The race to dominate the emerging artificial intelligence 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 put into their data centers and power their cloud and software products. Alphabet, the furthest along of the four companies, is even reportedly in talks to sell its physical chips, called TPUs, to Meta, a move that would put it head-to-head with leading chipmaker Nvidia (NVDA).
These efforts have prompted analysts at Bloomberg Intelligence to predict that the custom AI chip market will grow to $122 billion by 2033.
Big tech companies are making their own components beyond chips: Microsoft and Amazon are actively investing in dark fiber, underground fiber optic cables that are currently unused, RBC Capital Markets analyst Jonathan Atkin said in a recent note to clients. Google and Meta also own their own cables but still buy them from third parties, he wrote. These cables are necessary to connect corporate data centers to the businesses that use them.
The dynamic of cloud providers manufacturing their own components (hardware) to run their core products (software) signals Silicon Valley’s return to vertical integration—an operating model pioneered by oil and steel barons in the late 19th century and adopted by IBM during the digital revolution.
IBM was one of the most successful vertically integrated companies in the 1960s, when it manufactured hardware components for its mainframes, or mainframe computer systems. IBM’s strategy stemmed from the idea that making its own specialized parts would improve its end product (the mainframe) and profit margins, and out of concerns about supply shortages of parts for early computers. It worked: In 1985, the company accounted for more than half of the computer industry’s market value, Carliss Y. Baldwin noted in her book “Design Rules.”
Of course, it all fell apart later. Falling semiconductor production costs in the 1990s and the rise of software giant Microsoft and chip leader Intel weakened IBM’s once-strong competitive moat, and by 2000 the company no longer claimed to be vertically integrated, Baldwin said.
Just as the advent of computers propelled IBM toward vertical integration, the proliferation of artificial intelligence since the launch of ChatGPT in late 2022 has put today’s cloud giants on a similar trajectory. In particular, the high cost of Nvidia chips and their limited availability have prompted the tech giant to advance the development of its artificial intelligence chips. These custom chips are cheaper and better optimized for the company’s software.
