Everybody needs a hobby, apparently ours is cost accounting

Intel held a webinar this week to provide investors an update on the plans for the fab operations. People were expecting good news on the timing of the manufacturing process. Instead we got cost accounting. And oddly, we found this more fascinating.

Intel held the event to unveil the new reporting structure they have put in place. They created a new business unit whose working name is the Manufacturing Group which holds all of Intel’s production fabs as well as the R&D responsible for designing their manufacturing process. This new business unit will charge the design side of Intel for use of its services. There was no change to Intel’s corporate profitability, but they way they count costs internally is changing in a really important way. The goal of this is to allow Intel’s fabs to operate more like a foundry – producing chips for third parties, except in this case the first (and only) customer is the design side of Intel.

The Street did not appreciate any of this, with Intel’s stock down 6% on the day. Many had expected more tangible news. Many investors seemed to react fairly negatively to the fact this new business unit will start life with massively negative operating margins. Some were also probably hoping that these changes might signal a shift towards splitting the company in two. There are many on the Street who think this is the best path forward, but the company made it clear that was not in the cards, and highlighted the reasons why it would be so hard to do. Still, we think this a profound milestone.

More than just shuffling numbers around, we think this structure will bring about important changes to how Intel does business, over time. Aside from the obvious changes to aligning the Manufacturing group’s incentives, we think this will be highly impactful to the design side of Intel as well. A big part of the presentation dealt with the ways in which Intel’s prior accounting model, which allocated manufacturing costs to the business units, led to some very expensive bad habits that compounded over time. For instance, the design side of Intel largely had free rein in putting in expedited orders to the fabs, and the costs of these were significant as Intel now estimates eliminating these (or charging market rate for them) will save up to $1 billion a year. The company laid a half dozen of similar examples, which total to some significant savings once these changes take effect.

That being said, actually putting these changes in place is likely to prove fairly traumatic to the organization. Intel’s past accounting practices gave Intel some significant competitive advantages. Take that expedited orders example above. When the design side had access to these they used them to much advantage in the marketplace. They could use them to secure orders and ensure major customers got that extra level of customer service. Part of our interest in this event was the fact that we have been trying to quantify, or even just explain, all the ways in in which Intel’s integrated fab-led model gave them a competitive advantage.

And then there is the important question as to whether these changes will actually stick. As we have pointed out frequently in the past, the heart of Intel’s problems rests in its culture. Past attempts at top-down changes like these have often foundered on resistance from the middle levels of the company, and just plain inertia. In the past, perks from the operations side were determined essentially by political favor. Now they will ostensibly be determined by ‘commercial principles’. If the design side needs an expedited order they will now incur a financial penalty for it, they will have to ‘pay’ the fabs for those orders. But how will that work on the ground? Will the executive requesting that order actually be penalized for the added ‘cost’, or will they be given a pass – for political reasons? Going further, the company now says it will calculate these internal transfers at ‘market rates’, but as they currently have no external customers how and who will determine what those rates are? To be fair, cultural change takes time, and so we should view these changes as part of the process required to bring about those changes, rather than the change itself.

In some senses, this change is meaningless, especially for investors, just the left hand paying the right hand in a different way. But seen in another light this is a hugely significant change. For most of Intel’s existence its manufacturing operations have been the center around which the rest of the company orbited. Now, these operations are just one more business unit, not even first among equals. We have written a lot about the challenges Intel Foundry Services (IFS) will face when it is ready to start seeking third party orders, in particular we have said the company has to undergo a massive cultural shift for IFS to ever work. Today’s changes are the first step down that path.

Photo by Erik Mclean on Unsplash

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