Andy Grove and the iPhone SE

Andy Grove died yesterday. He is widely considered the greatest CEO in tech history.

The Andy Grove Impact

Grove’s remarkable backstory certainly plays a role in his reputation: a survivor of the Holocaust and the Soviet occupation of Hungary, Grove née Gróf arrived in the United States a penniless refugee and taught himself English while studying chemistry at the City College of New York; he later received his Ph.D. in chemical engineering from the University of California-Berkeley and then moved across the Bay to join Fairchild Semiconductor. When Robert Noyce and Gordon Moore (originally part of the Traitorous Eight who left transistor-inventor William Shockley) resigned from Fairchild Semiconductor to found Intel, Grove was their first hire1 and it fell to Grove to build the culture and processes that would scale to support the memory business upon which Intel would be built. And so it was that the Hungarian refugee became the poster child for Silicon Valley’s idealized view of itself: a place where anyone can make it thanks to nothing more than their talent and determination.

Beyond Grove’s personal background, the importance of Intel to the technology industry — and, by extension, to the world — cannot be overstated. While Moore is immortalized for having created “Moore’s Law”, the truth is that the word “Law” is a misnomer: the fact that the number of transistors in an integrated circuit doubles approximately every two years is the result of a choice made first and foremost by Intel to spend the amount of time and money necessary to make Moore’s Law a reality. This choice, by extension, made everything else in technology possible: the PC, the Internet, the mobile phone. And, the person most responsible for making this choice was Grove (and, I’d add, his presence in management was the biggest differentiator between Intel and its predecessors, both of which included Noyce and Moore).

That wasn’t Intel and Grove’s only contribution to Silicon Valley, either: Grove created a culture predicated on a lack of hierarchy, vigorous debate, and buy-in to the cause (compensated with stock). In other words, Intel not only made future tech companies possible, it also provided the template for how they should be run, and how knowledge workers broadly should be managed. Grove also helped establish the idea of “paying it forward”: the CEO was famous for his willingness to mentor young founders (most famously Steve Jobs), and he wrote multiple books as CEO focused on how to manage and dealing with strategic inflection points.

Grove’s Most Famous Decision

The basis of that latter book was Grove’s most famous decision and, by extension, the greatest contributor to his legendary status. Intel was founded as a memory company, and the company made its name by pioneering metal-oxide semiconductor technology in first SRAM2 and then in the first commercially available DRAM.3 It was memory that drove all of Intel’s initial revenue and profits, and the best employees and best manufacturing facilities were devoted to memory in adherence to Intel’s belief that memory was their “technology driver”, the product that made everything else — including their fledgling microprocessors — possible. As Grove wrote in Only the Paranoid Survive, “Our priorities were formed by our identity; after all, memories were us.”

The problem is that by the mid-1980s Japanese competitors were producing more reliable memory at lower costs (allegedly) backed by unlimited funding from the Japanese government, and Intel was struggling to compete. Grove wrote:

We tried a lot of things. We tried to focus on a niche of the memory market segment, we tried to invent special-purpose memories called value-added designs, we introduced more advanced technologies and built memories with them. What we were desperately trying to do was to earn a premium for our product in the marketplace as we couldn’t match the Japanese downward pricing spiral…as memories became a uniform worldwide commodity.

Grove soon persuaded Moore, who was still CEO4 to get out of the memory business, and then proceeded on the even more difficult task of getting the rest of Intel on board; it would take nearly three years for the company to fully commit to the microprocessor, even though said microprocessor was already a smashing success thanks to IBM’s decision to use it in their first PC.

Over the next two decades Intel would not only reap the benefits of IBM’s decision but also greatly increase their profits through more shrewd moves by Grove. As part of selecting Intel in the first place IBM insisted that Intel share their design with another chip manufacturer called Advanced Micro Devices (AMD) to ensure multiple suppliers, but once IBM’s position was weakened through the rise of IBM-compatible manufacturers like Compaq, Intel reneged and eventually renegotiated the deal, allowing the company to leverage its technical superiority5 into the sort of differentiation it had not been able to achieve in memory.

