Intel (NASDAQ:INTC) recently stated that it would convert one of its semiconductor plants in Dalian, China to produce memory chips. Intel plans to invest up to $3.5 billion over the next three to five years, then boost that amount to as much as $5.5 billion. The decision might seem odd, since Intel is generally known for manufacturing PC processors instead of memory chips, but it actually makes sense in current market conditions.

Micron and Intel's 3D NAND memory chips. Source: Micron

Why memory chips matter
Intel has been weighed down by two big issues over the past few quarters. First, PC sales are declining and probably won't stabilize until next year. Second, Intel continues to pay mobile device makers hefty subsidies to use its chips instead of designs licensed from ARM Holdings. Starting in fiscal 2015, Intel merged the two troubled businesses into a single client computing group. Last quarter, the unit's revenue fell 7% annually to $8.5 billion as operating profit declined 20% to $2.4 billion.

But instead of focusing on those sore spots, Intel has touted the strength of its nonvolatile memory, Internet of Things (IoT), and data center businesses, which all posted double-digit annual sales growth last quarter. Intel classifies its memory business under "all other" revenue, which rose 19% annually last quarter but accounted for just 5% of its top line. Intel claims that demand for memory chips offset weaker demand for PC processors during the third quarter.

Complementing other recent moves
Intel's decision to prioritize memory chip production over PC processor production in China complements its 10 year old joint venture with flash memory maker Micron (NASDAQ:MU). Earlier this year, the two companies started producing a new class of nonvolatile memory, called 3D XPoint, which will reportedly be "up to 1,000 times faster" than NAND, the most popular type of nonvolatile memory in the world.

Intel plans to install its NAND and 3D XPoint chips in flash-based SSDs (solid state drives), which have steadily replaced platter-based HDDs (hard disk drives) over the past few years. Micron told Bloomberg that no official agreement had been made with Intel regarding its participation in the Dalian project, although it might "have a greater participation in the future".

Upgrading its memory chip facilities also complements Intel's planned acquisition of Altera (UNKNOWN:ALTR.DL), which makes FPGAs (field programmable gate arrays) for enterprise SSD systems. FPGAs, which use flash memory, can be reprogrammed after a product has been shipped. These chips will complement Intel's flagship Xeon processors in data centers. Altera's new reference design, based on its Arria 10 SoCs, can also reportedly double the life of NAND chips, which should enhance Intel's in-house memory business.

The China-centered consolidation
The tie-ups between Intel, Micron, and Altera reflect a major market consolidation in semiconductors and flash memory. Much of that consolidation is based in the Chinese market, which researcher TrendForce expects to consume $6.7 billion in NAND chips this year, or 29% of global NAND revenue.

Last year, Intel bought 20% stakes in two mobile chipmakers owned by state-backed Tsinghua Holdings. Earlier this year, Tsinghua announced plans to buy a 15% stake in HDD market leader Western Digital. Tsinghua also tried to acquire Micron, but the offer faces major regulatory hurdles in the U.S. due to security concerns.

In October, the Chinese government finally cleared Western Digital's integration of the Hitachi hard drive business, which had been stalled for three years due to antitrust concerns. That deal slightly increases Western Digital's presence in SSDs, which complements its planned purchase of SanDisk, the second largest SSD maker in the world.

Survival of the biggest
The memory chip market is a notoriously low-margin one that will likely experience oversupply issues over the next two years. This means that only the largest players can use economies of scale to research better technologies and manufacture more units at lower prices. It also means that smaller competitors, like South Korean company SK Hynix, could struggle to stay ahead of the tech curve while offering competitive prices.

As the world's largest PC and data center chipmaker, Intel is well-positioned to flush smaller memory chip makers out of the market. While that growth is encouraging, investors should remember that memory chips still only represent a small part of Intel's overall business.