Relying on contra revenue and Shenzhen-based manufacturers for tablet growth could be a precarious strategy, but Intel has the means to come out a winner.

bk with sofia Intels big China bet

Intel’s most recent quarterly report painted a bleak picture for the future of Windows on tablets. During the first quarter of its 2014 fiscal year, Intel shipped 5 million tablet processors with “80 to 90 percent” destined for devices running Android and the rest going towards Windows slates.

The Mobile and Communications arm of Intel posted $929 million operating loss in the first quarter of 2014 on $156 million in revenue. In comparison, the much bigger PC Client group posted $2.8 billion in profit on $7.94 billion of revenue. In all of 2013, Intel’s mobile chip arm lost $3.15 billion, after posting an operating loss of $1.78 billion from a year prior.

Intel hasn’t been specific with Windows numbers yet, but as a point of comparison in all of 2013 Gartner reported that approximately 4 million Windows tablets shipped worldwide compared to 121 million Android tablets and 70 million Apple tablets.

Goals to meet

At the Intel’s recent developer’s forum in Shenzhen, CEO Brian Krzanich set a goal for the company of shipping 40 million tablets in 2014 (both Android and Windows). During the company’s recent earnings call, CFO Stacy Smith said Krzanich was “laser focused” on hitting this goal. To get there Intel will be relying on contra revenue — paying manufacturers to take its chips.

The most recent balance sheet from the latest quarter doesn’t specify exactly how much was spent on contra revenue. However as Intel’s mobile division posted a near billion dollar loss this quarter, and it’s safe to say — as it was heavily implied in the earnings call – that most of that loss accounts for heavy contra revenue subsidies to manufacturers to get chips in devices.

These contra revenue figures are set to increase in the coming quarter. During the earnings call Smith said that next quarter Intel will be ramping up production of tablet chips, and with that the associated subsidies to manufacturers.

560 intel profit loss Intels big China bet

Intel’s balance sheet for its first quarter

The cards it’s dealt

As Intel designs and manufactures a part that’s not customer facing — it doesn’t manufacture the tablets themselves or design the OS — it simply has to deal with the direction the market is going and what it’s given to work with. Consumers tend to associate Windows with the desktop and Android with mobile, thus prefer to keep the desired computing experience on a specific OS.

The most mobile computing experience with Windows is with a 2-in-1, a hybrid of tablet and notebook, which Intel counts in the results of the PC Client Group. The exact numbers of 2-in-1s sold haven’t been specifically disclosed by Intel, but there have been a few prominent wins in the form factor recently. While many people would associate 2-in-1 devices with tablets, an Intel spokesperson is quoted in the press as defining the difference between a tablet and a 2-in-1 as “if it detaches, that’s a tablet; if it just folds over, that’s a 2 in 1.”

As Intel has experienced some success with Windows in the 2-in-1 form factor, it’s not pushing for a divorce entirely from the operating system in the mobile space. Rather, it’s after a reimagining of its mobile strategy pivoting towards low-cost Chinese tablets made by ODMs and OEMs in Shenzhen.

A Shenzhen gambit

Intel is making a big bet in Shenzhen to help it get through the next decade. As announced at IDF, Krzanich said Intel is establishing a $100 million device innovation fund and building an innovation research center in the city. Both of which are intended to help low-cost Shenzhen tablet makers innovate and compete against established rivals all while using Intel chips.

Some of the devices shipped out of Shenzhen might have recognizable names to those familiar with Chinese brands, while others are intended as white label devices to be rebranded and used in environments such as retail or customer service.

But in order to rack up the hardware wins Intel will have to lean heavily on its device innovation fund — which will effectively be a local contra revenue account — and its innovation center. It will be an uphill battle to get manufacturers on board, as local rivals like Rockchip can provide SoCs in the $5-10 range while Intel’s chips usually cost between $30-$50 (before contra revenue discounts are applied). There’s also Taiwan’s MediaTek, an innovation powerhouse which already has multiple hardware wins in low-cost devices, and Qualcomm to deal with.

One danger Intel faces in Shenzhen when trying to get its chips-in-devices is local OEMs and ODMs taking the contra revenue subsidized processors for a few quarters or years in order to bootstrap their businesses and get their hardware into the hands of consumers. These manufacturers could later switch to suppliers like Rockchip or MediaTek once they establish themselves in the market or the subsidy funds run out.

In the end if Intel fails in Shenzhen, its mobile dreams are probably dashed. But this may mean little for the the company as mobile division will forever be overshadowed by its PC Client as well as data center divisions. One bright side is its emerging Internet of Things division appears to be doing well,  posting $482 million in revenue, up 32 percent from the year-earlier quarter.

More news on Intel’s mobile ambitions will likely come in the weeks before Computex, as a series of mobile related announcements are expected from the company at the trade show.