Intel (NASDAQ: INTC) has long dominated the server and PC processor markets and enjoyed high profit margins in both. According to our estimates these products together constitute around 80% of Intel’s stock value.

But it’s not clear that Intel will be able to maintain both its dominant market share and its elevated margins. Rival chipmaker AMD (NYSE: AMD) now sells the cheapest server processors on the market. More important, AMD’s latest processors deliver better performance ratios than Intel’s, measured on both per watt and per dollar bases.

Below we explain how AMD is putting pressure on Intel’s processor market share and underlying profit margins.

Intel’s Xeon processors outsell AMD’s Opterons, with better margins

Intel’s Xeon processors are currently used in approximately 70% of the total OEM servers shipped. The remainder use AMD’s Opteron processors.

Intel’s server processor profit margins were 50% in 2009, versus 10% for AMD.

Intel processors power approximately 80% of all mobile PCs

Intel’s Core, Celeron and Atom processors are used in approximately 80% of all mobile PCs (notebooks and netbooks) sold globally. Here also Intel has been able to maintain profit margins around 5X higher than those of AMD.

AMD processors gaining traction

AMD has recently shown the ability to underprice Intel without compromising performance. For example, AMD’s latest server processor cost only $99, verus $167 for Intel’s cheapest equivalent. AMD’s processors are well suited for intensive cloud computing applications as well as enterprises looking to cut down their IT costs.

Historically, Intel has outperformed AMD in the realm of chip manufacturing technology. Each manufacturing improvement (e.g advancing from the 45 nanometer process node technology standard to 32 nanometers) resulted in strong cost benefits and higher profits.

But with further technological advances becoming more difficult and AMD catching up fast on the manufacturing front, Intel may not enjoy these benefits for long.

Intel may have to sacrifice market share to maintain profit margins

Intel faces a stark choice: Slash prices and sacrifice margins to maintain its market share, or maintain its current margins but yield share to AMD.

The chart above shows the Trefis forecast for Intel’s share of the server and notebook processor markets. You can modify the chart to see how Intel’s stock will be affected if it loses share to AMD.

Can Intel avoid this dilemma by entering the services and software business?

Intel’s management has recently commented on the company’s growing interest in the high-margin software and services business. Last year Intel blurred the line between hardware and software by acquiring WindRiver, which develops software for robotic devices, vehicle systems and other non-PC hardware platforms. And Intel recently announced a partnership with Nokia (NYSE: NOK) to develop MeeGo, a software platform for mobile devices, connected TVs and vehicular infotainment systems.

If Intel makes meaningful inroads in the software and services market going forward, it may be able to justify cutting prices to maintain its processor market share, even if that means accepting lower margins.

You can see the complete $23.37 Trefis Price estimate for Intel’s stock here.