Image source: Intel.
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A key part of microprocessor giant Intel's (NASDAQ: INTC) data center growth story has been the consistent rise in the average selling prices of its chips. That average selling price growth, coupled with a reasonable amount of unit growth, has made this a solid revenue growth business for the chipmaker.
However, the company reported a 1% year-over-year decline in average selling prices of its server-oriented processors during its second quarter.
On the surface it may appear that the company's average selling price growth story might no longer be intact, but that's actually not the case. Let's take a closer look.
Average selling prices are actually still on the rise
On the call, CEO Brian Krzanich told investors that the company is seeing an "ongoing preference for performance up and down the pricing stack."
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"Average selling prices increased year-over-year in every microprocessor product segment from Atom and Xeon D [system-on-chips] at the low end, up through Xeon and Xeon Phi at the high end," the executive explained.
So, if the company saw an increase in average selling prices in "every microprocessor product segment," then why were the company's overall average data center platform selling prices down year over year?
Rapid growth in networking weighing on average selling prices
"We continue to gain share in network infrastructure throughout the entire segment, as Intel architecture becomes the solution of choice for the transformation of the network to [software defined networking], [network function virtualization], and 5G," Krzanich told investors.
Intel has indicated in the past that the processors that it sells into the networking market tend to carry lower average selling prices than products that it sells into other markets such as cloud computing and enterprise servers.
"The significant share gains at the low end of the network infrastructure segment resulted in an overall 1% decline in data center CPU average selling prices," Krzanich explained.
The way to think about it, then, is as follows: Intel's server CPU business is made up of different sub-segments with different average selling price characteristics.
Within each of those sub-segments, Intel says that average selling prices are moving up, but last quarter a sub-segment with naturally lower average selling prices dramatically outgrew segments with higher average selling prices, bringing down the overall average.
Do networking chips also carry lower margins?
Sometimes investors seem to equate "lower average selling prices" with "lower margins." However, margins are a function of both selling prices and cost structure.
As a simple example, a chip that costs $1 to make but sells for $3 carries a gross profit margin of 66%. A chip that costs $10 to make but sells for $11 carries a gross profit margin of just 9%.
CFO Stacy Smith pointed out that even though the chips that the company sells into networking are, on average, cheaper than the chips that it sells into other segments, those chips don't necessarily carry lower margins than the more expensive products.
"I wouldn't just immediately assume that because [networking is] a lower-priced segment of the market that it's a margin-hindered segment of the market because that's not the case," Smith said.
Average selling prices should move up again later this year
According to Smith, the average selling price story should get better during the second half of the year.
"As we enter the second half [of 2016], we expect the enterprise segment of the business to stabilize and the cloud segment growth rate to accelerate," Smith told investors.
In addition to what looks to be a greater mix of higher margin product segments, Krzanich is looking for the ramp of the company's recently released Broadwell-EP family of chips to help further drive average selling prices up.
"We typically see an [average selling price] uplift as people buy up in the stack with these new server systems coming out," Krzanich said.
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Ashraf Eassa owns shares of Intel. 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.