Case 11 Intel Corporation 1968–2013 Charles W.L. Hill Sch.docx

Case 11
Intel Corporation: 1968–2013
Charles W.L. Hill
School of Business, University of Washington Seattle, WA
981095, June 2013
inTroducTion
In 2012 Intel was the leading manufacturer of microprocessors
for personal computers in the world, a position that it had held
onto for more than two decades. Over 80% of all personal
computers sold in 2012 used Intel microprocessors. The
company reported revenues of $53 billion and net pro ts of $11
billion. Meanwhile, Intel’s only viable competitor, AMD, which
in the early 2000s had been gaining share from Intel, lost $1.2
billion on sales of $5.4 billion.
Despite its historic dominance, the future looked uncertain for
Intel. The rise of mobile devices had led to a strong substitution
effect, with sales of PCs falling as consumers switched to
smart phones and tablets for many of their computing needs. In
the rst quarter of 2013, global PC sales fell 14% on a year over
year basis according to the research rm IDC. This was the worst
yearly decline since IDC started tracking PC sales in 1994, and
the fth quarter in a row that PC sales had fallen. At the same
time, sales of smart phones and tablets were booming. IDC
predicted that sales of tablets would grow almost 60% in 2013,
and that tablet shipments would exceed those of portable
PCs.1
The crux of the problem for Intel is that most tablets and smart
phones used microprocessors that are based on technology
licensed from ARM Holdings PLC, a British company whose
chip designs are valued for their low power consumption, which
extends battery life. While Intel has a line of chips aimed at
mobile devices—the Atom chips—microprocessors
incorporating ARM’s technology were found on 95% of smart

phones in 2012 and over 30% of all mobile computing devices,
a cate- gory that includes tablets and PC notebooks.2 Moreover,
in 2012 Microsoft issued a version of its Windows 8
operating system that ran on ARM chips, rather than Intel chips,
creating a potential threat to Intel’s core PC business.
The FoundaTion oF inTel
Two executives from Fairchild Semiconductor, Robert Noyce
and Gordon Moore, founded Intel in 1968. Fairchild
Semiconductor was one of the leading semiconductor
companies in the world and a key enterprise in an area south of
San Francisco that would come to be known as Silicon Valley.
Noyce and Moore were no ordinary executives. They had been
among the eight founders of Fairchild Semiconductor. Noyce
was general manager at the company, while Moore was head
of R&D. Three years previously, Moore had articu- lated what
came to be known as Moore’s Law. He had observed that since
1958, due to process improvements the industry had doubled the
number of transistors that could be put on a chip every year (in
1975 he altered this to doubling every two years).
Fairchild Semiconductor had been established in 1957 with
funding from Sherman Fairchild, who had backed the founders
on the understanding that Fairchild Semiconductor would be a
subsidiary of his Fairchild Camera and Instrument Corporation
on New York. By 1968 Noyce and Moore were chaf ng at the bit
under management practices imposed from New York, and both
decided it was time to strike out on their own. Such were the
reputations of Noyce and Moore that they were able to raise
$2.3 million to fund the new venture “in an afternoon on the
basis of a couple of sheets of paper
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Case 11 Intel Corporation: 1968–2013
containing one of the sketchiest business plans ever nanced”.3
When business reporters got wind of the new venture, they
asked Noyce and Moore what they were in- tending to do, only
to be greeted by vague replies. The two executives, however,
knew exactly what they were going to do—manufacture silicon
memory chips—they just didn’t want potential competitors to
know that. At the time, sales of mainframe computers were
expanding. While these machines used integrated circuits to
perform logic calculations, programs and data were stored on
magnetic devices. Although inexpensive to produce, it was
relatively slow to access information on a magnetic device.
Noyce and Moore knew that if they could build a silicon based
integrated circuit that could function as a memory device, they
could speed up computers, making them more powerful, which
would expand their applications and allow them to shrink in
size.
These memory chips were knows as dynamic ran- dom access
memories (DRAMs). While much of the theoretical work
required to design an integrated circuit that could function as
a memory device had already been done, manufacturing DRAMs
cost ef ciently had so far proved impossible. At the same time,
some key research on manufacturing was being done at
Fairchild. This research included a technique known as metal
oxide on silicon, or MOS. Noyce and Moore wanted to mass-
produce DRAMs, and after looking at other possible
alternatives, they concluded that commercializing the MOS
research was the way to do it. This prompted some cynics to
note that Intel was established to steal the MOS process from
Fairchild.
andy Grove
To help them, Noyce and Moore hired a number of re- searchers
away from Fairchild, including, most notably, a young
Hungarian Jewish émigré called Andy Grove. At Fairchild,

Grove had reported directly to Moore. At Intel he became the
director of operations with responsibility for getting products
designed on time and built on cost. Through the force of his
own personality, Grove would transmute this position into
control over just about everything Intel did, making him
effectively the equal of Noyce and Moore, long before he was
elevated to the CEO position in 1987.
Grove was an interesting character. Born in 1936, he went into
hiding when the Germans invaded Hungary during World War
II and managed to escape the Holocaust.
After WWII, the tyranny of the Germans was replaced by the
tyranny of the Soviets as Hungary became a satellite state of the
Soviet Union. In 1956, after the failure of an uprising against
the Soviet puppet government, Grove es- caped across the
border to Austria, and made his way to the United States. He
put himself through college in New York by waiting on tables,
and then went to UC Berkley for graduate work, where he
received a Ph.D. in chemical engineering in 1963. His next stop
was Fairchild, where he worked until Moore recruited him away
in 1968.
Over the next three decades, Grove would stamp his personality
and management style on Intel. Regarded by many as one of the
most effective managers of the late twentieth century, Grove
was a very demanding and according to some, autocratic leader
who set high expectations for everyone, including himself. He
was detail orientated, pushed hard to measure everything, and
was constantly looking for ways to drive down costs and speed
up development processes. He was known for a confrontational
“in your face” management style, and would frequently
intimidate employees, shouting at those who failed to meet his
expectations. Grove himself, who seemed to enjoy a good ght,
characterized this behavior as “constructive confrontation”. He
would push people to their limits to get things done. As he once
noted, “there is a growth rate at which everybody fails, and the
whole situation results in chaos. I feel it is my most important
function. . . . to identify the maximum growth rate at which this

wholesale failure begins”.4
Grove demanded discipline, insisting for example, that
everybody be at their desks at 8 a.m., even if they had worked
long into the night. He instituted a “late list”, requiring that
people who arrived after 8 a.m. sign in. If people arrived late
for meetings, he would not let them attend. Every year he sent
around a memo to employees reminding them that Christmas
Eve was not a holiday, and that they were expected to work a
full day. Known as the “Scrooge memo”, many would be
returned with nasty comments scrawled over them. May you eat
yellow snow, said one. A very neat man, if people’s desks were
messy, Grove would publically criticize them. Accord- ing to
one observer, “Andy Grove had an approach to discipline and
control that made you wonder how much he had been
unwittingly in uenced by the totalitarian re- gime he had been
so keen to escape”.5
Grove controlled managers through a regular budget- ing
process that required them to make detailed revenue and cost
projections. He also insisted that all managers establish medium
term objectives, and a set of key results by which success or
failure would be measured.
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He instituted regular one-on-one meetings where performance
was reviewed against objectives, holding managers
accountable for shortfalls. He also required monthly
management reviews where managers from different parts of the
company would meet to hear a presentation of its current
strengths, weaknesses, opportunities and threats. The goal was
to get managers to step back and look at the bigger picture, and
to encourage them to help each other solve problems.

Grove would also practice management by walking around,
inspecting facilities and of ces, demanding that they be clean,
something that earned him the nickname “Mr. Clean”. He
pushed the human resource department to institute a standard
system of ranking and rating that had four performance
categories; “superior”, “exceeds expectations”, “meets
expectations”, or “does not meet expectations”. People were
compared against others of their rank. Pay raises and later,
stock option awards were based on these rankings.
Despite his autocratic style, Grove was grudgingly admired
within the company. He was a brilliant problem solver, a man
with tremendous control of facts and details, someone who was
determined to master the challenging technical projects that
Intel was working on. Moreover, while he drove everyone hard,
he drove himself harder still, thereby earning the respect of
many employees.
The MeMory chip coMpany
Making a DRAM using MOS methods proved to be extremely
challenging. One major problem—small partials of dust would
contaminate the circuits during manufacturing, making them
useless. So Intel had to develop “clean rooms” for keeping
dust out of the process. Another was how to etch circuit lines on
silicon wafers, without having the etched lines fracture and
break as the wafer was heated and cooled repeatedly during the
manufacturing process. The solution to this problem, identi ed
by Moore, was to “dope” the metal oxide with impurities,
making it less brittle. Intel subsequently went to some lengths
to keep this aspect of the manufacturing process secret from
competitors for as long as possible.
Intel, of course, was not alone in the race to develop a
commercial process for manufacturing DRAMs. Among the
potential competitors was another semiconductor
company started in 1969 by Jerry Sanders, a former marketing
director at Fairchild. Sanders started his company with the help
several other Fairchild employees who had not been recruited
by Intel. Called Advanced Micro devices, or AMD, the company

found it tough to raise capital until it received an investment
from non other than Robert Noyce, who saw something he liked
in the amboyant Sanders.
Driven by constant pressure from Andy Grove, whose “in your
face” management style was bearing fruit, albeit at some human
cost, by October 1970 In- tel succeeded in producing a DRAM
chip, named the 1103, in relatively high yields (which implied
that relatively few chips had to be discarded). The 1103 could
store 1,024 bits of information (zeros or ones), which was 4
times as much as the highest capacity semiconductor memory
device currently available. Since the xed costs required to
establish a manufacturing facility were very high, the key to
making money on the 1103 was high yields and high volume. If
Intel could achieve both, unit costs would fall enabling Intel to
make a lot of pro t at low price points. In turn, low prices
implied that DRAMs would start to gain wide adoption among
computer manufacturers.
The 1103 put Intel rmly on the map. The chip soon became the
memory technology of choice for computer makers, and by the
end of 1971, 14 out of the world’s 18 leading mainframe
computer makers were using the 1103. However, Intel did not
have the market entirely to itself. Computer makers did not
want to become dependent upon a single source of supply for
critical components. To avoid this, most computer makers
mandated that components had to be at least duel sourced, and
for Intel, this meant that if it wanted business, it had to license
its technology to other companies. Intel rst licensed the rights
to produce the 1103 to a Canadian rm, MIL, in exchange for an
upfront payment and per unit royalty fee. Before long, MIL was
competing against Intel in the market for the 1103, but MIL
made a critical mistake in their manufacturing processes, and it
wasn’t long before a stream of former MIL customers were
knocking on Intel’s door.
Along the way, Intel received an inquiry from two disgruntled
engineers at Honeywell, asking if Intel was interested in
building memory systems. The idea was to mount thousands of

