2 Major Drivers of Intel Corporation's Industry-Leading Profit Margins

By Markets Fool.com

Image source: Intel.

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Microprocessor giant Intel (NASDAQ: INTC) is something of a rare, if not unique, phenomenon within the chip industry. The company brings in an extraordinary amount of revenue -- $55.4 billion in 2015 -- at an extremely robust gross profit margin of over 60%.

That favorable combination makes Intel one of the most profitable chip companies in the world, raking in a whopping $14 billion in operating profit and $11.4 billion in net income in 2015.

Because of the importance of Intel's gross profit margin to the company's overall profitability, it's worth taking a look at some of the key factors that influence this figure. Here are two big ones that come to mind.

Product features and competitiveness

Former Intel Chief Financial Officer Stacy Smith said it best on the company's second quarter earnings call back in July 2015:

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For us, the key is to have great products, and that's why we're adding this third wave of products. At the first approximation, that's the best correlation of gross margin is when you've got leadership products, you tend to have a healthy gross margin.

Indeed, Intel's personal computer and server/data center processor products usually offer best-in-class performance and power efficiency. Furthermore, Intel has done a good job over the years of continuing to integrate additional features and technologies that previously required separate chips, allowing the company to capture additional value with its offerings.

If Intel can continue to field feature-rich products that deliver unmatched efficiency and performance, it should continue to command robust margins. However, if Intel slips (or competitors execute really well), then the company's gross profit margins would be at risk.

Product cost structure

Gross profit margin is a function of both the amount that a company can charge per-unit and the manufacturing costs per-unit of a given product. Having competitive features and performance enables Intel to command relatively high prices for its products. However, if the company can only achieve that product competitiveness by blowing up its cost structure, then its margins see no improvement.

A good rule of thumb is that, assuming all else equal, a larger chip is going to be more expensive to manufacture than a smaller chip.

What Intel has worked to do for quite some time is to develop different variants of its products targeted at different price and performance points. More expensive, higher-performance chips tend to be larger -- as they usually pack in additional processor cores, graphics, and so on -- while lower-cost, lower-performance chips tend to be smaller.

Building multiple variants of a chip to target different price points does require additional research and development spending, but at the unit and revenue scale that the chipmaker operates in, the additional spending is more than offset by the gross profit margin benefit from building "right-sized" products for each segment.

That said, chip size isn't the only thing that affects cost structure. Intel owns and operates its own chip manufacturing plants and spends significantly to develop the manufacturing processes to actually build those chips.

The yield rates that Intel achieves with these manufacturing technologies directly affect a chip's cost structure. Remember, if you assume wafer cost is fixed, and if you assume the number of chips per wafer is fixed -- dependent on the size of the chip -- then the cost of those chips depends on how many of those come off the wafer usable, since better yields mean more salable chips for a given wafer cost.

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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.