intel first began cooking up semiconductors, it has taken great pride in its in-house manufacturing chops. If a chip carried the Intel brand, you could be sure it was created in an Intel fab.

Today the pride is the same, but the methods are changing. The Silicon Valley chipmaker on Monday announced a deal that will allow Taiwanese contract manufacturer TSMC to make custom versions of the Atom chip, the first time it's giving another company access to some of its chip cores. How big a deal is this? It's a little like George Lucas agreeing to let someone else make Star Wars movies. (Judging by the most recent ones, that might not be such a bad idea.)

It's not a decision Intel (INTC) came to lightly. For years, companies like TSMC (TSM) have begged Intel for the chance to make chips based on cutting-edge Intel architecture – and Intel has told them to get lost. It was obvious why other chip companies longed to build Intel chips; they serve as the brains of roughly 80% of the world's computers, and oh yeah, they pull in a tidy profit in the process. But why would Intel ever share its secret sauce? By doing everything in-house, the company has grown into one of just a few mega-brands in tech.

In today's environment, though, Intel needs TSMC. What for? In case you haven't noticed, the PC business isn't what it used to be. Technology research firm Gartner predicts that the industry will have its worst year ever, with worldwide shipments dropping 12%. (Until now, the worst decline on record was a 3% dip in 2001.) To keep growing, Intel needs to expand into new markets. Largely, that means mobile: Everything that has a screen and uses battery power is a potential candidate to get Intel inside, including the GPS device in your car, the iPhone in your pocket, and the Nintendo DS in your kid's backpack.

To get that new mobile business, however, Intel knows it has to change some things – including the way it makes chips. Here's why: When it comes to mobile devices, the Nintendos (NTDOF) and Apples (AAPL) of the world don't play by the old PC rules. Instead, they use customizable chip designs from a company called ARM (ARMH).

It turns out, customization and flexibility is a big deal in the mobile world. Intel's chip manufacturing may be the most advanced in the world, but many mobile customers would rather use a chip architecture that lets them tweak the capabilities. (That's why Apple last year bought chip design shop PA Semi for a reported $278 million; word is the engineers are working on custom chip designs for future iPhones and iPods.)

Which brings us back to Monday's announcement. It just so happens that many companies get their custom ARM-based designs manufactured by – you guessed it – TSMC. So by allowing TSMC to make some Atom chips, Intel's sending the message that to be a player in the mobile market, it's prepared to play by the mobile rules, and give customers more flexibility than it ever has before.

This doesn't mean Intel is backing away from its role as a manufacturer. Intel will continue to make chips itself – it recently announced plans to spend $7 billion to enhance its own manufacturing capabilities – and it will place strict limits on how TSMC can use its Atom cores. Any customer who wants to customize Atom will still have to deal with Intel. This deal with TSMC adds a new flexibility to Intel's model, and in the process, Intel also gets access to TSMC's processes, intellectual property, libraries and design flows – the ingredients that let customers tweak their chips.

Could Intel have offered that flexibility without TSMC's help? Not anytime soon. In a way, TSMC is the perfect partner for Intel's needs. Because it's a foundry that makes chips for a legion of customers, TSMC is like a short-order chef set up to make custom meals. Intel, on the other hand, is like a gourmet chef set up specifically to whip up his own menu.

It will be a while before we see whether these two chefs can work well together. Both companies said they're eager for TSMC to start serving up Atom chips, but there are still a lot of business and product details to work out.

And then there are the cultural issues that are sure to arise. Just think: All its life, Intel's been top chef in its own restaurant. It may find that working with a partner feels like too many cooks in the kitchen. (INTC) (AMD) (TSM) (AAPL) (QCOM) (NOK) (MOT) (NVDA)

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