Since establishing our Next Generation investment philosophy more than a decade ago, Digital Disruption has always been at its core. It captures the megatrend of digitalisation with all its subtrends, including Cloud Computing & AI and Cybersecurity. Of course, our focus is on the benefits digitalisation brings to our economy and society, but in a very ironic way we – and the world – needed to learn last week what digital disruption might in fact mean.
The world suffered one of the worst-ever information technology (IT) outages, triggered by a flawed update from CrowdStrike, a leading provider of cybersecurity software. This outage serves as a stark reminder of our increasing dependence on software and cybersecurity products, which have become an integral part of the digital economy. While the global economic impact is still unclear, the immediate consequences for the companies involved in such IT incidents can be severe, including litigation for financial compensation, reputational damage, and loss of new business. If there is a positive element to the outage, it is the fact that it was ‘only’ caused by a flawed update instead of fundamental shortcomings of the software or an actual cyberattack.
Cloud computing & AI: The monetisation gap
The gap between artificial intelligence (AI) infrastructure investments and the revenues generated by the AI ecosystem needs to close. While challenges such as elongated sales cycles, flattening adoption curves, and pricing model disruptions set a high bar for success, generative AI presents significant opportunities for software companies to innovate and expand their markets. Despite these hurdles, the AI investment cycle remains on track for now.
The AI sector is currently under scrutiny due to concerns about a potential bubble, with a significant gap between infrastructure investments and the revenues that are generated from AI ecosystems. Sequoia Capital estimates this gap at USD 600 billion.
Independent of timing, this gap needs to close, either as spending on infrastructure slows down or as monetisation picks up, which is of vital importance for the AI rally to continue. Software companies are facing various hurdles, including the following:
- Creating AI tools with a strong value proposition and integrating them into customer systems is a lengthy process.
- Post-pandemic overhangs are still impacting sales, as purchases were pulled forward into 2020 and 2021, followed by a period of spending optimisation.
- The adoption curve of software has flattened, resulting in slower sales growth.
- There are concerns about AI potentially reducing the addressable market by replacing workers and reducing license seats.
That said, software companies should be able to compensate lost seats through pricing power, which is underpinned by switching costs, while new products with a clear value proposition could expand the addressable market.
What does this mean for investors?
While it is too early to draw conclusions about AI monetisation, the investment cycle appears to be ongoing. Only time will tell if these high revenue expectations will be met and whether the gap with infrastructure spending will be closed. In the meantime, we continue to monitor our universe to track AI integration in software. For now, we remain Constructive on our Cloud Computing & AI theme, as our investment thesis remains robust. After a strong rally in the first half of the year, the current consolidation phase is both expected and necessary. While we anticipate elevated volatility in the coming weeks, we advise investors to maintain their positions.