At Intel's (NASDAQ:INTC) investor meeting, investors were extremely excited when CEO Brian Krzanich announced the company's intentions to sell 40 million tablet processors during the course of 2014 – quadrupling the company's 2013 tablet shipments . The crowd cheered, and the stock price saw a meaningful boost throughout the day.
However, the share price came crashing down when CFO Stacy Smith admitted that the sale of these 40 million tablet chips would actually hurt corporate gross margin to the tune of 150bps for the year and that the "Other IA" division (which sells mobile products) would see flat revenues in 2014 and a wider operating loss. What gives?
Intel's Bay Trail blunder
Intel's recently launched Bay Trail system-on-chip is widely viewed as a rather nice tablet chip – it has leadership CPU performance against its ARM (NASDAQ:ARMH) peers, but as far as graphics performance goes, it's good but not at the top of the pack.
However, it has a couple of problems. First of all, it was designed very richly – with a die size of 102mm^2, it's clearly aimed at the highest end of the mobile market. On top of that, it seems that the actual platform cost – that is, the bill of materials that needs to surround the chip – is decidedly high end.
So, in order to sell 40 million units, Intel needs to gun for not just the high end, but the mid-range as well as the low end. Intel plans to do this mostly with Bay Trail, but there's a problem: it's expensive. Not only is the actual silicon cost more suitable for the high end, but remember that bill of materials? It's, according to CFO Stacy Smith, about $20 higher than competing platforms. This left Intel with a difficult choice: go for market-share and try to build relationships, or preserve profitability until it had the right product.
Time was out, drastic actions needed to be taken
A mobile design is by its very nature embedded. It's not anywhere close to the "traditional" PC days where people could swap motherboards in and out at will, but instead requires a close collaboration of all of the chip and part vendors. Right now, Qualcomm (NASDAQ:QCOM) is eating everybody else's lunch and has built relationships with every relevant tablet vendor.
The longer that Intel dithered, the more entrenched Qualcomm (and potentially others) would become. So, management made the tough – but seemingly correct – decision to basically eat the costs of porting over designs and to offer steep rebates in order to nullify the high platform costs. Given that the added bill-of-materials cost in order to use a Bay Trail is about $20 higher than competing chips, the reimbursement for this overhead just about cancels out the revenue generated for the sale of each chip.
This was a tough move, but it makes a lot of sense. First, it gets Intel entrenched with the OEMs – as long as Intel can provide leadership products going forward, it should be able to keep the designs it wins from its drastic actions in 2014. This means that in 2015, things should look rather good, particularly as Intel's products become even more competitive.
Long term win, short term fail
Intel's management made the correct decision to do what it needed to in order to get a real foothold in the tablet market. Being late to the market and delivering the wrong product is costly, and the 2014 guidance is the price that the company and its shareholders had to pay for these mistakes.
However, from a long term perspective, Intel needed to get into tablets and with the PC market crumbling, time was of the essence. While many management teams make (nearly fatal) mistakes, very few in those positions have the guts to take the hard actions required to climb out of the hole.
Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel and 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.