1103 chips on a circuit board that could then be plugged into a
mainframe computer to increase its memory capability.
Impressed by the idea, Intel promptly hired the two engineers
and set up a division to do this. Before long, the new division
was selling circuit
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boards to customers running IBM mainframes. This was
something of a coup: IBM would not even consider buying the
1103, and had started making its own memory chips. Now Intel
had access to a formerly closed market that accounted for 70%
of all memory sales.
Around the same time, an accidental discovery at Intel led to a
second product line—erasable program- mable read only
memory (EPROM). Read only memory chips (ROM) were nding
wide applications in computing. ROM had desired data, a
program for example, per- manently burnt into its circuits. ROM
was used to store programs, such as a machine operating
system, or part of that system. The troubling thing about ROM
is that if an engineer made a mistake in programming the chip,
he would have to burn another chip, which was a pains- taking
and time consuming process. While exploring the reason for
failure of 1103 chips in the manufacturing process, Dov
Froham, another ex Fairchild researcher at Intel, found that the
cause was that some of the “gates” inside the chips had become
disconnected; they were oating. Froham realized that this aw in
the 1103 had a potential use; it might enable an engineer to

design a ROM chip that could be programmed with ease in a
few minutes. Moreover, he found that the data on such chips
could be erased and rewritten by shinning an ultra violet light
on it and the EPROM was born.
Engineers loved the EPROM chip, and once Intel solved the
manufacturing problem and started to produce EMROM chips in
large quantities, demand surged. Bet- ter still, for two years
Intel had a virtual monopoly on the product. While other
companies tried to produce similar chips, they were unable to
solve the manufacturing problems, enabling Intel to charge a
relatively high price for a product whose cost was falling every
day with advances in cumulative volume.
The BirTh oF The Microprocessor
By 1971 Intel had already created two revolutionary in-
novations in the semiconductor industry, the DRAM and the
EPROM chips. A third, the microprocessor, was also created
that year. The microprocessor was born out of an inquiry from a
Japanese company. The company asked Intel if it could build a
set of eight logic chips to perform arithmetic functions in a
calculator it was planning to produce. Intel took on the project.
Ted Hoff, one of the
inventors of the DRAM, wondered if it might not make more
sense to build a miniaturized general purpose computer, which
could then be programmed to do the arithmetic for the
company’s calculator.
The project was given to Federico Faggin, an Italian engineer
who made some of the basic breakthroughs on MOS technology
while working at Fairchild. Although the Japanese company
subsequently decided not to build the calculator, Intel pushed
ahead with the project. Faggin, who worked 12 to 14 hour days
for weeks on end, produced several prototypes in short order.
(A source of irritation for Faggin was that despite the long
hours, his boss, following Grove’s lead, constantly complained
that Faggin was late for work!)
Due to Faggin’s efforts, by November 1971 Intel had its third
product, the 4004 microprocessor. In an article in Electronic

News that accompanied its introduction, and which described
the 4004 as a computer on a chip, Gordon Moore heralded the
4004 as “one of the most revolutionary products in the history
of mankind”. No one paid much attention. People in the
computer industry viewed the 4004 as a fascinating novelty.
Although small and cheap, it could only process 4 bits on
information at a time, which made it slow and thus unsuitable
for use in the computers of the time. The 4004 was followed by
the 8008 microprocessor, which could process eight bits of
information at a time. Although faster, it too was a product in
search of a market. In an attempt to speed adoption, Intel started
to sell development tools that made it easier and faster for
outside engineers to develop and test programs for new
microprocessors. Slowly the microprocessor began to make
inroads into the computer industry, primarily in peripherals
such as printers and tape drives.
The personal coMpuTer revoluTion
By the mid 1970s and embryonic new industry was ap- pearing,
the personal computer industry. A company called MITS based
in Albuquerque, New Mexico produced the rst true personal
computer. The MITS Altair used an Intel 8080 microprocessor,
which was priced at $360. The rst program offered for sale with
the Altair was a version of the BASIC programming language,
written by Bill Gates and Paul Allen, and designed to run on the
8080. The two had moved to Albuquerque to
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be near to MITS, and they had established a company of their
own, Microsoft. The Altair was sold primarily to hobbyists who
wanted to write computer code at home (for which Microsoft
Basic came in handy).

In short order, a number of companies sprung up making
personal computers. The most successful of the early companies
was Apple Computer, which introduced its revolutionary Apple
II in 1977. By this time, a number of other companies were
also producing microprocessors, including Motorola, whose
processor Apple used in the Apple II. The Apple II was a big
commercial success, in no small part because it was easy to use
for, and because one of the most successful early programs, a
spreadsheet called VisiCalc, was written to run on the Apple II.
The commercial success of the Apple II got the world’s largest
computer company, IBM, to take the nascent personal computer
seriously. IBM started to develop its own personal computer in
1979 in a top-secret project. To speed the product to market,
IBM took a mon- umental strategic decision—it decided to use
“off the shelf components” to build the PC rather than develop
everything itself, which had been the norm at IBM. Orig- inally
the company planned to use a microprocessor from Motorola
and an operating system called CP/M from a company called
Digital Research. However, Motorola was late developing its
product, and Digital Research’s CEO, Gary Kildall, proved to
be dif cult to work with. Casting around for alternatives, IBM
contacted Intel, offering to purchase it’s latest microprocessor,
the 8088, which was a derivative of Intel’s 8086 chip. However,
IBM did not tell Intel what the microprocessor was to be used
for (originally Intel was told that it was to go in a printer). As
part of the deal, IBM insisted on alternative sources for the
8088. Reluctantly Intel allowed AMD and a number of other
companies to produce the 8088 under license. A 1982 cross
licensing agreement with AMD, which gave AMD the right to
produce the 8088 chip, would come to haunt Intel for years to
come.
For the operating system of its rst PC, IBM decided to use MS-
DOS, a Microsoft operating system. Origi- nally developed by
Seattle Computer, and called Q-DOS (which stood for quick and
dirty operating system), Q-DOS was purchased by Microsoft for
$50,000 when Bill Gates heard that IBM was looking for an

operating system. Gates renamed the product, and quickly
turned around and licensed MS-DOS to IBM. In what was to be
a stroke of genius that had enormous implications for the future
of all parties involved, Gates, sensing that IBM
executives were desperate to get their hands on an operating
system in order to get the IBM PC to market on time, negotiated
a nonexclusive license with IBM.
Executives at Intel, who by now had realized that IBM was
developing a personal computer, were pro- foundly unimpressed
with the choice of MS-DOS and Microsoft. After a visit to
Microsoft, one Intel executive noted: “These people are akes.
They’re not original, they don’t really understand what they are
doing, their ambitions are very low, and it’s not really clear that
they have succeeded even at that.”6 For its part, Microsoft had
to produce a version of MS-DOS that would run on the Intel
microprocessor. From now on, like it or not, Microsoft and Intel
would be joined at the hip.
Introduced in 1981, the IBM PC was an instant success. To
stoke sales, IBM offered a number of applications for the IBM
PC that were sold separately, including a version of VisiCalc,
a word processor called EasyWriter, and well-known series of
business programs from Peachtree Software. Over the next two
years, IBM would sell more than 500,000 PCs, seizing market
leadership from Apple. IBM had what Apple lacked, an abil-
ity to sell into corporate America.
As sales of the IBM PC mounted, two things happened. First,
independent software developers started to write program to run
on the IBM PC. These included two applications that drove
adoptions of the IBM PC: word processing programs (Word
Perfect) and a spread sheet (Lotus 1-2-3). Second, the success
of IBM gave birth to clone manufacturers who made “IBM
compat- ible” PCs that also utilized an Intel microprocessor and
Microsoft’s MS-DOS operating system. The rst and most
successful of the clone makers was Compaq, which in 1983
introduced its rst personal computer, a 28-pound “portable” PC.
In its rst year, Compaq booked $111 million in sales, which at

the time was a record for rst year sales of a company. Before
long, a profusion of IBM clone makers entered the market,
including Tandy, Zenith, Leading Edge, and Dell Computer.
This entry led to market share fragmentation in the PC industry.
By 1982, Intel had a replacement chip ready for the IBM PC,
the 80286 microprocessor. The 80286 was des- perately needed
since the 8088 was painfully slow running some of the newer
applications. IBM introduced a new PC, the AT, to use the
80286 chip, and priced it at a premium. Demand was so strong
that IBM put the AT on allocation, which opened the door to
clone makers, particularly Compaq. By now, 70% of the
microprocessors sold to PC manufacturers were made by Intel,
with AMD
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accounting for a signi cant portion of the remainder. For the
80286, Intel had cut the number of licenses down to 4. It also
ran an intensive marketing and sales campaign, called
Checkmate, which was successful in getting many Original
Equipment Manufacturers (OEMs) to use Intel’s version of the
80286 in their machines.
The draM deBacle
In 1984 Intel booked revenues of $1.6 and made almost $200
million net pro t, up from $134 million in revenues and $20
million in net pro t a decade earlier. The growth had been
dramatic. However, Intel’s share of the DRAM market had been
sliding for years. New entrants, particularly from Japan, had

