IBM (NYSE:IBM) recently announced the creation of the tiniest chip in the world, which uses 7nm-thick transistors. That's about 1/1,000th the size of a single red blood cell.

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IBM's test chip with 7nm transistors. Source: IBM

The smallest transistors currently used in mass-produced chips are 14nm. Intel (NASDAQ:INTC), which launched its first 14nm chips last year, plans to launch 10nm chips by 2017.

IBM believes that 7nm chips should start appearing in devices by 2017-2018, and that an entire chip developed with the 7nm process should have roughly 20 billion transistors. By comparison, Intel's Core i7 Broadwell-U, a 14nm chip, has about 1.9 billion transistors.

Therefore, IBM's development of a 7nm chip leapfrogs over Intel and indicates that Moore's Law -- which declares that the number of transistors per chip will double every two years -- will continue to hold. But why is IBM developing new processors when it generates most of its revenue from software sales and IT services?

Big Blue's game plan
IBM developed the 7nm chip in collaboration with GlobalFoundries and Samsung, two of the largest chip foundries in the world. IBM still designs chips, but it no longer manufactures or sells them. Instead, it agreed to pay GlobalFoundries $1.5 billion over three years to take over its unprofitable chip-making unit, as part of CEO Ginni Rometty's plan to shed Big Blue's "empty calories."

GlobalFoundries agreed to be IBM's exclusive provider of certain Power processors over the next decade, in exchange for access to IBM's patent portfolio. IBM's Power processors are mainly installed in its high-end servers and supercomputers, two markets that are firmly dominated by Intel's Xeon processors.

The development of the 7nm chip is part of a $3 billion, five-year investment in chip research that IBM announced last year, and it won't be affected by the divestment of the chip-making business. Instead of losing money on chip manufacturing by going head-to-head against Intel, IBM is now taking a more passive approach by beefing up its patent portfolio.

Who benefits?
By partnering with IBM, Samsung and GlobalFoundries could gain a competitive edge over rival foundries TSMC and Intel. By licensing its chip-making technology to Samsung and GlobalFoundries, IBM can indirectly help numerous "fabless" chipmakers that outsource all of their production to make smaller and more powerful chips.

IBM's progress toward 7nm chips could also benefit Chinese tech companies. In March, IBM made the controversial decision to license designs for semiconductor chips, servers, and software to Chinese tech firms. This means that IBM's Power chips could eventually play a critical role in the construction of Chinese supercomputers, which could raise objections from the U.S. government. In April, the U.S. government blocked Intel from selling its Xeon chips to all Chinese supercomputers, citing concerns about their use in nuclear simulations.

But IBM isn't only sharing its technologies with China. IBM is also licensing its patents to tech firms in other countries through Open Power, a program that it launched in 2013. The alliance -- which includes several other top tech firms -- provides "base" technologies to overseas companies that can be subsequently enhanced by local companies. In other words, Open Power seeks to undermine Intel by making hardware "open source."

Don't count Intel out yet
But Intel can't be beaten that easily. Its Xeon processors control over 90% of the global server market for a simple reason -- they're the most powerful chips in the world. Intel is currently working on a path toward a 7nm transistor, which PC World estimates will be manufactured as early as 2018.

Forrester Research analyst Richard Fichera states, "Intel might have these working in their labs, but they haven't shown anybody." Fichera also notes that there's "no guarantee" that IBM's process is the best way to manufacture 7nm transistors. Nonetheless, Moor Insights and Strategy analyst Patrick Moorhead points out that it's encouraging to see more "concrete proof" that Moore's Law can continue to hold -- especially from a company other than Intel.

The bottom line
Looking ahead, IBM's chip-design business should be considered an IP play instead of a revenue one. By expanding its patent portfolio with new chip designs, IBM can eventually generate passive royalty revenue from chip makers without being exposed to the overhead risks of chip fabrication.

When those patents are bundled with other hardware and software licenses through Open Power, they can also help IBM forge stronger alliances in challenging markets like China.

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Intel. 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.