MEMORANDUM
To: From: Subject: Date: Andrew Grove, PhD – President and CEO of Intel Corporation FT50812 Intel Pentium Chip Controversy December 17, 1994

Summary
Intel’s reputation as a producer of quality microprocessors is being questioned. Public perception views Intel as insensitive to consumer concerns and overly profit driven. The investments Intel has made in the Pentium chip to secure a competitive advantage will be pointless if consumers lose trust in the Intel brand.

Analysis of Issues
Intel’s dilemma is whether to recall a product that is defective under certain conditions (p. 2).1 This decision requires consideration of the financial and operational issues, as well as the potential long-term impact to Intel’s competitive advantage in the computer industry and Intel’s relationships with companies that purchase microprocessors. These issues are further described below.

Competitive Advantage
The new Pentium chip is the embodiment of Intel’s advantage over other companies. Intel has the distinction of being first in the industry to engineer and produce microprocessors (p. 2). In addition, Intel has made significant investments in research and development to design the Pentium, has incurred significant expenditure in promotions, and has secured its investment with a name-based patent (p. 3).

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All page numbers referenced herein are drawn from the following case study: Narayanan, V.C. (2002). The Intel Pentium Chip Controversy (A). Harvard Business School. 9-196-091. 1

Computer technology is a fast-paced industry. It is only a matter of time before other companies will be able to compete with Intel on the basis of similar technology (p. 2). Given that the technology is growing more widespread, Intel needs to maintain its position in public perception as the foremost provider of high-quality microprocessors. If Intel continues to disregard consumer and manufacturer concerns over the quality of the Pentium chip, they may seek an alternative product.

Financial Impact of Conducting a Recall
Refer to Appendix A for detailed cost implications of issuing an unconditional recall of the defective chip. Appendix B details assumptions made in the course of preparing this analysis. Cost implications of an unconditional product recall are as follows:      Replacing Pentium chips (assuming 100% replacement): Refunding cost of sold but not yet installed chips: Lost potential revenue due to using new chips to replace old: Amount of bad inventory to be discarded: Potential loss of market share during Q1 and Q2 1995 due to lack of product available for sale to new customers: Not monetized $2.2 billion $172.5 million $1.8 billion 2,460,000 chips

Note: requirement of returning the computer to manufacturer or Intel for chip replacement may act as a barrier to some consumers and result in fewer requests for replacement. Accounting Options Recommended option is to recognize revenue “on the defective product already sold” and match expenses with a provision for “estimated contingency losses (e.g., cost of replacing the product already sold)” (p. 5). Account for sold but uninstalled chips as a sales return. Write off unsold defective inventory as bad inventory (p. 5).

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An alternative would be to defer recognition of revenue until after replacement of defective products. “This option could be applied prospectively to future sales of defective products or retrospectively by reversing revenue that has already been recognized” (p. 5). Do not avoid including this event in the accounting record on the basis that it is not material. This approach would be seen as grounds for further mistrust by shareholders and the public (p. 5).

Implications of Not Conducting a Recall
Intel’s admission in November 1994 (p. 3) that it had been aware of the flaw in the original Pentium chip and had fixed it in a future chip, but chose not to inform customers, was perceived as a betrayal of customer trust and an attempt to deceive consumers and computer manufacturers about the quality and reliability of Intel’s product. If Intel does not respond to consumer concerns with an unconditional recall, and continues to maintain its position that the defect is immaterial to most users, manufacturers and consumers may look for an alternative to an Intel microprocessor, resulting in a significant loss of market share and future sales revenue. In addition, the continuation of the current approach to this crisis is an ineffective use of human resources. Intel’s engineers’ time could better spent working on solutions or new products, instead of individually assessing each customer’s situation through the established hotline.

Alternative Solutions
Each possible solution was assessed using the following decision criteria:    What financial impact will this decision have on Intel? How will this decision impact Intel’s reputation? How will this decision impact Intel’s operations?

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Option 1: Recall and replace defective chips. Preferred option that is considered to have long-term benefits in terms of maintaining Intel’s competitive advantage and market share in industry that exceed the short-term costs. Option 2: Maintain status quo: continue assuring customers the defect is immaterial and only replace chips proven to impact the user. This option is financially a better option in the short-term, but does not consider the longterm effects of disregarding consumer concerns. Option 3: Develop software fix to issue to customers with defective Pentium chips. Not considered viable because it is not known how long such a fix would take to develop or whether it is possible. Consumers may not trust a software fix to be sufficient.

Recommendation
Offer unconditional replacement to all consumers (at no cost to the consumer) of the defective Pentium chip. Tasks Hire a public relations expert to guide the recall process and advise how best to repair Intel’s reputation. Engage in transparent and easily understandable communication with consumers to acknowledge the defect, fully explain its possible impact to users, and apologize for not addressing the issue sooner. Issue a public thank you to computer manufacturers for halting production so Intel would be able to more easily replace defective chips. December 18, 1994 December 20, 1994 Start Date December 19, 1994

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Tasks Develop mechanisms to address both the needs of business users and personal users. Work with computer manufacturers such as IBM, Dell, and Sequent to engage with consumers. Replace the defective Pentium chip for each consumer requesting replacement.

Start Date January 3, 1995

January – June 1995

Word count: 999 words

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Appendix A – Financial Analysis

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Appendix B – Key Assumptions
Defective Pentium Chips Manufactured, Sold, and Installed The case indicates approximately 5.5 million defective chips were installed in 1993 and 1994. However, a total of 5.96 million Pentium chips were sold in 1993 and 1994. Therefore, it is assumed that approximately 460,000 chips sold in 1994 were not installed. The buyers of these chips will need to be refunded the sale cost (assumed unit cost of $375 from Q4 1994) and the defective chips can then be accounted for as bad inventory. Continued Production of Defective Chips “Intel’s manufacturing and upgrading processes required some plants to continue producing defective chips through the first quarter of 1995” (p. 4). Defective chip production in some plants was assumed to be approximately half of estimated production in Q1 1995, or 2 million chips. Production of chips without defects is assumed to start in Q1 1995 at a rate of half of overall production and continue into Q2 1995 at 100% of production. The defective chips produced in Q1 1995 will be accounted for as bad inventory. Production of Non-Defective Chips The case does not indicate whether production of non-defective chips has begun (“Intel had repaired the planned next version of the Pentium” (p. 3)), but the case does note that Intel “could not change all production to the new chip” as some facilities would continue producing defective chips through Q1 1995 (p. 4). Therefore production is assumed to begin in Q1 1995. Production of sufficient new chips to replace the defective chips produced and installed in 1993 and 1994 (total of 5.5 million chips) is expected to be complete in Q2 1995, as 7.66 million chips are estimated to be sold by the end of Q2.

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