been grabbing ever more DRAM sales. They had done this by
undertaking large scale investment to build ef cient fabrication
facilities (fabs) and paying meticulous attention to quality and
costs, doing everything possible to drive up yields. One source
suggested that while peak yields and U.S. DRAM plants, such
as Intel’s, were around 50%, in Japan they were closer to 80%.
This translated into a huge cost advantage for the Japanese
producers.
The American manufacturers, Intel included, had made the
crucial mistake of underestimating the Japa- nese threat.
Demands from computer companies for second sources had
helped to facilitate diffusion of the underlying product
technology and commoditized DRAMs. In such a market,
advantage went to the most ef cient, and this was the Japanese.
Moreover, Japanese companies seized the lead in developing
more powerful DRAM chips. While Intel had created the
market for DRAMs, and dominated the market for 1K chips, in
each subsequent generation it fell further and further behind. By
1983 when fth generation 256K DRAMs started to appear, Intel
was a year behind in the development cycle and as a
consequence, was at a distinct cost disadvantage when it
introduced its product.
Somehow, despite Grove’s aggressive leadership, Intel’s share
had fallen to only 1% of the total DRAM market. To regain
market share, management understood that Intel would have to
build a new fabrication facility, at a cost of $600 million, and
throw company R&D resources behind an effort to bring a next
generation 1 megabyte DRAM chip to the market. To make
matters worse, the DRAM market was in a big slump, bought on
by over- capacity as a result of aggressive investments by Asian
producers, and Intel was losing money in the DRAM business.
Faced with this bleak prospect, Intel’s senior management had
to decide whether to continue to compete in the DRAM
business, the market they had created, or to focus resources on
the more pro table microprocessor market. It was not an easy
decision. Irrespective of the economics, there was enormous

emotional attachment within the company to the DRAM
business. Many at Intel wanted to build a 1 M DRAM. There
were also valid arguments for staying in the DRAM business.
Some thought that DRAMs were the technology driver in
semiconductor manufacturing, and without the knowledge
gained from making DRAMs, Intel’s microprocessor business
would suffer. In addition, there was the argument that custom-
ers would prefer to buy from a company that offered a full
product range, and if it exited the DRAM business Intel would
not be able to do that.
As Andy Grove describes it, a crucial point arrived when he and
Gordon Moore were discussing what Intel’s strategy should be.
Grove asked Moore, “If we got kicked out, and the board bought
in a new CEO, what would he do?” Moore’s reply, “he would
get us out of memories”. Grove then said, “why don’t we just
walk out of the door, and come back and do it ourselves.” It was
one thing to make the decision, another to implement it. Grove
removed the head of the DRAM division, recognizing that he
was not the man to wield the ax, and replaced him with another
manager, who promptly “went native” and started to argue for
going ahead with the 1 megabyte DRAM chip. He too was
replaced, and a year after the decision was made, Intel nally
exited the DRAM business.
The Microprocessor Business
In 1987 Gordon Moore stepped down as CEO of Intel, passing
the torch on to Andy Grove, although Moore remained as
Chairman. Grove, who held the CEO position through until
1998, and was then chairman until 2005, had no intention of
letting Intel’s dominance in microprocessors go the same way
as its DRAM business.
chip design
By now, it was well understood at Intel that the market had an
unquenchable thirst for more powerful microprocessors.
Software was advancing rapidly, with new

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applications becoming available all the time. Running these
applications quickly required more computing power, and users
were willing to pay a premium for this. Intel knew that
consumers would only be too happy to replace their old PCs
with better, faster machines. It thus became critical to develop
and introduce newer microprocessors. At the same time, the
market demanded backward compatibility. The new machines
had to run older software, and this implied that each new
generation of chip should be able to run older programs. This
requirement implied that too a degree, Intel was locked into the
microprocessor architecture that had started with the 8086 (from
which the 8088 was derived), and continued with the 80286.
The next microprocessor in what was now known as the x86
architecture was the 80386, or i386 for short.
First introduced in October 1985, i386 was a 32-bit
microprocessor that was much faster than the i286. Intel had
been trying for over a year to get IBM to introduce a machine
based on the i386, but IBM seemed to be dragging its feet. The
problem for IBM was that an i386 PC would be very close in
power to minicomputers that IBM was making a lot of money
on. Fearing that i386 machines would cannibalize its product
line, IBM seemed to want to keep the i386 of the market as long
as possible. At the same time, Apple computer had introduced
a new machine, the rst Macintosh, which used a Motorola
microprocessor. The Apple Mac was the rst computer with a
graphical user interface and a mouse. As it started to gain
market share, Grove feared that the market might switch to the
Apple standard, making it more critical than ever to get i386
based machines on the market.
Intel had an ally in Compaq Computer. In 1986, Compaq took
advantage of IBM’s sloth to be the rst to introduce a PC built

around the i386. Compaq seized the lead from IBM, other
computer makers quickly followed, and from then on, IBM
started to lose in u- ence and share in the PC business. As the
high margin i386 chip gained traction, Intel’s sales exploded,
hitting $2.9 billion in 1988, while pro ts surged to $450 million.
Over the next two decades Intel continued to drive the industry
forward with regular advances in its x86 architecture. These
included the i486 (introduced in 1989), the rst Pentium chip
(1993), The Pentium Pro (1995), various derivatives of the
Pentium Pro architecture, and more recently, its 64-bit Core 2
Duo and Quad processor line, rst introduced in 2006. The latest
Intel processors have pushed the limits of performance by
building two or four processors into a chip. Intel prices new
chips at a premium then drops prices as manufacturing yields
improve. It is not unusual to see prices drop by 30–50% in one
year.
By continually increasing the performance of its chips, Intel
was able to vanquish several potential competitors, including a
series of fast chips from AMD in the early 2000s, and several
chips based on an architecture known as reduce instruction set
computing, or RISC, that during the 1990s seemed to threaten
Intel’s market dominance. One notable RISC chip arose out of
an attempt by Apple, Motorola and IBM to seize momentum
away from Intel with a RISC processor called the PowerPC.
However, few companies outside of Apple adopted the
processor. The limited volume meant high costs, which were
further compounded by manufacturing problems at Motorola,
and the PowerPC never gained wide ac- ceptance. In 2006,
Apple effectively killed the PowerPC when it announced that it
would henceforth use Intel microprocessors in its machines.
Following Moore’s law, successive generations of Intel chips
have used ever-smaller micron geometries to cram ever more
transistors on a chip. Intel’s 8088 chip, introduced in 1979, had
29,000 transistors, the i486 chip, introduced in 1989, had 1.2
million transistors, and by 2012, its most powerful PC chips
contained 1.48 billion transistors. By 2012 Intel was working

with such small sub micro geometries that more than 100
million transistors could t onto the head of a pin! Compared to
its original 4004 chip introduced in 2012, the chips Intel was
producing in 2012 ran 4,000 times as fast and each transistor
used 5,000 times less energy, while the price per transistor had
dropped by a factor of 50,000. Driving forward chip design and
production requires very heavy R&D spending. By 2012, Intel
was spending over $10 billion a year on R&D, or 19% of sales.
This was split between spending on chip design, and spending
on improving manufacturing processes.
Manufacturing processes
Designing and manufacturing these devices requires constantly
pushing against the limits of physics and technology.
Microprocessors are built in layers on a silicon wafer through
various processes using chemicals, gas and light. It is an
extremely demanding process involving more than 300 steps
and, on modern chips, 20 layers are connected with micro
circuitry to form a complex three- dimensional structure. Intel
is pushing the frontiers of sub
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micron geometry. The company is currently is producing
transistors that measure just 22 nanometers, whereas most other
semiconductor manufacturers are still making 45 nm or 32 nm
chips (a nanometer is one billionth of a meter). Intel newest
factory in Arizona, designed to come on line in 2014, will push
this frontier still further making chips that have just 14 nm

geometry. To carve features this small on a silicon chip, Intel
uses a technique known as extreme ultra violet lithography.
This is a way of printing circuit patterns onto silicon chips that
goes beyond lasers and lenses, and utilizes xenon gas and
microscopic re ec- tors. If it sounds incredibly complex and
esoteric, this is because it is at the leading edge of what is
scienti cally possible. Indeed, each new generation of Intel
chips relies upon pushing processes beyond what was attainable
just a few years earlier.
So complex is the manufacturing process, that the high tech
fabrication plants, or foundries, required to make
microprocessors cost up to $5 billion each. By 2012 Intel had
16 of these plants around the world. Too equip its plants, Intel
works very closely with equipment vendors. Due to its scale,
Intel enjoys considerable lever- age over equipment suppliers.
In some cases, Intel will design a new machine itself, and then
have equipment vendors manufacture it. In others, Intel works
closely with the vendors on the design of a piece of equipment.
As a result, Intel itself holds hundreds of patents relat- ing to
the processes for manufacturing semiconduc- tors. Whenever
equipment is developed speci cally for Intel’s requirements,
vendors are generally prohibited from selling that equipment to
other companies, such as AMD, for a given period.
When installing new equipment, the goal is to gain
manufacturing ef ciencies through increased yields, or other
process improvements. For example, in the 2000s Intel switched
from using 200 mm to 300 mm wafers in its manufacturing
processes. The larger wafers allowed Intel to put more
microprocessors on each, increasing throughput and signi cantly
lowering costs. Intel is currently working to develop the
commercialization of 450 mm wafers and is forecasting that it
will start to make microprocessors on 450mm wafers by
2016/2017. If it can achieve this, it will be the rst in the world
to do so. This may give Intel an advantage in manufacturing ef
ciencies that will be very hard for other chipmakers to match.
To boost yields, raising the percentage of processors that come

of the line operating perfectly, Intel uses sophisticated
statistical process control procedures. Since
even a microscopic piece of dust can contaminate a chip, the
speci cations that Intel works to are extremely demanding and
tight. Over time, Intel has turned yield improvement into a
precise science. With each succeeding generation of
microprocessor geometry, the company seems able to achieve a
steeper learning curve. By constantly pushing out the envelop
with regard to manufacturing technology, product design, and
yields, Intel has reportedly been able to reduce its unit
manufacturing costs for a processor by as much as 25–30% a
year.
Typically, Intel will re ne new manufacturing processes in one
factory, perfecting yields and reducing costs, and then transfer
those processes to other facilities. To do this, it relies upon a
methodology known as “Copy Exactly!” Under this
methodology, engineers spend up to four years perfecting a new
manufacturing technique in one of Intel’s development factories
in Hillsboro Oregon. Once they are satis ed with the results,
they work to meticulously import every last detail to other
factories around the world. Engineers strive to duplicate even
the subtlest of manufacturing variables, from the color of a
worker’s gloves to the type of uorescent lights in the building.
Employees from around the world spend more than a year at the
development factory, learning their small piece of the new
recipe so they can bring it back to their home factory. The idea
is to capture the in nite number of intangibles that have allowed
a process to succeed in plants that have already brought it
online. According to one Intel manager: “It’s not just there’s a
speci cation or a recipe or a program you put into a machine. It
also is what the human being does and how they interact with
the machine.”7
The extremes to which Intel engineers go to control the precise
conditions in its dozen or so factories has become legendary.
A few years ago Intel engineers were trying to gure out why one
plant in Arizona wasn’t hitting the benchmarks achieved at

