What Apple Should Learn from Intel

As a top business story, the problems with Apple's iPhone 4 has almost all of the key ingredients:

• It features a top company and a leading personality, Steve Jobs;
• It is easy to understand;
• There is a clear problem including an identifiable mistake; and
• There are loyal defenders and vigorous attackers.

(If only the antenna problem were the result of a sex scandal of some sort, the issue would be perfect). 

These ingredients open the field to everyone.  In our office we watched the CNBC "box of six" where all participants were describing what Apple had done wrong, how Steve Jobs was mis-handling the situation, and what he should do now.  No matter that none of the critics has any of his experience, imagination, entrepreneurship, leadership, or communication skills.  On this day, and on this particular subject, the door to Monday morning quarterbacking is wide open for us all.

Intel and the Floating Point Processor Problem

When I recounted the Intel story today at lunch I did not have the exact year in mind, although I remembered the facts, where I was, and what I did.  Intel had a regular and very profitable cycle introducing new chips — the original PC processor, the 286, the 386, the 486, and by 1994, the Pentium.  Each cycle moved Intel a step ahead of competition and enabled new and more powerful software.  The Pentium had been released and was shipping in new computers.

In late November of 1994 there was a story about a "bug" in the new floating point processor.  The problem had been identified weeks before.  It was known in some scientific circles, but the story was not widespread. It appeared on some Internet "newsgroups" which were relatively small, specialized forums for discussion. (These days the story would have moved much more quickly).  The "bug" only affected a small minority of users who had software where the floating point processor was invoked and needed accuracy to many decimal places.  For those of us doing routine work, we would never know the difference.

Intel's initial response was to downplay the problem, explaining that it was not important and they would do a fix for anyone who could demonstrate they needed a replacement.  They held this position for weeks.

Can you guess the reaction?  The stock tanked to the tune of billions of dollars in market cap.  I found a nice reference for the entire story at Vince Emery's site.  Here are some jokes demonstrating how a great company can be an easy target:

• At Intel, quality is job 0.999999998.
• Q: Know how the Republicans can cut taxes and pay the deficit at the same time? A: Their spreadsheet runs on a Pentium computer.
• We are Pentium of Borg. Resistance is futile. You will be approximated.
• The Intel version of Casablanca: "Round off the usual suspects."
• Q: How many Pentium designers does it take to screw in a light bulb? A: .99995827903, but that's close enough for nontechnical people.

Investment Reaction – 1994

When the story broke on TV I was at the health club.  I grabbed something from the sign-in desk and did an actual back-of-the-envelope calculation.  Knowing a few relevant facts, I determined that Intel could completely replace all of the suspect processors for less than 40 cents/share.  I guessed that they would figure this out.  I made some calls to my clients and we all did some buying.

It took a few days, but the company finally announced the program.  They set aside about $400 million to cover a complete replacement program.  As I recall, very few people actually took them up on the offer, since part of the program was a careful explanation of the problem.  Most did not want to take the trouble, but were reassured that they could do the exchange if they wanted to.  I think they only used a small fraction of the reserve, so my estimate was actually too high!

It was a very profitable trade and carried a good lesson.  Most investors, and even most analysts, do not really try to estimate losses.  When there is "headline risk" they simply sell.  Readers can easily think of a few other companies in the current news where there has been massive selling because the risks were difficult to quantify.

The Lesson for Apple

Let us assume that the Apple executives are confident of their position — they really believe that they are right.  Here is the lesson Vince Emery derives (emphasis added):

…when you see hundreds of email messages and newsgroup postings which all say you have a problem, and you don't think you have a problem, think twice: you really do have a problem. You might not have a technical problem, but you have a PR problem. Intel said, "Pentium chips have a flaw, but it doesn't matter." Intel's customers said, "It does too matter." Intel responded "No, it doesn't," and even though Intel meant well, thousands of its customers on the Internet swore they saw Intel stick its virtual tongue out at them. In retrospect, it seems like a no-brainer, but Intel had the facts on its side and thought that the facts mattered. They didn't. When you are absolutely sure you are right, you increase your likelihood of making a mistake. Ask any prosecuting attorney. The facts have very little to do with the outcome of a case–it's how the facts are couched and presented that sways your jury.

Investment Reaction — 2010

I do not know how long it will take Apple to reach the same conclusion as Intel, but they will get there eventually.  There is an inexpensive fix (free "bumper" cases for all customers) that would only cost a few million dollars.

Disclosure:  Long Apple (AAPL) and adding to positions.  Also long Intel (INTC).