AI industry profits depend on investor funding, warns economist

In a recent analysis, Apollo Chief Economist Torsten Slok highlighted the troubling dynamics of the AI industry, particularly in the United States. He pointed out that while companies involved in creating AI models and applications are experiencing significant investment, they are simultaneously facing negative operating margins. This is a stark contrast to traditional business models where profit margins are typically higher for companies selling end products directly to consumers. Slok categorized AI companies into four segments: models and applications, cloud and compute, energy and grid, and silicon and equipment. His findings, based on data from Pitchbook and Bloomberg, revealed that silicon and equipment, such as chipmakers, boast the highest profit margins at 41%, while models and applications, like Anthropic, suffer from a staggering -59% operating margin. This disparity raises concerns about the sustainability of the industry's growth, as it relies heavily on capital raised from investors rather than actual demand from customers. Slok emphasized that the current profits in the AI boom are being funded by investors, creating a precarious situation for the industry. If investment slows down, the entire structure could be at risk, as the most profitable segments depend on the continued growth of the least profitable ones. The Bank of International Settlements echoed these concerns in its annual report, noting that the rapid pace of AI investment is outstripping earnings and free cash flow, leading companies to issue significant amounts of debt. This trend raises alarms about the potential for a sudden pullback in financing, which could have widespread repercussions across the supply chain. Tech writer Ed Zitron further illustrated the risks by discussing Oracle's substantial negative cash flow and its reliance on a massive deal with OpenAI. The overall sentiment among economists is that the current AI expansion may not be sustainable without tangible returns for end customers, raising questions about the future viability of the industry.