another in Oregon, where the processes were rst developed.
Then it hit them: Arizona’s desert air was so much drier than
the air in Portland, and the engineers in Arizona were skipping
several steps taken in Oregon to dehumidify. Intel scien- tists
theorized that the dehumidifying, besides removing water, also
eliminated impurities such as ammonia. So engineers began
adding water vapor to the air in the Arizona foundry, essentially
making Portland air, and then subjected it to the same dehumidi
ers used in Oregon. It worked! According to one engineer, this
“shows the level of things you’ve got to worry about when you
try to make something as complex as the chips we make.”8
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intellectual property
From the i386 chip onwards, Grove was determined to ensure
that Intel was the only supplier in the world of its architecture.
AMD, however, believed that under the terms of the 1982
technology sharing agreement between the two companies, it
had rights to Intel’s designs. Intel simply refused to hand over
technical speci cations for the i386 to AMD, sparking off a
lengthy court battle between the two that persisted until 1995.
In the end, the two chipmakers agreed to drop all pending
lawsuits against each other, settled existing lawsuits, and signed
a cross-licensing agreement. Irrespective of the nal set- tlement,
AMD had spent $40 million a year on legal fees alone. Senior
management attention had been diverted by the ongoing legal
battle. AMD had been slow to develop its own version of the
i386, waiting instead to get speci cations from Intel, which Intel
only shared after ordered to in a 1990 ruling.
intel inside
For years, Intel had viewed its customers as original equipment

manufacturers, focusing its marketing efforts on engineers
within those companies. But the nature of the end market was
changing. By the early 1990s increasingly sophisticated
customers were making their own purchasing decisions, often in
computer super- stores, or buying direct from companies like
Dell and Gateway. Consumers now had in uence on the process,
and could exercise choice over not just the machine, but also
the components that went into it, including the microprocessor.
In 1991, Intel started to market directly to consumers with its
Intel Inside campaign, effectively telling them that a computer
with an Intel chip inside would guarantee advanced technology
and compatibility with prior software. Supported by slick
advertisements, the campaign was a stunning success. Within a
year, Intel was listed as the third most valuable brand name on
the planet. In 1993 Grove was able to claim that the number of
consumers who preferred a PC with an Intel microprocessor
had risen from 60 to 80%. By 1994, some 1,200 computer
companies had signed on to the campaign, adhering “Intel
Inside” logos on their machines, or including the logo on their
product ads.
Complicating matters, one aspect of the long running legal
battle between Intel and AMD was a trademark dispute. Intel
had claimed that “386” referred to its
trademark, and competitors like AMD could not use it.
However, in 1991 a court had ruled that the name “386” was so
widely used that it had become generic. The ruling infuriated
Grove, who believed that clone makers would now be able to
piggyback on Intel’s marketing campaigns for the 386 and 486.
He then made the sug- gestion that the next chip, which was to
have been known as the i586, be given another name that could
be trade- marked, and the Pentium was born.
Forward vertical integration
and customers
Intel vertically integrated forward into the production of PCs
in the mid 1980s, selling “boxes” without a screen, keyboard, or
brand logo to well known computer companies who put there

own brand on them and resold them. The move led to
complaints from several of Intel’s customers, who felt that Intel
was indirectly competing against them in the end market and
lowering barriers to entry into the PC industry. After push back,
in the early 1990s Intel exited this business. However, the
company continued to make motherboards, which are large
printed circuit boards that hold the microprocessors, other
critical chips, slots for connecting memory and graphics cards,
and so on.
Intel’s move into motherboards assured more rapid diffusion of
each new generation of chips by making it much easier for PC
companies to incorporate those chips into their machines. The
move infuriated PCs manufacturers such as Compaq and IBM
who generally made their own motherboards. Compaq had been
able to gain a competitive advantage by bring PCs containing
the latest generation Intel chips to market early. Compaq re-
sponded by trying to reduce their dependence on Intel. They
used for chips from AMD and initially refused to participate in
the Intel inside branding scheme. However, by the mid 1990s
Intel’s position was so strong that this had only marginal impact
on the company.
Intel continued to make motherboards through the 2000s, even
though pro t margins were lower than on sales of stand-alone
microprocessors. By 2007 some 24% of Intel’s revenues came
from the sale of motherboards. At this point, large branded
OEMs with a global reach (HP, Dell, Lenovo, Acer, Toshiba and
Apple), accounted for about 50–53% of global PC sales, with
the remainder being captured by a long tail of smaller local
brands. As of 2012, some 18% of Intel’s total sales (stand alone
chips and motherboards) went to Hewlett
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Packard. Dell Computer accounted for another 14% and Lenovo
for 11%.
The Microsoft connection
Throughout the 1980s and much of the 1990s, the relationship
between Intel and Microsoft, was an uneasy one. When
Microsoft introduced Windows 3.0 in 1990, its rst operating
system with a graphical user interface, it boosted demand for
new PCs to run graphics heavy programs. The same happened
when Windows 95 was introduced ve years later. In both cases,
Intel was a bene ciary of the resulting upgrade cycle. Intel
clearly needed Microsoft, but that did not mean that they re-
spected the company. Intel was frustrated that Microsoft did not
seem particularly interested in optimizing their software to run
on Intel’s chips. Microsoft’s engineers seemed more concerned
with adding features to their products, than in streamlining code
so that it took advantage of the full capabilities of Intel’s
microprocessors.
Microsoft, one the other hand, was interested in making its
Windows operating system as ubiquitous as possible, and that
logically implied making a version of Windows that would run
on other microprocessors, such as the new generation of RISC
chips. During the 1990s Microsoft was eyeing users of powerful
computer work- stations, many of which used RISC chips. This
was a potential nightmare for Intel, and it became all to real
when Microsoft announced the development of Win- dows NT, a
high end version of Windows that would run on both Intel and
RISC microprocessors, including the PowerPC. What stopped
the nightmare from occurring was the development of the
Pentium Pro, which was so fast and ef cient that it effectively
eclipsed rivals who used RISC architecture.
Re ecting these underlying tensions, relationships between Andy

Grove and Microsoft’s Bill Gates were often rocky, and there
were reports of meetings dissolv- ing into shouting matches.
This started to change in the mid 1990s. It may have been that
after the failure of the RISC challenge to Intel, the two
companies, and their respective leaders recognized their
interdependence and decided that cooperation was better than
con ict. Be- ginning in 1996, quarterly meetings were held
between Grove and Gates, aimed at coordinating strategy and
re- solving differences.
In 2012 new cracks began to appear in the symbiotic
relationship between Microsoft and Intel when Microsoft
introduced a version of its Windows 8
operating system that would run on ARM processors. For
Microsoft, this was a logical move given its strategy of having
Windows 8 run on all devices, including tablets and
smartphones where the low power consumption offered by
ARM processors was highly valued. Microsoft reportedly made
the decision to produce an ARM version of Windows 8
because Intel’s atom processor con- sumed too much power to
make it a compelling choice in tablets. The move opened the
door for PC manufacturers to start building machines that ran
on none Intel chips.
The BarreTT era
In 1998 Craig Barrett succeeded Andy Grove as CEO. A former
Stanford engineering professor who had become chief operating
of cer of Intel in 1993, Barrett’s tenure as CEO was market by
an aggressive push into new markets. By the 1990s the Internet
was starting to take center place in computing, and Barrett saw
opportunities in extending Intel’s reach into chips to drive
computer networking gear and wireless handsets. Moreover,
Barrett was concerned that without product diversi cation, Intel
would not be able to maintain its growth rate given the
maturation of the PC market in many developed nations. In his
rst three years as CEO Intel spent some $12 billion on
acquisitions and internal new ventures designed to strength the
company’s position in these emerging areas.

Barrett’s push into these areas failed to yield any quick returns.
By 2004 Intel only had 6% of the market for chips used in
networking gear, and 7% of the market for processing chips
within wireless phones. Part of the problem; Intel ran into stiff
competition from embedded competitors. In the market for
wireless phone chips, for example, Intel was competing against
the likes of Texas Instruments and Qualcomm, both of whom
had a strong market and technological position.
Moreover, Barrett’s tenure was marred by some em- barrassing
product delays, capacity constraints that drove some customers
to AMD, and product recalls. To make matters worse, in the
early 2000s AMD seized the lead in chip design for the rst time,
and for two years AMD could boast that it was technological
leader in the industry until Intel recaptured the lead with newer
chips. Compli- cating matters, the PC industry went through a
sharp con- traction in 2001 that led to slumping sales and pro ts
for Intel. While the industry recovered in 2002, growth rates
since 2002 have been lower than in the 1990.
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Some observers have blamed the problems of the Barrett era on
management issues at Intel. The company, they say, had become
too large, too bureaucratic, and was no longer the egalitarian
entity of its early years. The “constructive confrontation” of the
Grove years, which had kept managers on their toes, had been
replaced by an autocratic culture dominated by people who got
pro- moted for managing upwards. A management vacuum
following Grove’s departure led to a lack of account- ability
and control. To quote one critic: “In the Grove era, each leader
who spearheaded an unsuccessful attempt left the company
after the project failed. However, throughout the Barrett era

each gure head has remained at Intel after the project failed”.9
paul oTellini’s plaTForM sTraTeGy
In 2005 Barrett became chairman. Paul Otellini replaced him as
CEO. Another long time Intel employee, Otellini was the rst
Intel CEO to not have an engineering back- ground (Otellini
was an MBA with a career in nance and marketing). As head of
company wide sales and marketing, Otellini gained prominence
at Intel during the late 1990s by pushing the company to adopt a
more aggressive approach to market segmentation. By the late
1990s prices for low end PCs were falling to under $1,000, and
in this commodity market OEMs were casting around for
cheaper microprocessor and motherboard options. Ontellini
came up with the idea of reserving the Pentium brand for higher
end chips, and creating a new brand, Celeron, for lower
performance chips aimed at low cost PCs.
In the early 2000s, Otellini pushed for the creation of the
Centrino chip platform for lap top computers. While Intel
engineers were focused on designing faster more powerful
processors, Otellini argued that lap top users cared more about
heat generation, battery life, and wireless capabilities. The
Centrino platform was designed for them. It combined an Intel
microprocessor with a WiFi chip (for wireless networking), and
associated software. Personal computer manufacturers were
initially skepti- cal about the value of the Centrino platform.
For a while they continued to buy an Intel microprocessor while
purchasing WiFi chips from other companies. But when
performance tests showed that the Centrino platform worked
well, most manufacturers shifted to purchasing
this platform for their laptops and Centrino quickly became a
recognizable brand.
Introduced in 2003, the Centrino was a huge hit, and helped to
pull Intel out of its sales slump. Indeed, by the late 2000s Intel
was dominating the market for lap top chips with its chipset
offerings. Upon succeeding Barrett, Otellini called for the
Centrino strategy to be applied to other areas of the computer
industry. He wanted Intel to design separate “platforms” for