Equally important was the groundbreaking “Intel Inside” campaign that recognized end users were increasingly the market for computer manufacturers, and that they could be persuaded to care more about who made their computer’s processor than who made the computer itself. It was again a move that resulted in increased differentiation and, by extension, increased profits. By the time Grove stepped down as CEO in 1998 Intel was earning $6.9 billion profit on $25.0 billion in revenue, thanks to a gross margin of 60.3%.

Intel’s Big Miss

Intel today is still a very profitable company: last year the chip-maker earned $11.4 billion on $55.4 billion in revenue, with a gross margin of 62.6%. There is a sense, though, that the company’s strategic position is much less secure than its financials indicate, thanks to Intel’s having missed mobile.6

The critical decision came in 2005; Apple had just switched its Mac lineup to Intel x86 processors, but Steve Jobs was interested in another Intel product: the XScale ARM-based processor.7 The device it would be used for would be the iPhone. Then-CEO Paul Otellini told Alexis Madrigal at The Atlantic what happened:

“We ended up not winning it or passing on it, depending on how you want to view it. And the world would have been a lot different if we’d done it,” Otellini told me in a two-hour conversation during his last month at Intel. “The thing you have to remember is that this was before the iPhone was introduced and no one knew what the iPhone would do…At the end of the day, there was a chip that they were interested in that they wanted to pay a certain price for and not a nickel more and that price was below our forecasted cost. I couldn’t see it. It wasn’t one of these things you can make up on volume. And in hindsight, the forecasted cost was wrong and the volume was 100x what anyone thought.”

It was the opposite of Grove’s memory-to-microprocessor decision: Otellini prioritized Intel’s current business (x86 processors) instead of moving to what was next (Intel would go on to sell XScale to Marvell in 2006), much to the company’s long-term detriment.

And yet, for all of the deserved praise that Grove has received over the years, and as difficult as his memory-to-microprocessor decision may have been, Otellini’s decision was in my estimation far more difficult. Grove had to change Intel’s culture and perception of itself, and that is incredibly difficult, but at the end of the day he was making the choice that made financial sense: microprocessors were already more profitable and offered far greater potential for sustainable differentiation. Otellini, on the other hand, was choosing between maintaining Intel’s margins and pursuing unknown volume, and while it’s easy to sit here in 2016 and say he got it wrong, it’s only right to wonder who in 2005 would have gotten it right.

The Intel-Apple Parallel

Coincidentally Grove passed away the same day that Apple held one of its oddest events in some time: the company introduced two new devices, both derivatives of products that are already on the market. The new 9.7″ iPad Pro is better than its larger sibling when it comes to the camera and display, but from the perspective of most consumers it’s the same device in a form factor that has been around for a while; the iPhone SE, meanwhile, is a clone of the two-and-a-half year-old 5S with mostly-iPhone 6S innards.

There are definite parallels between Apple and Intel, particularly when it comes to Grove’s fateful decision: Apple’s biggest business shifted from computers to iPods, and shifted again from iPods to iPhones; the company even changed its name from Apple Computer to simply Apple. Both shifts are impressive in their own right: focusing on the iPod was to in some sense abandon Apple’s founding identity, while making the iPhone meant the cannibalization of Apple’s most profitable product ever.

Still, just as Grove’s decision to abandon memory and focus on microprocessors was in some senses “easy” given the fact microprocessors was a growing business that offered more margin, not less, Apple’s shift to the iPhone has been an “easy” one as well: the iPhone is nearly as profitable on a gross margin basis as Intel’s processors are. Make no mistake, overruling internal culture and hierarchies is hard, but giving away margin tends to be a lot harder.

The Celeron and the iPhone SE

That’s why the Grove decision that actually impresses me the most is Intel’s launch of the Celeron processor in 1998.8 Grove had been introduced to a then-relatively-unknown Harvard Business School professor named Clayton Christensen, who told him about research for an upcoming book (The Innovator’s Dilemma) that explained how companies in their pursuit of margin allowed themselves to be beat on the low-end. Grove took the lesson to heart and directed Intel to create a low-end processor (Celeron) that certainly cannibalized Intel’s top-of-the-line processor to an extent but also dominated the low-end, quickly gaining 35% market share.

To date Apple has declined to make a similar move; the iPhone 5C was thought, particularly before launch, to be the fabled “low-price iPhone,” but it turns out it was simply a substitute for an iPhone 5 that had significant manufacturing problems. It certainly wasn’t low-price: it started at $549, exactly where the year-old iPhone 5 would have been, and like every iPhone before it stepped down to $449 the following year before being discontinued.

