Intel (INTC) announced that it would be taking some drastic actions in order to gain market segment share in tablets next year. In a nutshell, Intel is going to be pushing its top-shelf 22 nanometer "Bay Trail" product into just about every tier of the market, from the highest of the high end to (presumably) probably the mid-range and even the upper half of the low end. This, of course, came with certain ramifications that I believe are not really well understood by investors. A common question that has come to my inbox has been to try to explain this as best as I can (keep the requests coming, by the way).
Some Basic Terminology
There are two phrases that are relevant here that I believe should be defined:
- Non-Recurring Engineering ("NRE") - this is the one time cost to develop a product (such as a tablet, phone, etc.).
- Contra-Revenue - These are deductions from gross revenue. For the purposes of this discussion, think of it as a sales discount.
With that in mind, here is the slide from Intel's CFO presentation that I'm going to try to explain here:
So, What Is Intel Doing?
Here's the story. So, remember how "Bay Trail" is a chip intended for the high end of the tablet segment? Well, when you design a chip intended to be sold for $20-$30, you'll make many different design choices than you would if you were trying to sell a $10-$15 chip. Now, these design decisions aren't just confined to the actual chip, but to the platform surrounding said chip (since a cheaper chip will presumably go into cheaper tablets and a richer one will go into more expensive tablets).
So, that's the first part of it, and Intel is getting around this high bill of materials cost by essentially telling the OEMs, "Hey, don't worry about it - we'll reimburse you for having to use more expensive/more components". In essence, Intel is making its chip painless to use from a bill-of-materials perspective, and it is probably also cutting the OEMs a good deal on the chips themselves. In this case, OEMs win as they can stick a high performance part into a cost-optimized tablet, and Intel wins as it gains market share. However, there's one more "snag".
Intel is very clearly aiming to displace a good number of its ARM (ARMH) based competitors, and that means convincing OEMs to port their designs over to the Intel platform. Porting a design takes engineering effort, which costs money. Intel, by offering increased NRE incentives, is essentially footing the bill for the "change-over" from whatever competing SoC was going to go into the design to Intel's. Intel wants market share and it wants it now, so it's going to make switching painless for the OEMs.
Now, on top of all of this, Intel is probably showing these OEMs a highly compelling road map. Even with Intel footing the bill for the switch to Intel, these guys don't want to have to keep switching back and forth. They need confidence that Intel's Atom road map will consistently deliver the best performance per watt and will do so at a good cost. While the OEMs already had the road maps that Hermann Eul presented at the Investor Meeting, investors needed to see that the road map would be compelling enough to convince OEMs. I believe that it is.
Intel is now paying the price for not having a suitable low cost/integrated part for the mass tablet space, but this is the right move for the company long term. It needs to win designs and establish credibility with both Wall Street and, more importantly, the OEMs. This isn't going to be easy, and shareholders are going to feel the brunt of it as "Other IA" dives deeper into operating loss territory, but for the long-term future of the company, waiting another year for the "right" products to materialize just isn't going to fly.
On the bright side, Intel should see some very nice operating leverage in Other IA by 2015.