The race to dominate the burgeoning 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 put in their data centers and power their cloud and software offerings. Alphabet, the most distant of the four companies, is even in talks to sell its physical chips called TPU to Meta — a move that would put it head-to-head with chipmaker Nvidia (NVDA).
These efforts have led Bloomberg Intelligence analysts to predict the custom AI chip market will grow to $122 billion by 2033.
Big Tech component manufacturing 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 own their own cables but still buy from third parties, he wrote. These cables are needed to connect companies’ data centers and the businesses that use them.
The dynamic in which cloud providers produce their own components (hardware) to run their core products (software) shows that Silicon Valley is turning to vertical integration – an operating model pioneered by oil and steel magnates 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 for its mainframes, or large computer systems. IBM’s strategy arose out of the idea that making its own specialized parts would improve the end product (mainframe) and profit margins—and amid concerns about parts shortages for early computers. It worked: In 1985, the company accounted for more than half the market value of the computer industry, noted Carliss Y. Baldwin in her book “Design Rules.”
Of course, it all came crashing down later. In the 1990s, falling semiconductor manufacturing costs — as well as the rise of Microsoft’s software power and chip leader Intel — dug into IBM’s once-formidable competitive moat, and the company no longer claimed to be vertically integrated until 2000, Baldwin said.
Just as the advent of computing pushed IBM toward 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 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 companies’ software.
