Technological paradigm shifts have, in the past, created an opening for new entrants to dominate. The introduction of SaaS in the late 90s and early 2000s enabled Salesforce’s CRM to race ahead of incumbent on-premise solutions like SAP and Oracle. The rise of the internet enabled digital platforms like Amazon and Netflix to surpass brick-and-mortar incumbents like Borders and Blockbuster. The introduction of cloud computing enabled Amazon and Microsoft to build dramatically larger computing businesses than IBM or Oracle.
The current AI boom is lauded as the latest paradigm shift. And technologically, that seems obvious. Some estimates indicate that generative AI has the potential to add $4.4 trillion in annual value, with half of all work activities getting automated by 2045. But at the same time there is a much more limited “leap frogging” going on between incumbents and new entrants.
The immediate counterpoint to that is OpenAI. The company was estimated to be generating $3.4 billion in revenue as of June 2024. And there are certainly some extenuating circumstances with OpenAI. The company benefits from a sort of “status quo” effect — nobody gets fired for buying OpenAI’s products.
At the same time there is a clear and obvious feeling of OpenAI being beholden to Microsoft. And that’s not even reading between the lines. If you remember one surprising piece of posturing from Satya Nadella, the CEO of Microsoft, it was how explicitly he made OpenAI sound dominated:
"If OpenAl disappeared tomorrow, we have all the IP rights and all the capability. We have the people, we have the compute, we have the data, we have everything. We are below them, above them, around them."
Unlike any prior paradigm shift before the incumbents who are intimately connected to AI continue to demand sacrifices of the companies striving to innovate in the space. At first, it was Microsoft paying $650 million in March 2024 for a “licensing” deal to use Inflection’s models. Oh, and by the way, the deal let Microsoft hire away most of the company’s staff and co-founders. Next, it was Amazon inking an identical deal with the team at Adept (though its unclear if they even had to pay anything.) Most recently it was Google’s deal with Character AI to buyout the company’s investors at 2.5x the company’s $1 billion valuation from 2023.
Predictions for what’s next? Mistral acquired by Meta’s AI team?
Several of these deals were poised as “license and hire” vs. acquisitions in order to avoid regulatory scrutiny. Despite the attempted maneuver, the FTC is still taking note. Thus far the Microsoft and Inflection deal has come under investigation, but it could very easily extend to the others as well.
The combination of massive costs for compute, training data, and talent seem to be sizable hurdles for anyone other than the incumbents, or those who’ve been bequeathed their power, like OpenAI, to succeed. Companies like Glean, Cohere, Writer, Harvey, and Hugging Face are tripling or quadrupling their revenue. But these have anywhere from $30 to $100 million in revenue; a far cry from the billions the incumbents are generating.
And what’s more, firms like Sequoia are cautioning the potential bubble that exists in AI, pointing the need for $600 billion of AI revenue to materialize to justify the investment in the space. Massive hedge funds, like $70 billion Elliot Management, are saying Nvidia is “a bubble” and that AI is “overhyped.” Companies like Microsoft and Meta are hedging their bets, saying it could take 15 years for these investments to pay off. In fact, Microsoft is already missing revenue targets around its AI business. And the investment certainly isn’t slowing. Alphabet, Microsoft, and Meta are heavily investing in AI, with a combined expenditure of $40.5 billion on infrastructure, land, and chips in Q2 2024 alone.
The question now will be whether there are still meaningful opportunities to build sizable AI businesses independent of the existing incumbents? Or if this will just be an extension of the cloud wars playing out in public? When you have Google employees leaving to start an AI company and then getting “acqui-hired” back three years later… it feels like it might be the latter.
