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 Amazon.com 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers