“AI added $5 trillion to the market cap of the top 7 tech companies in 2023,” said author and professor Pedro Domingos. This includes the ‘Magnificent Seven’ – Meta, Amazon, Apple (not so much), Alphabet, Microsoft, NVIDIA and Tesla – that are driving the market stocks in the name of AI, everywhere. 

Not just big tech companies, AI research startups are also riding high, receiving multi-million (even billion) dollar valuations. However, analysts have raised questions on their revenue-generating model, doubting their long-term profitability. 

“It’s a classic example of a big market delusion,” said Rob Arnott, VC and founder of Research Affiliates, recently equating the AI hype to the 2000 dot com era when everyone was betting big on the internet changing everything. He, however, said that the recent growth of AI hype is not a mere apple-to-apple comparison. 

The rising AI valuation 

AI companies often receive high valuations due to their potential for growth, rather than their present earnings. The return models for AI companies are valued on future promise rather than actual sales. Interestingly, as per a study conducted by Microsoft through IDC, for every $1 invested by companies in AI, they are realising an average of $3.5 in return, and over 5% of organisations globally are even realising an average of $8 in return.

VCs support high levels of AI valuations by attributing to the high usage rate of products. The assumption of free users converting to paid customers is something they believe will justify the value. However, that again is not entirely the right way. 

Big-tech companies that offer cloud-services have pumped in millions of dollars into AI research companies, such as Microsoft’s $13 billion investment in OpenAI, Amazon’s $4 billion in Anthropic and in Perplexity AI. Full details of their strategic partnership with respect to revenue expectation are unknown. 

Sky’s the limit 

A few days ago, Indian AI company Krutrim successfully closed its first round of funding with $50 million, pushing the valuation of the company to $1 billion in a span of just a few months. It is now India’s fastest and first AI unicorn. 

The valuations for AI startups have been on a crazy rage of late. French AI startup Mistral AI, which was founded eight months ago, has crossed a valuation of $2 billion. Other Indian AI startups have also been receiving generous funding from investors over the past few weeks. 

While OpenAI was in talks to raise investments over a $100 billion valuation, AI startup Anthropic was in talks to raise $750 million at an $18 billion valuation. In a little over a year, AI-powered search engine Perplexity AI is valued at $520 million. 

Social Capital VC and CEO Chamath Palihapitiya said, “The AI industry is in a curious state right now.” He believes that though significant amounts are being invested in capital expenditures, credits, and tokens, there seems to be no substantial increase in the customer revenue. 

Palihapitiya also believes that AI primarily focuses on enhancing efficiency, thereby leading companies to adopt agents and automation to decrease costs, in the process, allowing AI to generate operation expenditure (OpEX) savings. Thus, hinting at a different way of evaluating AI companies. 

Is it a fair comparison? 

Considering how the AI market has grown over the past year, companies emerging in this space are relatively new. It is, hence, probably incorrect to compare their revenue or profit models to existing SaaS or normal startup ventures. It is also too soon to conclude these investments as an overvaluation. 

As per a recent report, the profit margins for AI startups is said to be lower than existing enterprise software firms, which has raised the alarm on the possibility of overvaluation of these AI companies.

Unlike the traditional expectation of startups to hit profits in three to four years, and five to seven years for SaaS companies, the expectation for AI research companies to really hit profits cannot follow the same tangent. 

At Davos 2024, Microsoft chief Satya Nadella, spoke about a broader use of AI, sharing how AI can be the growth driver for many economies. “Inflation adjusted, there is no economic growth in the world. It is a pretty disappointing state. The developed world may have negative economic growth,” said Nadella, adding that he is optimistic about AI being a general-purpose technology that can drive economic growth. 

Sometimes it might take forever. OpenAI, for instance, took close to seven years to release a product like ChatGPT and other APIs and hit the limelight. OpenAI’s annualised revenue topped $1.6 billion, implying $130 million from sale of subscriptions to ChatGPT and other models, however, profits are barely in billions, and doesn’t really equate to how much it is spending on customer acquisition cost and infrastructure. 

CEO Sam Altman is trying really hard to bring it to zero…