In-Depth

Albert's Analysis -- Microelectronics: IBM’s New Chip Technology and Revenue Generator

• By Sam Albert
• 04/01/2001

IBM, witnessing the profound effect of the Internet on the electronics industry, is capturing a remarkable opportunity in the manufacture of chips for servers, networking gear and pervasive computing devices, to supplant the standard PC microprocessor chip. As the business and consumer economy continues to shift away from the standard desktop as its primary source of information and Web access, IBM and other industry leaders (including a few notable rivals, such as Intel, Dell, HP and Microsoft,) are casting an eye on networked appliances of the future.

Market forces are at work to facilitate this shift. Prices on standard PCs have been steadily declining in recent years, driving down profit margins. It’s becoming more difficult to differentiate PCs, as they increasingly become commodity products. Manufacturers and service providers, struggling to keep their revenues and stock prices at healthy levels, have been looking to next-generation industries, such as the gaming industry, storage devices, cell phones and consumer devices.

It’s what John Buchholz, Director of Communications for IBM’s Technology Group, refers to as a "shifting epicenter of the semiconductor industry. When we first began selling our component technology to the merchant market, we observed a shift away from the desktop. Most of the new market segments are providing supporting infrastructure for the Internet. And, they are experiencing unprecedented growth."

In addition to capitalizing on the growth in the Internet economy through its chip sales, IBM, also, boasts of securing the most U.S. patents of any company, for the eighth consecutive year. And a profitable "cottage industry" has sprouted from this technology treasure-trove – the licensing of IBM’s proprietary know-how. IBM is investing millions (including a new chip technology development center as part of a $5 billion capital investment) in the research and development of faster, lower-powered chip technology, and has successfully offset much of that cost by "selling" its chip products and licensing its intellectual property for use in other companies’ designs. But, this area is capital-intensive, and IBM sees the opportunity and is placing its bets!

Big Blue is licensing intellectual property from its patent portfolio and selling its leading edge chip technology – primarily to networking companies, competitors, high-growth start-ups and systems providers – to the tune of billions in revenue each year. Year 2000 set a new record, bringing in more than $1.6 billion in licensing revenue for IBM from its IP alone and nearly $4 billion in chips, according to market researcher Dataquest.

Buchholz refers to IBM’s Technology Group, and, specifically, the Microelectronics Division, as a "selective arms supplier." "We have a healthy business, selling to external merchant markets. We’re making many new alliances."

The key words today in microelectronics are "open relationships." And today, alliances with Internet systems vendors, like Juniper, Alcatel, Nortel and Ericsson, rule the day. Not bad for a Technology Group that coalesced just two years ago by pulling together three related internal business units – microelectronics, storage and microdrives.

IBM is also becoming its own "venture capitalist," of sorts, pursuing equity positions with promising start-ups. But, these equity stakes are small, serving primarily as a vehicle to acquire access to more strategic IP rather than an investment growth fund.

Historically, IBM’s microelectronics division developed chip components only for its internal division customers, such as mainframe and storage. Since then, Big Blue researchers have pioneered the use of copper, silicon germanium and silicon-on-insulator into their chip technology. The result: next-generation chips with higher, faster performance, and chips that use less power.

Customers, including those new economy system and service vendors, are demanding those better, faster, cheaper chips to fuel their network communications. It’s a newer, different IBM that’s responding. By putting its technology into "real world" practice, IBM is making money and successfully amortizing its costly R&D. And, the operative word from a previously "proprietary" IBM (that protected the "family jewels") is now OPEN in capital letters!

Lou Gerstner isn’t letting the technology languish in a lab somewhere. That truly is a feather in his cap and a fresh, money-making approach to one of IBM’s biggest assets, its technology and patent portfolio. Watch this "under the covers" opportunity, which, I predict, will grow in the coming years and watch IBM’s profit grow right along with it.