corporate computers, home computers and lap top computers.
Each platform was to combine several chips, and focus on
providing utility to a speci c customer set. The platform for
corporate computers was to package a microprocessor with
chips and software that enhance the security of computers,
keeping them virus free, and allow for the remote management
and servicing of computers (which could bring large cost
savings to corporations). The platform for home computers was
to combine a microprocessor with chips and software for a
wireless base station (for home networking), chips for showing
digital movies, and chips for three dimensional graphics
processing (for computer games).
The goal was to enable Intel to capture more of the value going
into every computer sold and that should increase the
company’s pro tability and pro t growth. To implement this
plan, Otellini announced a sweeping reorganization of Intel,
creating separate market focused divisions for mobile
computing (lap tops), corporate computing, home computing,
and health care computing (which Intel regarded as a
promising growth market with its own unique set of customer
requirements). Each division has its own engineering, software
and marketing personnel, and is charged with developing a
platform for its target market.
To further the strategy of capturing more value going into every
computer sold, Intel moved into the graphics chip business,
integrating graphics capabilities into its chipsets. Although Intel
gained some share at the low end, ATI and Nvidia currently
dominate the high- end graphics chip business. The most
important and demanding applications for graphics chips are
computer games. In 2006, AMD purchased ATI for $5.4 billion,
signaling its intention to bundle both microprocessors and
graphics chips together.
In mid 2008 Intel introduced a new line of low power
consumption chips called Atom that were aimed at mobile
internet devices (MIDs)—which was then de ned as devices
between a smart phone and a conventional laptop and included

net-books (very small laptops meant
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primarily for web sur ng). At the time the Atom chip was
introduced, Apple had yet to revolutionized the computer
market with the introduction of the iPad, although the iPhone
had been introduced a year earlier. Unfortunately for Intel,
smart phone and tablet makers, including Apple, quickly
gravitated to low power consumptions chips based upon
technology pioneered by the British company ARM Holdings
Plc. The main advantage of ARM technology was that it
generated far more computing power per watt than alternative
designs, which implied extended battery life, a key requirement
from consumers. ARM does not manufacture chips itself.
Rather, it licenses its technology to other companies, in-
cluding Apple, Samsung, NVIDIA and Qualcomm, who
incorporated it in their chip designs. They then get the chips
made by contract manufacturers. By 2012, ARM chips had
become the de facto standard for mobile devices such as smart
phones and tablets, leaving Intel at the fringe of the market.
inTel in 2013
Paul Otellini retired in May 2013. His legacy was a mixed one.
On the positive side, he had helped Intel to reassert itself
against a resurgent AMD and cemented the company’s
dominance in the PC market. The company’s revenues grew
from $39 billion to $54 billion, earnings per share increased
from $1.40 to $2.39, and Otellini left Intel with a commanding

market share lead in its core business. More- over, its
manufacturing capabilities remained unmatched in the industry.
On the other hand, Intel had largely missed the move towards
mobile computing, despite the introduction of the Atom chip,
and the company was struggling to gain share against ARM
chips.
More worrying still, PC sales were now in decline as demand
switched towards tablets. That being said, no one expects the
PC to disappear. Indeed, there is a belief that sooner or later the
need to replace aging PC inventory will lead to a robust
replacement cycle. There was some hope that the introduction of
Windows 8 in 2012 might stimulate replacement demand, but
many consumers were put off by the new tile based interface
Micro- soft utilized on Windows 8, and replacement demand
remains muted for the time being.
That being said, there is a silver lining in the rapid switch
towards mobile computing: Increasingly, these devices are using
high-speed wireless links to store data on “the cloud” and
access applications that resided
on “the cloud”. At the heart of the cloud are very large server
farms containing hundreds of thousands of PC servers that are
networked together. Most of these servers, as it happens, are
based on PC architecture and run on Intel microprocessors. Thus
the growth of mobile devices that are connected to the Internet
through the cloud could result in more server farms and more
demand for Intel microprocessors going forward. Nevertheless,
for the time being Intel is clearly ghting headwinds in its
microprocessor business.
Otellini’s successor as CEO is Brian Krzanich, the former COO.
A long time Intel employee, Krzanich made his mark in the
company as head of the manufacturing organization. His
elevation to the CEO position probably speaks volumes about
the importance Intel at- taches to the manufacturing aspect of
its business. A key task for Krzanich is to make sure that the
company remains relevant in the post PC era.
Intel is not sitting back and letting ARM chips dominate the

mobile device market. It is introducing a new generation of its
Atom chips that appear to be far more competitive with ARM
chips, and deliver similar performance per watt. These are
22nm chips and will be manufactured using the latest
technology. If the new generation of Atom chips are
competitive, it is possible that Microsoft will again focus just
on writing Windows to run on Intel architecture, since
producing two versions of Windows is a costly exercise. This
could provide upside for Intel, particularly if Windows 8 and its
successors gain traction in the tablet and smart phone markets—
although to date that has yet to happen. Even if the Atom chip is
successful, however, the economic impact for Intel might well
be muted by the lower average selling price of chips for mobile
devices, as opposed to PCs.
Another aspect of Intel’s current strategy is to defend the laptop
market from encroachment by ARM chips. In 2013 Intel
introduced its Haswell chips that can run PC software but have
longer battery life. Reportedly, laptops running on Haswell
chips have a battery life of up to 10 hours, which represents a
50% improvement over prior generation chips and comparable
with the battery life for a tablet.
Although Krzanich seems to be following the script laid out by
Otellini, it is clear that he faces signi cant challenges going
forward. The task for Intel is to remain relevant in the post PC
era, to hold the rise of ARM chips in check, to continue to
dominate its base, to revitalize, if possible, its long-term
symbiotic relationship with Microsoft (a company that is itself
facing signi cant
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4:55 PM
challenges), and to gain meaningful traction in the rapidly

growing mobile device market where Intel so far has been little
more than a bystander.
reFerences
1. Anonymous, “Intel’s Right Hand Turn”, The Economist, May
14th, 2005, page 67.
2. Anonymous, “The empire strikes back”, The Economist,
December 2nd, 2006, page 69.
3. Anonymous, “Battlechips”, The Economist, June 7th, 2008,
pp 75–76.
4. B. Colman and L. Shrine, Losing Faith, Colman and Shrine,
2006.
5. R.P. Colwell, The Pentium Chronicles, John Wiley, New
Jersey, 2006.
6. C. Edwards, “Getting Intel back on the Inside Track,” Busi-
ness Week, November 29th, 2004, page 39.
7. C. Edwards, “Shaking up Intel’s Insides”, Business Week,
January 31st, 2005, page 35.
8. P. Frieberger and M. Swaine, Fire in the Valley, McGraw
Hill, New York, 2000.
9. A. Hesseldahl, “AMD vs Intel: The challengers new plan”,
Business Week Online, July 11th, 2008, page 1.
10. A. Hesseldahl, “AMD wins another round against Intel”,
Business Week Online, June 9th, 2008, page 12.
11. Intel Corporation, Form 10K 2007.
12. T. Jackson, Inside Intel, Penguin Books, New York, 1997.
13. Lashinsky, “Is this the right man for Intel?”, Fortune,
April 18th, 2005, pp 110–120.
14. R. Parloff, “Intel’s worse nightmare”, Fortune, August 21st,
2006, pp 60–70.
15. B. Snyder Bulik, “Intel’s New Strategy Demands a New
Partner”, Advertising Age, March 14th, 2005, pp 4–5.
16. Intel Corp. 10K Statement, 2012
17. Intel Corp: Assessing Intel’s Atom Tablet Opportunity,
Morgan Stanley, May 15th, 2013.
18. Vivek Arya, “Haswell: Mobility of a tablet, power of a
PC”, Bank of America Merrill Lynch, May 30th, 2013.

19. Anonymous, “Chip of the old Block: Intel v ARM”, The
Economist, May 2nd, 2013. noTes
1.
2. 3. 4. 5. 6. 7. 8. 9.
T. Samson, “IDC: PC shipments worst than predicted, tablet
shipments get better to exceed PC shipments by 2015”,
InfoWorld, May 28th, 2013.
D. Traviosm, “ARM Holdings and Qualcomm: The Winners in
Mobile”, Forbes, February 28th, 2013.
Tim Jackson, Inside Intel, Penguin Books, New York, 1997,
page 18.
R.S. Redlow, “The Education of Andy Grove”, Fortune,
December 12th, 2005, page 116.
page 33.
page 206.
Anonymous, “When Intel says ‘Copy Exactly’, it means it”,
Chinadaily.com, May 30th, 2006.
Anonymous, “When Intel says ‘Copy Exactly’, it means it”,
Chinadaily.com, May 30th, 2006.
B. Coleman and L. Shrine, Losing Faith: How the Grove
Survivors led the Decline of Intel’s Corporate Culture (Logan
and Shrine, 2006), page 117.
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CHAPTER 7 Managing Inventories
MGMT 400
Operations Methods in Value Chain Management
Learning Objectives
1. Define the different types and roles of inventory
2. Explain the financial impact of inventory
3. Explain and compute measures of inventory performance
4. Describe practical techniques for inventory planning and
management
5. Explain how inventory impacts and must be managed across
the entire supply chain
7
–
2
Chapter 7: Lists and Groupings
Types of Inventory
1. Raw Materials
2. Component Parts
3. Work in Process (WIP)
4. Finished Goods
5. Maintenance, Repair and Operating
Supplies (MRO)
6. Transit
Roles of Inventory
1. Balancing Supply and Demand
2. Buffering Uncertainty in Demand or
Supply
3. Enabling Economies of Buying
4. Enabling Geographic Specialization
Costs Relayed to Inventory
1. Product Costs

