Report: NVIDIA Corporation's in-House Graphics Cards to Affect Partners' Profitability

With the launch of its GeForce GTX 1070 and GeForce GTX 1080 graphics cards, NVIDIA (NASDAQ: NVDA) did something unusual. In the past, the company would build what are commonly referred to as "reference design" graphics cards. These are add-in-boards that incorporate NVIDIA's graphics processors that are sold to end users, who then plug them into their computers.

NVIDIA's Titan X graphics card. Image source: NVIDIA.

Over the last several years, NVIDIA would distribute these built-by-NVIDIA add-in-boards through its major partners, which include companies like ASUSTek, Gigabyte Technology, MSI, EVGA, and others. Then, once NVIDIA's partners could get customized add-in-boards into the marketplace, it would stop shipping its in-house cards through those vendors (a sensible strategy as these third-party cards tended to either be cheaper than or better than NVIDIA's own cards -- or both).

With the 1070/1080, NVIDIA changed its strategy. Rather than stop selling its own cards once the new ones launched, it kept its own cards in the market -- generally at a premium to what many of the other third-party cards were priced at -- by selling them directly through its website and a few brick-and-mortar stores.

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According to DigiTimes, NVIDIA's efforts are "likely to affect the profitability of graphics cards suppliers in Taiwan and China in 2017 and beyond."

Let's take a closer look at what the DigiTimes report says and what it ultimately means for NVIDIA.

Grabbing some more profit

DigiTimes' sources claim that the top-six graphics card vendors, combined, generated nearly $160 million in profit. This, the report claims, is "encouraging [NVIDIA] to step into the segment to slice part of the growing earnings."

To put this profit amount into perspective, NVIDIA's total operating profit year to date, on a GAAP basis, has totaled about $1.2 billion -- up substantially from the $495 million that it saw in the prior-year period. Operating income for the full year should be substantially more than that, as the company's current guidance implies more than $600 million in operating income for the fourth quarter of the current fiscal year.

So, while it is true that NVIDIA is currently capturing and will likely continue to capture profit share, to the detriment of its partners' profit share, as it is a zero-sum game, the potential impact here to NVIDIA isn't likely to be large enough to really move the needle.

Indeed, most, if not all, of NVIDIA's partners are far smaller and much less profitable than NVIDIA itself, meaning that a small boost to NVIDIA's bottom line at the expense of these other players could be significant negatives for said players.

A balancing act

Going forward, NVIDIA is going to need to be careful about balancing its desire to capture some of the graphics add-in-board industry profits and making sure to keep its partners sufficiently interested in investing in compelling add-in-boards based on its graphics processors.

After all, many of the add-in-board vendors have quite good reputations with the gaming community, and those same vendors are also major vendors of other gaming-related components -- motherboards, monitors, complete systems, and so on.

I don't think NVIDIA should stop building its own graphics boards because it can capture some additional profits and it can't hurt to build direct relationships with customers. However, it would probably be best if the company continued to keep distribution of its own graphics cards limited to give its partners some breathing room.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Nvidia. The Motley Fool has a disclosure policy.