INTEL Knows Best?
A Major Marketing Mistake
When Thomas Nicely, a mathematician at Lynchburg College in Virginia, first went public with the fact that Intel's new Pentium chip was defective Intel admitted to the fact that it had sold millions of defective chips, and had known about the defective chips for over four
months. Intel said its reasoning for not going public was that most people would never encounter any problems with the chip. Intel said that a spreadsheet user doing random calculations would only have a problem every 27,000 years, therefore they saw no reason to replace all of the defective chips. However if a user possessed a defective chip and could convince Intel that his or her calculations were particularly vulnerable to the flaw in the defective chip then Intel it would supply those people with a new chip. This attitude of 'father knows best' fostered by Intel created an uproar among users and owners of the defective chips. Six weeks after Mr. Nicely went public, IBM, a major purchaser of Pentium chips, stopped all shipments of computers containing the defective Pentium chips. Intel's stock dropped 5% following this bold move by IBM. IBM's main contention was that it puts its customers first, and Intel was failing to do this.
Intel's handling of this defective chip situation gives rise to many questions. During the course of this paper I will address several of them. The first of which is how did a company with such a stellar reputation for consumer satisfaction fall into the trap that the customer does not know best? Secondly, what made this chip defect more of a public issue than other defective products manufactured and sold to the public in the past? Finally, how did Intel recover from such a mistake? How much did it cost them and what lessons can other companies learn from Intel's marketing blunder so that they do not make the same mistake?
Intel is spearheaded by a chief executive named Andrew Grove. Grove is a "tightly wound engineering Ph.D. who has molded the company in his image. Both the secret of his success and the source of his current dilemma is an anxious management philosophy built around the motto 'Only the paranoid survive'." However, even with this type of philosophy the resulting dominance he has achieved in the computer arena cannot be overlooked. Intel practically dominates the computer market with $11.5 billion in sales. Intel has over 70% of the $11 billion microprocessor market, while it's Pentium and 486 chips basically control the IBM-compatible PC market. All of these factors have resulted in an envious 56% profit margin that only Intel can seem to achieve. So what did Intel do to achieve this sort of profit margin?
In mid-1994 Intel launched a $150m marketing campaign aimed at getting consumers to recognize the Pentium name and the "Intel Inside" logo. In order to achieve this goal of brand recognition Intel advertised its own name in conjunction with the "Intel Inside" logo and stated 'with Intel Inside, you know you have got. . . unparalleled quality'. This provided immediate name recognition for the company and led the consumers to associate Intel with high quality computers. Then Intel went the extra mile in the marketing world and spent another $80m to promote its new Pentium chips. The basis for this extra $80m was to "speed the market's acceptance of the new chip". The marketing campaign was a success. Intel had managed to achieve brand recognition. "Once the products were branded, companies found that they could generate even higher sales by advertising the benefits of their products. This advertising led consumers to regard brands as having very human personality traits, with one proving fundamental to brand longevity -- trustworthiness." Consumers readily identified a quality, up to date computer as one with a Pentium chip and the 'Intel Inside' logo stamped on the front. This "push" marketing strategy of Intel totally dominated the market, thus forcing the Pentium chip to the forefront of the computer market, all at the expense of the cheaper 486. This "push strategy" of Intel made it plainly clear to its purchasers that Intel was looking out for number one first and its purchasers such as Compaq and IBM second. Making the Pentium chip the mainstay of the computer industry was the goal of Intel, but a goal that would later come back to haunt them for a brief period of time.
Throughout the history of the computer industry many manufacturers have sold defective products. According to Forbes journalist Andrew Kessler, "Every piece of hardware and software ever shipped had a bug in it. You better get used to it." Whether or not 'every' piece ever shipped has had a bug is debatable, but there have been numerous examples of valid software bugs. For example Quicken 3.0 had a bug that resulted in the capitalizing of the second letter of a name incorrectly. Intuit, however, handled the situation by selling an upgraded version (Quicken 4.0) which fixed the problem, and left the consumer feeling as though he or she had gotten an upgraded version of the existing program. In essence Intuit had not labeled the upgrade as a debugging program, therefore it had fixed the problem and satisfied the customer all at the same time. While Intuit's customers were feeling as though they had a better product by buying the upgrade, Intuit was padding its pocket books through all of the upgrade sales. Other examples of companies standing behind their products are in the news week after week. Just a few years ago Saturn, the GM subsidiary, sent thousands of cars to the junkyards for scrap metal due to corroded engines, a result of contaminated engine coolant. Johnson & Johnson, the maker of Tylenol, recalled every bottle of medicine carrying the Tylenol name and offered a 100% money back guarantee to anyone who had purchased a bottle that might be contaminated. The precedence was already set, so why would a company with the reputation of Intel fail to immediately replace all of the defective chips it had sold? Furthermore, why did Intel not come forth immediately when it first discovered that its chips had a problem?