2. Holding (Carrying) Costs 3. Order and Setup Costs
4. Stockout Costs (Shortage)
Measures of Inventory Performance 1. Inventory Turnover
2. Days of Supply
3. Service Level
7
–
3
Definitions
• Inventory is the supply of items held by a firm to meet demand
• Inventory specific to manufacturing (items contributing or
becoming a firm’s output):
– Raw materials
– Component parts – Work-in-Process – Finished products
• Inventory in all types of organizations:
– MRO inventory (maintenance, repair, operating
supplies) –Transit Inventory
7
–
4
Types of Inventory
• Inventory: supply of items held to meet demand
Suppliers
Raw Material
Components Work in
Process (WIP)
Transportation
MRO Maintenance, repair & operating supplies

Finished Goods (FGI)
: Transit Inventory
Distribution
Customers
7
–
5
Types of Inventory
Which type of inventory could the following products be?
Examples?
–Oranges
• Finished product (orchards)
• Raw material inventory (orange juice manufacturer)
• Work-in-process (company that sells ready-make fruit salads
for grocery stores)
• Maybe MRO in an office environment as part of “office
supplies”?
– Computer Processor
• Component part (Dell, Playstation production, etc.)
• Finished products (Intel, AMD) • MRO at a school
7
–
6

Roles of Inventory
2. Buffering Uncertainty in Demand of Supply
Roles of Inventory
• Balancing (timing of) supply and demand: decouples
differences in supply and demand requirements
• Buffers against uncertainties: variation in supply and demand
are managed with safety (buffer) stock
• Economies of Buying: price discounts or reduced shipping
costs
• Geographic Specialization: supply and demand locations vary
7
–
7
Roles of Inventory
Roles of Inventory
• Balancing (Timing of) Supply and Demand
–In most cases, it is beneficial to produce batches of products
before demand realizes. (Exception?)
–Customers expect many products to be available at the time
they decide to purchaseavailability of product
–Seasonality of demand or supply:
• Customers may be interested in products only at certain time
of year, but production runs all year.
• Some products can only be produced at certain times of year,

but are demand all year long (agriculture).
7
–
8
Roles of Inventory
Roles of Inventory
Demand:
–Typically, it is impossible to know exact future demand.
–If demand is higher than inventory, customers cannot make
the purchase.shortage costs (explained later)
Supply:
–Uncertainty concerning how long until replenishments arrive
–Without safety stock, your operations might have to be stopped
if replenishment is delayed.
safety (or buffer) stock is extra inventory held to guard against
uncertainty in supply or demand
7
–
9
Roles of Inventory

Roles of Inventory
• Economies of buying: price discounts or reduced shipping
costs
–Economies of Scale at the supplier lead to a decreasing price
per unit as purchase volume increases.
–Economies of Scale lead to lower unit transportation costs as
shipment size increases.
–Speculative buying
• Buy large amounts when prices are low in anticipation of price
increases (jet fuel, heating oil, silicon,...)
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10
Roles of Inventory
Roles of Inventory
–Demand for most products exists virtually everywhere.
–Production locations are typically few, so larger quantities
have to be produced, shipped, and stored.
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11
Costs Related to Inventory
1. Product Costs 2. Holding Costs 3. Order and Setup 4.
Stockout Costs

Financial Impact of Inventory
• Product Costs: amount paid to suppliers for the products that
are purchased
• Holding (Carrying) Costs
– Usually stated as a percentage of the value of the inventory
– Capital costs
• Cost of the capital or opportunity cost
– Storage costs
• Storage and warehouse management, cost of space, workers,
and equipment
– Risk costs
• Obsolescence, deterioration, spoilage, shrinkage
• Taxes and insurance
• Material handling, tracking, damage, and management
7
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12
Costs Related to Inventory 1. Product Costs
2. Holding Costs
3. Order and Setup
4. Stockout Costs
Holding (Carrying) Costs
Annual inventory holding costs can be estimated as a percentage
of inventory value:
–Cost of Money 6% - 12%
–Taxes 2% - 6%
–Insurance 1% - 3%
–Warehouse & Handling Expenses 2% - 5% –Clerical &
Inventory Control 3% - 6% –Obsolescence 6% - 12%
–Deterioration & Pilferage 3% - 6%
Annual holding costs can easily be 25% of the total value of
inventory

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13
2. Holding Costs
3. Order and Setup
4. Stockout Costs
• Ordering and Set-up Costs
–Purchased items: placing and receiving orders –Make items:
set-up or change-over between items
Cheetos Snack Production
7
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14
2. Holding Costs
3. Order and Setup
4. Stockout Costs
• Stockout (Shortage) Costs
–Lost sales or customer loyalty
–Schedule disruptions for downstream partners –
Expediting/backorder costs
Japan Tsunami 2011
Empty Store Shelves
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15

Measures of Inventory Performance
• Inventory turnover: ratio between average inventory on-hand
and level of sales
Three definitions
= Cost of goods sold / Average inventory at cost
= Net sales / Average inventory at selling price = Unit sales /
Average inventory in units
With an annual cost of goods sold of $500M and average
inventory of $80M.
Inventory turns = $500/$80 = 6.25 turns per year
The number of times average inventory is sold and replaced
annually
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16
• Advantages of high inventory turnover
– “Fresh” inventory from high sales
– Less risk of obsolescence or need to mark down – Reduced
total inventory holding costs
– Lower asset investment and higher productivity
• Dangers of high inventory turnover
– Lower sales if desired inventory is not available
(stockouts)
– Increased costs from missing quantity requirements (loss of
economies of scale)
– Increased ordering costs 7
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17

• Days of Supply: length of time operations can be supported
with inventory on-hand
– Based on demand forecasts or input requirement forecasts
(depending on type of operations)
– More meaningful for specific items than overall inventory
holdings
Days of Supply = Current Inventory / Daily demand
Average Days of Supply = Average Inventory / Daily Demand
If current inventory is 2,000 and daily demand is 25/day:
Days of Supply = 2,000/25 = 80 days
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• Service level measures the ability to meet customer demand
without a stockout.
– Different ways to measure service level
• 1: Percentage of customers whose order you can satisfy
without delay using your inventory
• 2: Percentage of demand volume you can deliver without delay
using your inventory
• Example:
– Assume you have 100 bottles of beer in stock. 99 customers
arrive and order 1 bottle each. Then the 100th customer arrives
and orders 101 bottles of beer, but you only have 1 left.
• Service level (type 1): 99/100 = 99% • Service level (type 2):
100/200 = 50%
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Managing Inventory
• Basic decisions involve:
– How much to order
• How much inventory should be held?
– When to order
– Where in the organization / supply chain should inventory be
held?
• Important Tools
– Inventory item classification
– Information systems and accurate inventory records
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Managing Inventory
Managing inventory involves managing: • Cycle stocks
– Average inventory needed to meet demand between the times
the firm orders more inventory
• Safety (or buffer) stocks
• Inventory locations
• Inventory information systems
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Managing Inventory: Cycle Stocks
• Primary driver of cycle stock size is the order quantity
• Lower optimal order quantity is achieved with:
–Lower ordering or setup costs
–Reducing quantity discounts with always lowest price

• How can ordering or setup costs be reduced?
–Online ordering –Automated payments –Decreasing setup time
• Lowering order costs will lower the order quantity, which will
lead to decline in cycle stock
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Managing Inventory: Safety Stocks
• Safety stock is required because of uncertainty and variability,
so reducing variability would reduce required safety stock
levels
• Variability and uncertainty can be reduced through:
– Better forecasting (Chapter 12)
– Reduced lead (shipping) times
– Better supplier relationships
– Changes in transportation method
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Item Classification
• ABC analysis: ranking of inventory by importance allows
firms to focus on critical inventory items.
–Determine the percentage of the total usage or sales (or other
criteria of importance) by each item and rank the items from
highest to lowest percentage
• Different policies for different items:
–Safety stock policy
• A items have higher safety stock levels than B items • Little or
even no safety stock for C items
–Purchasing policy
• More purchasing effort warranted for A items than B or C
items

–Inventory audits
• More frequent inventory check for A items than B or C items
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ABC Analysis
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24
Managing Inventory: Locations
Where a firm locates inventory impacts the cost and amount of
required inventory
• Distribution centers can reduce the total inventory level
– While providing fast reliable service to stores and downstream
locations
– Also allows for offering of more products without
accumulating too much inventory
• Transshipment and inventory sharing policies can reduce
overall inventory
– Can quickly get parts from other locations
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Inventory Information Systems and Accuracy
• Inventory information systems provide data for inventory
analysis and require unique product identifiers.
• Finished Products:
–Use the UPC (Universal Product Code) barcode in North
America
• Raw Materials and Components:
–No standardized systems developed yet, part number vary
between companies
–Part Number: unique identifier used by a specific firm

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Inventory Information Systems and Accuracy
• Inventory Record Accuracy
· – Human errors or accidents can lead to costly inaccuracies of
inventory levels
· – Cycle Counting: inventory is physically counted (audited)
on a routine schedule
• ABC analysis used to determine audit cycles
• Cycle through products so that “a little is checked every day”
· – Point-of-sale scanning (UPC barcodes) and RFID tags can
increase accuracy
Any system is only as good as the data that it contains!!
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Managing Inventory Across the Supply Chain
• Inventory Value:
–As an item moves in the supply chain, value is constantly
being added to it
• Finished good has a value that is much greater than the sum of
its individual parts
–Items are more expensive to stock further downstream in the
supply chain (or conversely, less expensive to stock upstream)
• Bullwhip Effect:
–Variation increases upstream in the supply chain (from
consumer to manufacturers)
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28
Bullwhip Effect
Increasing Variability of Orders up the Supply Chain
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Managing Inventory Across the Supply Chain
• Vendor-managed Inventory (VMI): the vendor is responsible
for managing inventory for the customer
–Vendor monitors and replenishes inventory balances –
Customer saves holding costs
–Vendor has higher visibility of inventory usage
• Collaborative planning, forecasting and replenishment (CPFR)
–Supply chain partners sharing information to jointly develop
their production, distribution, and replenishment plans
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Managing Inventories Summary
1. Multiple types and roles of inventory
2. Inventory is an asset, and has multiple costs
3. Multiple performance metrics such as inventory turns, days
of supply, and service level
4. An inventory policy determines how much and when to order
5. Lowering order costs will reduce cycle stock
6. Reducing variability/uncertainty will reduce safety stock
7. Bullwhip effect describes increasing upstream variation for
supply chain partners
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31
CHAPTER 11 Logistics Management
MGMT 400
11
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1
Learning Objectives
1. Explain logistics and major managerial decisions made by
logistics managers
2. Describe impact of consolidation on cost
3. Describe carrier mode selection process
4. Explain roles and activities of warehousing and distribution
5. Explain importance of packaging and materials handling
6. Explain network design decisions
7. Describe benefits of integrated service providers
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Activities of Integrated Logistics Management 1.Inventory
Management
2.Order Processing
3.Transportation Management 4.Warehouse Management
5.Material Handling and Packaging
6.Network Design Consolidation Strategies
1.Market Area 2.Pooled Delivery 3.Scheduled Delivery
Modes of Transportation 1.Truck

