Windows and Intel, Kings of the PC: Divided They Fall?

A legendary partnership is strained by the rise of mobile and Web computing, and the companies' own outside ventures

By Olga Kharif, Peter Burrows and Cliff Edwards

Tech giants Intel (INTC) and Microsoft (MSFT) have clashed plenty of times since Intel's chips and Microsoft's Windows software combined to spark the PC revolution in 1981. In a 1993 note unearthed by Harvard Business School historian Richard S. Tedlow, former Intel Chief Executive Andy Grove recalls a phone call with Microsoft Chairman Bill Gates. "He threatened me a bunch of times with everything from disembowelment upward," Grove wrote.

These days, though, the ties that bind the two companies are starting to fray more openly. In the past, Grove, Gates, and their companies operated in a business climate very much under their control. With few exceptions, people did their computing on PCs built around this so-called Wintel duopoly. But now PC sales are slowing, and users are doing more of their computing on sophisticated mobile phones and other devices that require no Wintel.

HEDGING THEIR BETS

The new reality is straining the alliance. Intel is pushing low-power chips designed to work with a range of small, lower-cost computers, including many that don't run Windows. And two sources tell BusinessWeek that Microsoft is experimenting with a version of its upcoming Windows 7 operating system that will work with chips based on the designs of Britain's ARM Holdings, and made by Intel rivals such as Qualcomm (QCOM) and Texas Instruments (TXN). That would help those companies compete more forcefully against Intel in new markets. It's growing evidence that, as the nature of computing changes, both companies have to hedge their bets. Says Intel Executive Vice-President Sean Maloney: "It was never an exclusive relationship. I think that's become more obvious over the last few years." A Microsoft spokesman says Intel remains "qn important partner."

The personal computer remains the mainstay of the tech industry, with about 300 million sold last year. But growth in that market is expected to slow to an annual average of 9% over the next three years, according to researcher IDC. Meanwhile, sales of smartphones that can connect to the Net and handle e-mail are expected to surge 18%, and sales of small, cheap netbooks that do basic computing tasks will soar 50%.

The shift creates opportunity for companies that could never have hoped to overcome the Wintel duo's clout in the past. One clear beneficiary is Apple, whose iPods and iPhones use neither Intel chips nor Microsoft software. There are also startups and giants such as Nokia (NOK), which have a chance to play more influential roles in computing than ever before. Many are rallying around open-source software, particularly the Linux operating system that competes with Windows. Google (GOOG) helped develop the open-source Android software, which will appear in smartphones from a host of partners in the months ahead. The result is a flowering of innovation, says Massachusetts Institute of Technology management professor Michael A. Cusumano. "Variety is good for consumers," he says. "At this point, the more competition Microsoft and Intel have, the better it is for the rest of us."

Intel and Microsoft see these trends as clearly as anyone. In the past, they stuck together to fend off competitive threats—lowering prices and cranking up marketing to undercut new products yet maintain their profits. But now, Intel is pushing low-cost Atom chips designed to work on almost any operating system. In January it even unveiled its own Linux-based operating system, called Moblin, for use in netbooks and a new class of pocket-sized products it calls mobile Internet devices.

Wintel products will have some share of these newer markets. The duo has the lion's share of the netbook market now. But models based on ARM chips and Linux software can be one-third the cost of those using Windows and Intel chips, estimates Rob Lineback, a senior analyst at consultant IC Insights. If Intel doesn't find a way to close that price gap, more than 50% of netbooks and Mobile Internet Devices will use ARM chips by 2012, estimates Will Strauss, president of chip consultancy Forward Concepts. And to compete with Linux, Microsoft may have to take far less than the $20 or so it now gets for the Windows version that runs in netbooks, says Global Equities Research analyst Trip Chowdhry.

The Wintel partners still have mutual interests. Intel controls 81% of the $30 billion PC processor market, while Microsoft has 95% of the PC operating software market. "Microsoft and Intel never want to become enemies," says Cusumano. "They have too much to lose on both sides."

Kharif is a senior writer for BusinessWeek.com in Portland, Ore. Burrows is a senior writer for BusinessWeek, based in Silicon Valley . Edwards is a correspondent in BusinessWeek's Silicon Valley bureau.