Intel's Contra-Revenue Program Is Not What You Think It Is

Many mistake Intel's contra-revenue program as a way to "buy" share, but this couldn't be more wrong.

May 2, 2014 at 9:45AM

As an Intel (NASDAQ:INTC) investor, I have not been shy about both highlighting the company's strengths as well as really drilling into where the company has really failed to execute. That said, there seems to be a real misunderstanding among investors as well as the tech press alike that has served to put some investors on edge. The purpose of this article is to better explain this "contra-revenue" program and to help understand why it is actually a smart business move.

The bill-of-materials issue
At Intel's 2013 Investor Meeting, management admitted that the Bay Trail-T platform that it had developed specifically for tablets did not carry with it a competitive bill of materials. Now, you may be thinking that Bay Trail-T is just a single chip so this "bill of materials" is a cop-out, but that's far from the reality of the situation. A system-on-chip for tablets/phones or even PC chips requires an entire board full of components.

To put it in perspective, the original Bay Trail-T platform launched in September 2013 required no less than 700 components in order to support a full system design. For a $499 iPad Air-class product, this isn't a problem, but when you're trying to build a tablet that needs to be sold with positive gross margin for $129 or even $99, bringing these costs down is critical. MediaTek and Qualcomm (NASDAQ:QCOM) -- two of the leading system-on-chip vendors in tablets -- have this down pat.

Enter contra-revenue
So, say you're Intel and you've just developed this Bay Trail-T platform targeted at iPad-class products that typically sell for $300-$500, and all of a sudden the market around you has shifted toward $125-$250 devices. Further, suppose that your competitors have managed to beat your high end chip in critical dimensions of performance (Bay Trail-T's Achilles' heel – and Qualcomm's strength – is graphics).

Further, you're new to this market and you need to gain a pretty substantial footprint in the tablet market before it's too late. OEMs don't want your chip, as beastly as it would perform in low-end to mid-range tablets, because they can pay other chip vendors the same amount of money but it would cost them about $20 less per unit simply because the other companies have optimized the bill of materials for their platform better. What do you do? Contra-revenue.

The contra-revenue is an equalizer, not a "bribe"
Let's do some math. Assume that Intel and Qualcomm are both selling chips for $15. Intel's manufacturing lead allows it to pack more in there and get more performance from the transistors, so Intel's $15 chip performs better than the competitor's $15 chip (for the sake of argument). However, Intel's entire platform is $20 more expensive than the Qualcomm chip to implement and we're talking about a tablet that will sell for $199.

The OEM will go with the Qualcomm chip. Even if the Intel chip offers more performance, the chips offer mostly comparable performance as far as the end user is concerned, but the OEM could either pocket that $20 difference as margin or use that $20 to improve something more visible like including a bigger battery, higher resolution screen, or a more premium chassis. In this scenario, Intel has no chance.

But let's say you're Intel and you've got your team frantically working to make sure future platforms don't suffer this same bill-of-materials deficiency. You could either wait until next year to try to win designs with the right products or you could try to gain a footprint today by simply offering the platform bill-of-materials difference as part of any potential purchase deal to make it a non-issue for the OEM. Intel chose to gain the footprint today so that when it has the right product next year, it has proven itself to customers who will then presumably buy the new, improved, and profitable-for-Intel products.

Foolish bottom line
This is something where Intel was at a disadvantage relative to Qualcomm. Qualcomm hails from the world of smartphones, so optimizing the platform for cost effectiveness is in the company's DNA. But Intel has come from the notebook/desktop PC world, where component flexibility has typically been more important than platform cost as we are typically talking about systems ranging from $399 to $999 with very little margin for the device vendor.

Intel will get to that bill-of-materials parity next year with new products and its parts will be able to compete on their own merits while being profitable on a gross-margin dollar basis. This means a financial hit in 2014, but by 2015 the "contra-revenue" will be all but gone, allowing Intel to profitably attack the entire range of the tablet market. It all comes down to having products that compete well on performance and power. 

Are you ready to profit from this $14.4 trillion revolution?
Let's face it: Every investor wants to get in on revolutionary ideas before they hit it big. Like buying PC maker Dell in the late 1980s, before the consumer computing boom. Or purchasing stock in e-commerce pioneer in the late 1990s, when it was nothing more than an upstart online bookstore. The problem is, most investors don't understand the key to investing in hyper-growth markets. The real trick is to find a small-cap "pure play" and then watch as it grows in EXPLOSIVE lockstep with its industry. Our expert team of equity analysts has identified one stock that's poised to produce rocket-ship returns with the next $14.4 TRILLION industry. Click here to get the full story in this eye-opening report.

Ashraf Eassa owns shares of Intel. The Motley Fool recommends and owns shares of Intel. It also owns shares of Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information