Intel's engineers said that the defective chips would affect only one-tenth of 1% of all users, and those users would be doing floating-point operations. (Floating point operations utilize a matrix of precomputed values, similar to those found in the back of your 1040 tax booklet. If the values in the table are correct then you will come up with a correct answer. This was not the case with the Pentium. A table containing 1066 entries had five incorrect entries, resulting in certain calculations made by the Pentium chips to be inaccurate as high as the fourth significant digit.) Considering the low number of people that the chip would supposedly affect and the high cost ($475m) associated with replacing the chips, Intel decided a case by case replacement policy "for those limited users doing critical calculations". Intel's VP-corporate marketing director, Dennis Carter, stated, "We're satisfied that it's addressing the real problem. From a customer relations standpoint, this is clearly new territory for us. A recall would be disruptive for PC users and not the right thing to for the consumer". This policy infuriated the millions of Pentium purchasers who had bought a PC with a Pentium chip. Word spread like wildfire throughout the consumer world that Intel had sold a defective product and was now refusing to replace it. This selective replacement policy is a "classic example of a product driven company that feels its technical expertise is more important than buyers' feelings". Intel was faced with a decision. Should they take the attitude of brand is most important and we will take all necessary action to preserve it or take the attitude of what would be the monetary cost of doing the right thing and replacing all of the defective chips, and would it be worth it? Initially they decided that the monetary cost of replacing all defective chip would not be cost efficient due to the sheer numbers involved. Intel had sold an estimated 4.5 million Pentium chips worldwide, and approximately 1.9 million in the U.S. alone. Intel later reversed its selective replacement policy (Intel knows best attitude) and came out with a 100% replacement policy. What was the reasoning behind this change of attitude at Intel?
As a result of the selective replacement policy, IBM announced it would stop all shipments of PCs containing the flawed chips. This combined with the public outcry at having spent thousands of dollars for PCs that did not work as advertised, and the reluctance of corporate users of PCs to purchase new computers resulted in Intel changing its public policy concerning the defective chips. Intel's new policy was to offer a 100% replacement policy to anyone who desired a new chip. This policy entailed either sending replacement chips to those users who wanted to replace the chip themselves, or providing free professional replacement of the chip for those who did not feel comfortable doing it themselves. Intel's new policy was in line with public expectations, but it had been delayed for several precious weeks. So one might ask, "What did this delayed change in attitude cost Intel in terms of dollars and repeat customers?"
The resulting costs to Intel were enormous in some respects, but almost negligible in others. Intel's fourth-quarter earnings were charged $475m for the costs of replacing and writing off the flawed chips. This was 15% more than analysts had predicted. Fourth-quarter profits dropped 37% to $372m. This was a sharp drop in profits, but $372m is still a number to be reckoned with in the fast paced industry of computers. So did this drop in profits mean that Intel was losing its edge? I tend to think not, since Intel reported that the sale of Pentiums had doubled between the third and fourth quarters, thus lifting revenues in 1994 to $11.5 billion, a 31% increase. Apparently consumers rallied around the new replacement policy and continued to purchase the Pentium equipped computers at a very fast rate, despite the initial reaction of Intel towards replacing the defective chips. This renewed faith was not regained overnight, but nevertheless it happened, therefore Intel is unlikely to lose its commanding lead in the industry. So what type of assurance was it that led to this renewed faith in Intel?
Following Intel's announcement of its 100% replacement policy for the defective chips it recalculated its replacement policy on all future defective products. Intel realized that its "fatal flaw was adopting a 'father knows b