Quite correct, it is indeed "on-package"
I had quite the post typed and then hit ctrl-r instead of ctrl-t causing everything to be lost. Sick of typing this over, I'll be brief (and maybe suggest an auto-save ).
I was told some months ago (long before most people had heard of the pi project; take the story, despite its sense with a grain of salt) that some people at pi knew some people at Broadcom. An agreement was struck that pi could get end-run chips for near production cost. End run chips is (for explanation for whomever does not know) referring to extra chips made to ensure supply. For example, if a company orders 5 million chips, rather than make exactly that many and hope that all the chips work and that none are damaged before the chips are delivered, companies often make a few thousand extra chips. These add a little to the overall production cost, but can save millions in fees from not delivering enough chips on time. These chips would be perfect for both pi and Broadcom. Broadcom would be able to recover the base cost of the chips (and maybe get some good PR) while pi (who only expected unit sales from the thousands to low tens of thousands) would get cheap chips.
Despite this fact, I would rather pay a few dollars more and get a product that has a more open architecture. The focus of pi is software anyway. Increasing the difficulty with loads of binary blobs and (even worse) a blackbox architecture hurts the goals of the project more than a slight increase in price (IMHO). The only reason I can think of for Broadcom to be so protective is that TV or dvd player manufacturers (the primary purchasers of these chips) fear that opening the architecture will allow someone to steal free cable or something. While they may have a good business point, it is this exact point that states why these chips are unsuitable for the project; that is, hacking the pi (the old meaning of hacking) is nearly impossible. In addition, with the amount of orders that pi has, what are they doing for chips? Either they are placing their own orders (either at full price or getting some kind of deal, presumably because they're a charity) or they are delaying shipments until new end-runs appear.
edit: The Allwinner A10 is a 1.2GHz A8 processor with a Mali400 GPU for only $7 per unit. With the Allwinner costing at most $7 more than the Broadcom chip (and I bet it's more like $1-2), while offering much greater openness and much better performance, I don't see there being a contest. Also on the table for similar pricing is the Ingenic Xburst JZ4770. It's single-core 1GHz MIPS chip offers an IPC slightly lower than A9 (that's still better than the Allwinner A8 and much, much better than the ARM11 in the pi) while great 3D (and dedicated 2D) performance (there's OpenCL support too). Anyway, the point is that there are other less locked down options without breaking the budget.
Edited by hajile - 10/15/12 at 8:59pm