Apple's Chip Pain Will Ease -- Later

By Alex Salkever When IBM sneezes, Apple catches a cold, goes one variation on the old saw. As the maker of the PowerPC chips that run Apple's G5 desktop computers, IBM (IBM) is Jobs & Co.'s most important supplier. In fact, Apple (AAPL) has more or less staked its computing future on the G5 line, produced largely out of IBM's Fishkill (N.Y.) facility. Now, IBM is struggling to produce cutting-edge G5 chips of sufficient quality in sufficient quantity, and the upper half of Apple's hardware lineup is in limbo.

Sound familiar? Unfortunately for Apple, it faced a similar problem with the main supplier of its previous-generation G4 chips, Motorola (MOT). The Schaumburg (Ill.) company caused veins to pop and eyes to bulge at Apple HQ with its pokey pace of improvements.

These days, IBM is the goat, as Apple clearly indicated in its Apr. 14 conference call. It's counting heavily on Big Blue for rapid improvements to G5 chips that could drive sales of the high-end PowerMac line. So IBM's troubles at Fishkill could hit Apple's bottom line hard because the high-range Macs are disproportionately profitable.

POWERBOOK DELAYS. As IBM tries to fine-tune its chip production, could Apple fall ill? Probably not -- though there are some big caveats. Maintaining or increasing sales of these cash cows will become even more important as Apple watches margins slide in its iPod business. The new iPod minis provide much smaller profit margins than other models -- let alone desktop or laptop computers -- thanks to the tiny hard drives that are key to the model's small size but also expensive and in short supply.

Apple is frustrated with delivery delays of new G5 chips, cast with circuit widths of a mere 90 nanometers. That's 30% smaller than current G5 chips with 130-nanometer circuits. The upcoming chips will also run faster and much cooler. Apple needs these before it can finalize its much-awaited G5 PowerBook.

The problem goes beyond laptops. In a worst-case scenario, sales of Apple's top-of-the-line G5 PowerMacs will continue to languish, as buyers hold out for the speedy new chips. The delays in G5 progress may also force Apple CEO Steve Jobs to eat some crow. He had sworn to have a 3-gigahertz G5 desktop on the market this summer, something that looks increasingly unlikely.

BIG BLUE SKIES? Apple was also late launching its new G5 Xserve server that features a 90-nanometer IBM PowerPC chip. It finally shipped in late March, a month after the promised arrival date. All in all, IBM's production problems have thrown a huge monkey wrench into Apple's timetables.

Some experts still hold the view that in the long run, the IBM chip production problem is a blip and that Apple still looks smart for having thrown in with Big Blue. Fears that IBM's chip production problems are serious are seriously overblown, IBM Senior Vice-President and Chief Financial Officer John Joyce said in a recent conference call. And IBM has started to see much higher yields at its Fishkill plant lately, which means IBM's engineers are pretty close to ironing out the kinks, Joyce suggested.

If anyone can figure this mess out, it's IBM, which has a hard-won reputation for bleeding-edge research in chip fabrication. "IBM is in a better position to develop this technology because they have been doing more theoretical work in process technology. I'm reasonably confident they will solve these problems in the next several months," says Peter Glaskowsky, an independent chip analyst.

FULL SPEED AHEAD. The shift down to 90 nanometers has been a chore for IBM, but the future of chips for Apple actually looks pretty solid. IBM already has a next-generation chip out. Called the Power5 family (as opposed to the G5 chip which belongs to IBM's Power4 chip family), this version is going into some IBM servers already. Power5 chips use a technology called multithreading, which allows a computer to process more parallel strands of information and therefore work faster and more efficiently.

Chip heavyweights Intel (INTC) and Advanced Micro Devices (AMD) already build chips using similar technology, as does server powerhouse Sun Microsystems (SUNW). Thus far, though, Apple's chips haven't included multithreading. But they certainly could in the next iteration. That would mean a big performance bump, perhaps on the order of 40%. Such a well-defined itinerary for Apple is a luxury after the comparative uncertainty that surrounded the G4 during its waning years as Apple's top processor.

Finally, IBM can't kill these chips. Big Blue ruthlessly jettisoned its world-class hard-drive research and manufacturing unit, selling it to Japanese electronics giant Hitachi (HIT) in 2002. But chips are different. They remain a far more integral part of building the computing hardware that IBM still relies heavily on for profits.

SAFE BET. Big Blue has sunk $2 billion into making Fishkill a showcase plant that's the backbone of IBM's Microelectronics Div. If Fishkill fails, then the entire IBM chip effort could likely fail. That's not going to happen because IBM strongly prefers to have its own in-house option for high-end hardware products.

During the recent conference call, IBM indicated that later this year it expects the Microelectronics Div. to improve its financial performance significantly. Meanwhile, the unit continues to sign up new customers for its PowerPC chips. The latest was Sony Entertainment (SNE), which plans to build custom versions of the chips to power consumer and entertainment devices.

None of this alleviates Apple's immediate pain in dealing with IBM's slower-than-expected chip development. But at least Big Blue remains a safe bet for Apple's processing future, despite the road's rough spots right now. Salkever is Technology editor for BusinessWeek Online. Follow his Byte of the Apple column, only on BW Online

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