The race to dominate the growing AI market is pushing tech giants to adopt business models reminiscent of IBM (IBM) in the 1960s.
Big Tech “hyperscalers” Alphabet (GOOG, GOOGL), Meta (META), Microsoft (MSFT), and Amazon (AMZN) are all in various stages of developing their own custom AI chips to sit in their data centers and power their cloud and software offerings. Alphabet, the most distant of the four companies, is even reportedly in talks to sell its physical chips called TPUs to Meta – a move that would see it go head-to-head with major chip maker Nvidia (NVDA).
Those efforts have led Bloomberg Intelligence analysts to predict that the custom AI chip market will grow to $122 billion by 2033.
Big Tech’s production of their own components goes beyond chips: Microsoft and Amazon are actively investing in dark fiber, or currently unused fiber optic cables that are already underground, RBC Capital Markets analyst Jonathan Atkin said in a recent note to clients. Google and Meta also have their own cables but still buy from third parties, he wrote. Those cables are needed to connect the data centers of the companies and enterprises that use them.
The dynamic in which cloud providers are making their own components (hardware) to run their core products (software) shows Silicon Valley swinging back toward vertical integration — an operating model pioneered by oil and steel magnates at the end of the 19th century and adopted by IBM during the digital revolution.
IBM was one of the most successful vertically integrated companies in the sixties, when it made the hardware components for its mainframes, or large computer systems. IBM’s strategy arose from the idea that making its own specialized parts would improve its final product (mainframes) and profit margins – and amid concerns about a lack of supply of parts for early computers. It worked: In 1985, the company accounted for more than half the market value of the computer industry, Carliss Y. Baldwin noted in her book “Design Rules”.
Of course, that all fell apart later. In the 1990s, the falling costs of semiconductor production — as well as the rise of software powerhouse Microsoft and chip leader Intel — dug into IBM’s once formidable competitive moat, and the company no longer claimed to be vertically integrated by 2000, Baldwin said.
Just as the emergence of computing pushed IBM towards vertical integration, the popularization of AI since the launch of ChatGPT in late 2022 has put today’s cloud giants on a similar trajectory. In particular, the steep costs of Nvidia’s chips and their limited availability have pushed the tech giants to advance their AI chip efforts. Those custom chips are cheaper and better optimized for enterprise software.