2.Rail
3.Pipeline
4.Water
5.Air
Characteristics of Transportation Modes
1.Speed 2.Availability 3.Dependability 4.Capability
5.Frequency
Carrier Types 1.Common 2.Contract 3.Private
Warehouse Operations 1.Stockpiling 2.Production Support
3.Transshipment Points
1. Break-Bulk
2. Consolidation 3. Cross-Docking
4.Reverse Logistics
5.Value Added Services Warehouse Facilities
1.Private 2.Public 3.Contract
1
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3
Logistics Management
• Logistics Management: movement and storage of materials to
meet customer needs and organizational objectives
- Includes forward and reverse flow
- Includes flow of materials and information
- Load, offload, move, sort and select material
• Two dimensions
- Providing service to customers - Efficiently managing its costs
1
1

1
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4
Logistics is an integrating activity
• Inbound flows
–Work with suppliers and procurement managers
• Flows within the organization
–Information, products, and materials among different plants
and facilities
• Outbound flows
–Work with marketing, sales, and customers –Ensure customer
requirements are satisfied
1
11
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5
Logistics Impacts Customer Service
• Logistics plays a critical role in customer service •
Availability
–Locations for storing inventories
• Lead-time performance
–Transportation to customers –Packaged and loaded quickly
• Service reliability
–Without damage –To exact location –All items ordered
1
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Activities of Integrated Logistics Management
Figure 11-1 1
11
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7
7
Logistics management is challenging
1
1
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8
Logistics Cost Minimization & Trade-offs
• Logistics involves significant expense
–As much as 25-30% of each dollar of sales revenue –The total
cost of U.S. logistics was $1.4 trillion in 2014
• 8.3% of U.S. GDP
• Tradeoffs between service levels and cost
–Cost-to-Service: service levels = costs
carrying cost
–Cost-to-Cost: cost of one activity = cost of another
se locations
• Logistics seeks to minimize the total landed costs, not just one

cost element
1
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Logistics Cost Minimization & Trade-offs
•Total Landed Cost: sum of all product and logistics related
costs
- Costs within country of manufacture
• Raw materials, storage, labor...
- Cost in transit to country of sale
• Fuel, insurance, port charges...
- Cost within country of sale
• Local handling, taxes, maintenance...
1
11
1
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1. Inventory Management
2. Order Processing
3. Transportation Management
4. Warehouse Management
5. Material Handling and Packaging
6. Network Design
Inventory Management / Order Processing
• Inventory management

–Considers such questions as:
• Where to hold, in what form, how often to replenish
–Level of inventory is dependent on:
• Mode of transportation
• Location and number of warehouses
• Order processing
–Competitive advantage by improving the speed –Importance of
accuracy of service
Today’s business mantra: “information replaces inventory”
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11
2. Order Processing
6. Network Design
Transportation Management
• The most visible part of logistics
–Transportation costs 40-60% of logistics costs
• More important as companies have increased their global
reach
• Government’s Role:
–Economic Regulation (decreasing): entry of new carriers, rates
and services provided
–Safety (and Social) Regulation (increasing): safe for carriers
and public, including increased emphasis on security from
terrorist activity and transparency on travel locations
1

1
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1
12
Transportation Economics
- Economy of Scale: cost per unit of weight decreases as
shipment size increases
(“the larger the load, the lower the cost per pound”)
- Economy of Distance: cost per unit traveled decreases as
distance moved increases
(“the longer the haul, the lower the cost per mile”)
Cost Per Unit of Weight
Cost Per Unit of Distance
Weight of Shipment
Distance
1
11
1
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Consolidation
• Consolidation: combining many smaller shipments into one
large shipment
–Market Area: combine small shipments from one shipper going
to the same area
–Pooled Delivery: combine small shipments from different
shippers going to the same area
• Handled by independent transportation companies (UPS or

FedEx)
–Scheduled Delivery: delivery at specific times • Only possible
within the constraints of customers’
requirements
• Represents a cost-to-service tradeoff
1
11
1
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–14
Consolidation Example: In-Class Exercise
A firm has 3 customer orders, each for 12,000lbs of coal. It is
$15.75 per 100 lbs to ship directly to each customer, or $10.50
per 100 lbs for consolidated shipments with a $300 fee for each
stop. Should the firm consolidate shipments?
Cost of individual shipments:
$15.75 x (12,000/100) = $15.75 x 120 = $1,890 total for all
three shipments = 3 x $1,890 = $5,670
Consolidated shipments:
$10.50 x (36000/100) = $10.50 x 360 = $3,780 including stop
charge = 3 x $300 + $3780 = $4,680
Saving with consolidation = $5,670 - $4,680 = $990
1
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15
Consolidation Example: In-Class Exercise
You have three shipments to make. The weights are 3,000 lbs,
7,000 lbs, and 14,000 lbs. The transportation rates are as

follows:
Shipment Weight
1,000 – 5,000 lbs. 5,000 – 10,000 lbs. Over 10,000 lbs.
Cost per 100 pounds
$18 $16 $14
For consolidated shipments, there is a charge of $200 per stop.
Cost of individual shipments:
(3,000/100)($18) + (7,000/100)($16) + (14,000/100)($14) =
$540 +$1,120 + $1,960 = $3,620
Consolidated shipments:
(24,000/100)($14) + 3($200) = $3,360 + $600 = $3,960
$3,620 -
11
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16
Transportation Modes
• Five basic transportation modes
–Rail, Truck, Water, Air, Pipeline
1
11
1
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• When deciding which mode of transportation should be used
for each order, consider:
–Cost of each mode
–Service characteristics
• Speed
• Availability
• Dependability • Capability
• Frequency

1
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1
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18
Transport Modes
1. Truck
2. Rail
3. Water 4. Pipeline 5. Air
Truck
• Major transportation mode in U.S.
• Can offer door-to-door service anywhere
• Low fixed costs, high variable costs
• Three segments
–Truckload (TL): Non-stop loads over 15,000 lbs
• Price competitive
• Many small operators
–Less-than-truckload (LTL): Less than 15,000 lbs
• Consolidation required
• Few national carriers: Yellow Freight, Conway, Roadway
–Specialty carriers: Package haulers
• FedEx, UPS, USPS
Who has the strength of the last mile?
1
11
1
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19

Transport Modes 1. Truck
2. Rail
3. Water
4. Pipeline 5. Air
Rail
• Best suited to moving large shipments over long distances
• High fixed costs, low variable costs
• Slow, low flexibility
• Recent increase in freight moved by rail as fuel becomes more
expensive and railroad companies form alliances with other
modes
1
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1
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20
Rail Cars
Tank cars are designed to carry petroleum products, liquid
chemicals and gases. Tank car options can be insulated,
pressurized, and designed for single or multiple loads.
Hopper cars are used to transport commodities that are in a
loose bulk form, such as coal, iron ore, and grain.
11
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21
Auto Racks

•Each rail car can carry up-to 22 light trucks or minivans
•Rail cars can be reconfigured to have 2 or 3 levels
•Enclosed rail cars prevent the autos from getting damaged via
weather or vandalism. They also stopped the theft of autos and
parts off of autos and kept hobos from living in the
automobiles.
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22
2. Rail
3. Water
4. Pipeline 5. Air
Water
• Advantage: Move extremely large shipments economically
• Limited port availability • Fairly Slow
• Oldest mode
1
1
1
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2
23
Container Ships
• Cargo ships carrying everything in 20’, 40’, or 45’ containers,
with 40’ being the most common
• 90% non-bulk cargo is transported by container
11

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24
Pure Car Carrier / Pure Truck Carrier
• Roll-on/Roll-off (RoRo) completely enclosed ship • 12-Decks
with Adjustable Ceilings
• Extensive Fire Control Systems
• 6500 vehicle capacity
• Loading from rear and side
11
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25
A river barge hauling coal
Barges
· Flat-bottomed boat can carry 800 truckloads of freight!
· Built mainly for river and canal transport
· Most barges are not self-propelled and need to be moved by
tugboats towing or pushing them.
· Barges are still used today for low value bulk items (Weight
and Size)
· Cost of hauling goods by barge is very low.
Barge traffic increasing since using short sea or river shipping
to relieve roadway congestion and pollution
–
A barge carrying the Space Shuttle external tank is towed to
Port Canaveral, Florida.
11
26
2. Rail
3. Water
4. Pipeline

5. Air
Pipeline
• Appropriate for products in a gaseous, liquid, or slurry form
• Advantages: Never stops, not affected by the weather
• Highest fixed costs, lowest variable costs
• Lowest environmental impact
–What about oil spills?
1
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27
2. Rail
3. Water
4. Pipeline
5. Air
Air
• Newest and the least utilized mode
• Major advantage is speed
• Limited in size, shape, and weight of freight
• Appropriate for very high value, low-bulk items
• Low dependability and high variability
• High variable costs
–Fuel, user fees, labor, maintenance
• Low fixed costs
–Airports are publicly funded
1

1
1
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2
28
Future Transport Methods
Individual Amazon Drone Delivery
3D Printing Consumer Products
11
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29
Intermodal Methods
• TOFC: Trailer on Flatcar (Piggyback) • COFC: Container on
Flatcar
• Fishyback: Truck Trailer to Ship
• Trainship: Rail Car to Ship
• Land Bridge: Containers by Sea and Rail
–Pacific Rim to West Coast by Sea –West Coast to East Coast
by Rail –East Coast to Europe by Sea
Most Common
11
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30
Piggyback
An intermodal train carrying both shipping containers and
highway semi-trailers in "piggyback" service, on flatcars
· - TOFC: Trailer on Flatcar

