AI is going to save software companies' dreams of growth
It appears emerging price points for AI-powered software products will boost the total addressable market (TAM) for technology products and help reaccelerate growth at tech companies big and small.
In late 2023, Battery Ventures noted that the pullback of revenue growth at software startups had reached its nadir, and growth levels were starting to stabilize in the fourth quarter. Around the same time, Scale Venture Partners reported that after several years of deceleration, early-stage software companies were expected to renew momentum in 2024. Taken together, it seemed that tech companies were all but out of the woods.
Today, we’re seeing early indications that those optimistic takes were in tune with how 2024 would at least start to unfold. Companies are reporting their Q4 2023 results, and Big Tech companies have posted better-than-expected revenue and profit so far. Microsoft did well, Meta blew the doors off, and Amazon had a great quarter as well. We’re still waiting on a host of smaller SaaS companies to report, but it does appear that 2023 ended on a better note than earlier in the year.
Building a viable pricing model for generative AI features could be challenging
There’s good reason to expect more of the same in 2024. It appears that the market is willing to accept that software imbued with new AI capabilities will cost more. So, yes, software companies of all sizes will have something new to upsell existing customers and potentially land new accounts, and it means that the TAM of software companies is widening.
A business can grow faster for longer in a larger market than it can in a smaller market. AI is therefore serving as a near-term growth boost for tech companies while raising the ceiling for how big they can become over time.
The price of AI
Charging for AI software products is not merely a way to squeeze customers; it’s also a great way to defend margins. AI is not cheap, and recently we’ve seen people once again debating whether AI startups have worse gross margins than traditional SaaS businesses.
If you are going to run lots of LLM cycles, you have to charge for it. Otherwise, you are going to take large bales of cash and set them on fire. So it should not be entirely surprising that we’re seeing AI services coming at a stiff price point. Microsoft’s Copilot Pro will run you $20 per month, as will Google’s new level of consumer service that includes its latest AI model. GitHub Copilot costs $10 per month, minimum. Box is charging for AI as well, to put an enterprise spin on the point. The list goes on.
The cost of enterprise-level access to AI services can be partially graded on the success of Microsoft 365’s AI tools. They seem to be doing well. And OpenAI’s revenue growth is a useful proxy for demand for its services, given how popular ChatGPT is. Both seem to indicate that we’re seeing real demand for AI-powered software, which, in turn, should convert to additive growth for tech companies.
Looping back to where we started: This dynamic is why I expect software growth to be solid this year.
There’s another way to consider the impact of AI-related software services on tech companies’ top lines. Observe the following chart from Altimeter investor Jamin Ball:
This chart parses how much growth AI is driving for Microsoft’s cloud platform. If we presume that all hyperscale cloud infrastructure providers are seeing similar boosts to compute demand, we can infer that lots of tech companies are ramping up their usage of AI models inside their products. As no company wants to see their gross margins erode as they grow, the above implied spend that Ball charted must be converted into higher prices. That means growth.
It seems that the market isn’t hesitating to pay for AI-related software services. And given that demand for AI-related tooling is high, the combination of the two factors should not only boost tech growth today, but also the total tech market itself over time. How about that for a good foot to start the year on?