To me the pricing made perfect sense, and unlike Christensen, I wasn’t worried about the iPhone being disrupted by the low-end. Indeed, I’m still not worried: the iPhone’s hold on the top-end of the market is as strong as ever.

The problem is growth: specifically, how many high-end customers are there, and how many of those customers find their current iPhones to be good-enough? And, if Apple believed their market to be increasingly saturated, would the company be willing to cannibalize its high-margin iPhone?

The iPhone SE suggests the answer is yes, and that fact alone made yesterday’s event far more important than it seems.9 Specifically, Apple is offering top-of-the-line specs for an unprecedented price of $399. In other words, the SE is no 5C. In fact, it seems likely Apple learned some inadvertent lessons from the 5C: I am not at all surprised that the SE looks identical to a 5S;10 when an integral part of the iPhone value proposition is status what customer wants to advertise that they bought a model that was never a flagship?

This price point will likely expand the market in the developed world, particularly given the replacement of subsidies with installment plans, but it’s most interesting in developing markets, especially India. It’s tempting to compare the second-largest phone market in the world to China, but in fact the latter is significantly richer and has a much larger high-end that primarily values status; the former, meanwhile, is very well-informed about things like processor and camera specifications, and is likely to be particularly appreciative of the SE’s aggressive feature set. I’m not at all surprised that the SE is going on sale in India only a week after the U.S., which is noteworthy considering the 6S launched in India in very limited quantities a full four weeks after the U.S.11

The implications for Apple, though, are more profound than any one phone or any one market: the real long-term danger of occupying the high-end is falling in love with margin or average selling price at the expense of what makes sense strategically. Grove is to be admired for avoiding that trap, and it is encouraging that Apple CEO Tim Cook seems to be doing the same. And, fortunately for the Apple CEO, he, like Grove, can likely leave the truly devastating but ultimately understandable mistake for a successor.

  1. Due to an administrative error Grove was given employee number 4 instead of 3 which reportedly rankled Grove for years, not unlike Steve Jobs’ irritation at being employee number 2 behind Steve Wozniak []
  2. Static Random Access Memory, which is faster and more reliable than DRAM but more expensive, and is today used for on-processor cache []
  3. Dynamic Random Access Memory, which is simple and cheap relative to SRAM and is still used as the main memory for computers []
  4. It speaks of Grove’s influence on Intel that he is widely credited for this decision even though he was not yet CEO []
  5. Which AMD briefly interrupted by being the first to introduce a 64-bit extension to the x86 instruction set []
  6. This isn’t entirely fair: Intel supplies the overwhelming majority of server processors which power the cloud; the cloud is an integral part of mobile []
  7. Which was derived from one of Grove’s last deals as CEO (the acquisition via settlement of StrongARM from DEC) []
  8. The Celeron launched a month before Grove stepped down as CEO, although obviously the decision was made well before then []
  9. To be clear, I’m not saying the SE is a Celeron; the smartphone market is different. I’m just noting Apple is undercutting itself to a degree []
  10. Except for the matte-chamfered edges []
  11. The India pricing is interesting: in a rather bizarre screwup Apple first announced that the SE would cost Rs 30,000, only to issue a new press release correcting the cost to Rs 39,000. This seems unusually high given the fact the 6S is widely available at only Rs 49,500.

    In fact, though, the 6S official price is Rs 62,500, which is 1.44x as expensive as the U.S. retail price; Rs 39,000 is 1.46x the U.S. retail price for the SE, so that makes sense.

    What I suspect happened is that, given India’s unique retail market that is dominated by small shops, Apple has built in a cushion to the official retail price that it expects to disappear in the market. As I noted, the 6S is widely available for Rs 49,500, which translates to $742 US; this is 1.14x the U.S. price (which pays for import duties, sales taxes, etc.). It turns out that 1.14x the U.S. price for the SE is Rs 30,419, almost exactly what Apple first put in its press release.

    In other words, I think Apple is saying that the SE will cost Rs 39,000, but they expect to sell it for Rs 30,000; they just accidentally put the latter number in the press release []