· - COFC: Container on Flatcar
11
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31
Intermodal: FishyBack & Trainship
· Special Roll-on/Roll-off (RO-RO): Ships designed to carry
wheeled cargo such as automobiles, railcars, and trailers.
· ConRo: vessel is a hybrid between a RORO and a container
ship. This type of vessel has a below-decks area used for
vehicle storage while stacking containerized freight on the top
decks.
11
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32
2. Rail
3. Water
4. Pipeline 5. Air
Cost, speed and flexibility comparison
ShipOmpeentrsaatrienogften Intermodal Ti
Characteristics
Operating
Characteristics
Speed
ruck
Truck
2
Rail W
3

Rail
ater P
4
Water
pe A
5
Pipe
ir
Air
Speed
Availability
12
2
3
4
4
5
5
1
Availability
1
2
4
5
3
Dependability
2
3
4
1
5
Capability
Capability
33
2
2

1
1
5
5
4
FFrereqquueennccyy
22
44
55
11
3
Variable Cost
Cost
22
3
3
4
4
5
5
1
Dependability
2 3 4
1
3
1 5
4
3
1
Figure 11-2
1=best, highest; 5=worst, lowest
Highest Cost

1
11
1
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33
Activity
Which mode of transportation would you use for the following
products? Why?
· Steel
· Oil from Alaska
· Roses from Texas bound for New York
· Medicine for an out-of-stock pharmacy across the country
· A contract that must be signed within 24 hours
11
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34
Activity
Assume you need to relocate to New York from Los Angeles
when you graduate:
• What type of item needs to be transported by:
–Truck? –Rail? –Water? –Air?
• Why?
1
1
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35
Transportation Service Selection

• Carrier Types
· - Common: provide service to the public with published rates
· - Contract: provide service only to select, contracted
customers
· - Private: firm owns its own equipment
• Value Density: ratio of value to weight, often determines the
mode of transportation and type of carrier used
- Product value drives inventory (holding) costs
- Product weight drives transportation (shipping) costs
1
11
1
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–36
Transportation Service Selection
A firm must ship a box of 30 items (each item’s value = $500) a
distance of 1,000 miles. Transportation options are 8-day
ground for $50 or 2-day air for $90. Holding cost is 20% of
product value annually. How should the firm ship their product?
Total cost = In-transit holding cost + Freight cost In-transit
holding = days in transit/365 x value x holding cost
Ground: [(8days/365) x $15,000 x 20%] + $50 = $115.74 Air:
[(2days/365) x $15,000 x 20%] + $90 = $106.44
Example 11-2 1
11
1
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–37
2. Order Processing

6. Network Design
Warehouse Management
• Warehouse: historically a place to store inventory
• Distribution Centers (DCs): strategically store inventory,
package final product configurations and assortments
• Primary Functions:
– For Stockpiling: storage of inventories in warehouses to
protect against seasonality either in supply or demand
· – For Production Support: dedicated to storing parts and
components needed to support a plant’s operations
· – Increasingly used as Transshipment Points, where products
are received, sorted, sequenced, and selected into loads
consistent with each customer’s needs
1
11
1
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3
38
Primary Functions of Warehousing
Break-Bulk
Consolidation
Cross-Docking
1
11
1

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–39
Cross Docking
Source:
people.hofstra.edu/geotrans/eng/ch5en/conc5en/crossdocking.ht
ml
· Simplify unloading and reloading
· Allows consolidation
· Information and coordination replacing inventory
11
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40
Primary Functions of Warehousing
• Reverse Logistics:
- Material moves upstream in the supply chain
- Especially important in online retail
- Damaged, defective product
- Return, repair, refurbishment
- Warehouses act as collection points
• Send products back to disassembly, reclamation, or disposal
sites
• Value Added Services: providing additional value to the
customer, such as postponement in packaging, labeling, or even
small final assembly
1
11
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–41

Warehouse Facilities
• Private warehouse
–Offers more control over the products
–Opportunities to integrate with other activities within the
logistics system
–Flexibility in operating policies and procedures –Requires
commitment of financial resources
• Public warehouse
–Appropriate for a firm whose needs for warehouse capacity
vary substantially throughout the year
• Contract warehouse
–Typically offer expanded services
1
11
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–42
2. Order Processing
6. Network Design
Materials Handling and Packaging
· Handling and locating material increases costs and the risk of
damage
· Proper packaging and handling can decrease handling costs
and risk of damage
- Containerization or Unitization: filling or creating a larger
container from smaller ones
- Automated Storage and Retrieval Systems: robots that
retrieve, move, and put-away material

- RFID: electronic tracking of material 1
1
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4
43
Why study
OM? OM in the News
· Australian wine shipped in plastic bag
· 24,000L bags hold wine for 32,000 bottles
· Shipping container holds and ships 1-24,000L bag for only
20% higher cost than 13,200 bottles (9,900L)!
· “You lose a third of your volume to bottle and carton.”
· 54% of Australia wine exports are now bagged!
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44
2. Order Processing
6. Network Design
Network Design
• Determine the number and location of facilities • Most impact
on supply chain operations
• Multiple factors to consider

– Labor
– Proximity to suppliers and customers – Cost of land and
construction
– Taxes, incentives and regulations
– Transportation infrastructure
– Quality of life for employees
1
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4
45
Inbound & Outbound Transportation Costs
Manufacturer Warehouse
11
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46
Network Design
• Number of locations is determined by balancing inbound and
outbound transportation costs
–
Number of Facilities
Figure 11-5 1
11
1
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–47

• Transportation Cost
–Initially decreases with more facilities
• Financial savings from transportation consolidation
–Reaches total cost minimization point then increases as the
number of facilities goes up
• Total facility costs increase, smaller inbound shipments
• Inventory Cost
–As the number of warehouse locations increases, total amount
of inventory increases
• Each facility needs its own safety stock
• Logistics postponement for high-value density product
manufacturer
1
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–48
Network Design
–
(Both Inbound and Outbound)
Where total cost is minimized.
Not where inventory, facility, or transportation cost is
minimized!!
All while still meeting customer requirements!
Figure 11-6 1
11
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49

Integrated Service Providers (ISPs)
• More commonly called third-party logistics service providers
(3PLs)
• Major firms: UPS, FedEx, Ryder, DHL
• Provide a range of logistics services
–Intermodal transportation
–Warehousing
–Order processing, tracking and fulfillment and returns –
Inventory management
–JIT delivery to assembly line
–Sales support
1
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Logistics Management Summary
1. Flow of material and information between suppliers,
producers and customers
2. Meet customer needs at lowest landed cost
3. Includes multiple modes of transportation
4. Economies of scale and distance impact costs
5. Multiple distribution center types to facilitate optimal
material storage and flow
6. Network design and facility location are strategic decisions
that impact cost and customer service
1
11
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–51

CHAPTER 7 Managing Inventories
MGMT 400
Learning Objectives
1. Define the different types and roles of inventory
2. Explain the financial impact of inventory
3. Explain and compute measures of inventory performance
4. Describe practical techniques for inventory planning and
management
5. Explain how inventory impacts and must be managed across
the entire supply chain
7
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2
Types of Inventory
1. Raw Materials
2. Component Parts
3. Work in Process (WIP)
4. Finished Goods
5. Maintenance, Repair and Operating
Supplies (MRO)
6. Transit
Roles of Inventory
2. Buffering Uncertainty in Demand or
Supply
Costs Relayed to Inventory

1. Product Costs
2. Holding (Carrying) Costs 3. Order and Setup Costs
4. Stockout Costs (Shortage)
Measures of Inventory Performance 1. Inventory Turnover
2. Days of Supply
3. Service Level
7
–
3
Definitions
• Inventory is the supply of items held by a firm to meet demand
• Inventory specific to manufacturing (items contributing or
becoming a firm’s output):
– Raw materials
– Component parts – Work-in-Process – Finished products
• Inventory in all types of organizations:
– MRO inventory (maintenance, repair, operating
supplies) –Transit Inventory
7
–
4
Types of Inventory
• Inventory: supply of items held to meet demand
Suppliers
Raw Material
Components Work in
Process (WIP)
Transportation

MRO Maintenance, repair & operating supplies
Finished Goods (FGI)
: Transit Inventory
Distribution
Customers
7
–
5
Types of Inventory
Which type of inventory could the following products be?
Examples?
–Oranges
• Finished product (orchards)
• Raw material inventory (orange juice manufacturer)
• Work-in-process (company that sells ready-make fruit salads
for grocery stores)
• Maybe MRO in an office environment as part of “office
supplies”?
– Computer Processor
• Component part (Dell, Playstation production, etc.)
• Finished products (Intel, AMD) • MRO at a school
7
–

6
Roles of Inventory
Roles of Inventory
• Balancing (timing of) supply and demand: decouples
differences in supply and demand requirements
• Economies of Buying: price discounts or reduced shipping
costs
7
–
7
Roles of Inventory
Roles of Inventory
• Balancing (Timing of) Supply and Demand
–In most cases, it is beneficial to produce batches of products
before demand realizes. (Exception?)
–Customers expect many products to be available at the time
they decide to purchaseavailability of product
–Seasonality of demand or supply:
• Customers may be interested in products only at certain time
of year, but production runs all year.

• Some products can only be produced at certain times of year,
but are demand all year long (agriculture).
7
–
8
Roles of Inventory
Roles of Inventory
Demand:
–Typically, it is impossible to know exact future demand.
–If demand is higher than inventory, customers cannot make
the purchase.shortage costs (explained later)
Supply:
–Uncertainty concerning how long until replenishments arrive
–Without safety stock, your operations might have to be stopped
if replenishment is delayed.
safety (or buffer) stock is extra inventory held to guard against
uncertainty in supply or demand
7
–
9
Roles of Inventory

Case 11 Intel Corporation 1968–2013 Charles W.L. Hill Sch.docx

Case 11 Intel Corporation 1968–2013 Charles W.L. Hill Sch.docx

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Case 11 Intel Corporation 1968–2013 Charles W.L. Hill Sch.docx