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 house in their data centers and power their cloud and software offerings. Alphabet, the most distant of the four companies, is also reportedly in talks to sell its physical chips, called TPUs, to Meta — a move that would see it go head-to-head with leading chipmaker Nvidia (NVDA).
Those efforts have led Bloomberg Intelligence analysts to predict that the custom AI chip market will reach $122 billion by 2033.
Big tech’s own component production 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 them from third parties, he wrote. Those cables are needed to connect companies’ data centers and the enterprises that use them.
The dynamic in which cloud providers are building their own components (hardware) to run their core products (software) reflects Silicon Valley’s return to vertical integration — an operating model pioneered by oil and steel tycoons 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 made the hardware components for its mainframes, or large computer systems. IBM’s strategy stemmed from the idea that making its own specialized parts would improve its end product (mainframes) and profit margins—and amid concerns over supply shortages of parts for early computers. It worked: By 1985, the company accounted for more than half of the computer industry’s market value, noted Carlisle Y. Baldwin in his book “Design Rules.”
Of course, it all fell apart after that. In the 1990s, the falling cost of semiconductor manufacturing — as well as the rise of software powerhouse Microsoft and chip leader Intel — dug into IBM’s once-serious competitive moat, and the company didn’t claim to be vertically integrated until the 2000s, Baldwin said.
Just as the rise of computers pushed IBM towards vertical integration, the popularity of AI following the launch of ChatGPT in late 2022 has put today’s cloud giants on a similar path. In particular, the hefty cost of Nvidia’s chips and their limited availability have prompted the tech giant to step up their AI chip efforts. Those custom chips are cheap and well suited for companies’ software.
