282 lines
14 KiB
Plaintext
282 lines
14 KiB
Plaintext
Cal Paterson | [1]Home [2]Services [3]About
|
|
|
|
Building LLMs is probably not going be a brilliant business
|
|
|
|
November 2024
|
|
|
|
The Netscapes of AI
|
|
|
|
image of early 20th century train advert for Watford Railways improved the
|
|
lives of millions - but investors were rewarded with a [4]dramatic bust
|
|
|
|
Large language models (LLMs) like Chat-GPT and Claude.ai are whizzy and cool. A
|
|
lot of people think that they are going to be The Future. Maybe they are — but
|
|
that doesn't mean that building them is going to be a profitable business.
|
|
|
|
In the 1960s, airlines were The Future. That is why old films have so many
|
|
swish shots of airports in them. Airlines though, turned out to be an
|
|
unavoidably rubbish business. I've flown on loads of airlines that have gone
|
|
bust: Monarch, WOW Air, Thomas Cook, Flybmi, Zoom. And those are all busts from
|
|
before coronavirus - times change but being an airline is always a bad idea.
|
|
|
|
That's odd, because other businesses, even ones which seem really stupid, are
|
|
much more profitable. Selling fizzy drinks is, surprisingly, an amazing
|
|
business. Perhaps the best. Coca-Cola's return on equity has rarely fallen
|
|
below 30% in any given year. That seems very unfair because being an airline is
|
|
hard work but making coke is pretty easy. It's even more galling because
|
|
Coca-Cola don't actually make the coke themselves - that is outsourced to
|
|
"bottling companies". They literally just sell it.
|
|
|
|
Industry structure - what makes a business good
|
|
|
|
If you were to believe LinkedIn you would think a great business is made with
|
|
efficiency, hard work, innovation or some other intrinsic reason to do with how
|
|
hardworking, or clever, the people in the business are. That simply is not the
|
|
case.
|
|
|
|
What makes a good business is industry structure.
|
|
|
|
Airlines - unfavourable industry structure
|
|
|
|
To be an airline is to be in an almost uniquely terrible market position. For
|
|
starters, there are only two makers of aeroplanes (Airbus and Boeing). For
|
|
reasons of training and staff efficiency, you have to commit to one or the
|
|
other, which gives the aeroplane makers very strong pricing power.
|
|
|
|
And buyers of airline tickets are incredibly fickle and have no loyalty. They
|
|
will switch from one "carrier" to another over even small differences in price.
|
|
Annoyingly, there are loads of other airlines and they're all running the same
|
|
routes as you!
|
|
|
|
Worse yet, starting a new airline is surprisingly easy. Aircraft hold their
|
|
value so banks will happily lend against them. There are loads of staff
|
|
available that new entrants can hire. So randos will continually enter your
|
|
market, often selling tickets below cost for quite a while before they go bust.
|
|
And to top it off, there are plenty of substitutes for air travel - from
|
|
government-subsidised high speed trains to Zoom calls.
|
|
|
|
Airlines that get more efficient, work harder or come up with innovations
|
|
aren't going to be able to "capture" the value of what they've done. If you
|
|
make more than the bare minimum to survive Airbus will notice that you're being
|
|
undercharged and you'll find that the next renewal on your service contract
|
|
eats up the difference.
|
|
|
|
Fizzy-drinks - very favourable industry structure
|
|
|
|
Being the Coca-Cola company is pretty great though.
|
|
|
|
Coke is just water, colourant, flavouring, caffeine and sweetener. Those are
|
|
all widely available and really cheap. And as I said, you don't even have to
|
|
combine them yourselves - bottling companies will do that for you for almost
|
|
nothing.
|
|
|
|
Handily, consumers are really picky about what goes in their mouth. The
|
|
unofficial motto of your main competitor is "Is Pepsi ok?". This is despite the
|
|
fact that they are identical in both taste and colour. And a significant
|
|
minority of people actually say no!
|
|
|
|
And it isn't easy for new competitors to enter the market. They can't call
|
|
their new drink "coke" due to trademarks. They have to call it something else.
|
|
And consumers will generally refuse it because drinking an alternative is
|
|
considered some kind of weird statement.
|
|
|
|
What is industry structure?
|
|
|
|
Classically, there are five basic parts ("forces") to a company's position:
|
|
|
|
1. The power of their suppliers to increase their prices
|
|
2. The power of their buyers to reduce your prices
|
|
3. The strength of direct competitors
|
|
4. The threat of any new entrants
|
|
5. The threat of substitutes
|
|
|
|
It's industry structure that makes a business profitable or not. Not
|
|
efficiency, not hard work and not innovation.
|
|
|
|
If none of the forces are very much against you, your business will do ok. If
|
|
they are all against you, you'll be in the position of the airlines. And if
|
|
they're all in your favour: brill, you're Coca-Cola.
|
|
|
|
The industry structure of LLM makers: OpenAI/Anthropic/Gemini/etc
|
|
|
|
So is the position of LLM makers any good? I'm afraid it's not good news.
|
|
|
|
LLM makers sometimes imply that their suppliers are cloud companies like Amazon
|
|
Web Services, Google Cloud, etc. That wouldn't be so bad because you could shop
|
|
around and make them compete to cut the huge cost of model training.
|
|
|
|
Really though, LLM makers have only one true supplier: NVIDIA. NVIDIA make the
|
|
[5]chips that all models are trained on - regardless of cloud vendor. And that
|
|
gives NVIDIA colossal, near total pricing power. NVIDIA are more powerful
|
|
relative to Anthropic or OpenAI than Airbus or Boeing could ever dream of
|
|
being.
|
|
|
|
How much power do buyers have over LLM token prices? So far, it seems fairly
|
|
high. Most LLM users seem willing to change from Chat-GPT to Claude, for
|
|
example. It doesn't seem like brand loyalty is being built up. And companies
|
|
that build AI into their businesses are starting to do so via abstraction
|
|
layers that allow them to switch model easily. That makes LLMs interchangeable
|
|
- which is bad for those who sell them.
|
|
|
|
What's the strength of direct competitors? Again, it is considerable. There are
|
|
loads of LLM vendors and pricing [6]appears competitive. Worst of all, Facebook
|
|
basically dump their model on the market for no cost. It's [7]reminiscent of
|
|
Internet Explorer - not exactly a great portent.
|
|
|
|
And it seems fairly easy for new entrants to build brand new models. That is
|
|
why there are so many LLM makers. Most of the techniques for making LLMs are
|
|
openly published in papers. Even bad models can gain customers if they are
|
|
cheap, which allows new entrants to gain a foothold.
|
|
|
|
The situation on substitutes is mixed. Instead of having Chat-GPT write some
|
|
text you could pay a person to do it instead. That is likely to be much more
|
|
expensive but also less likely to hallucinate, which might be important for
|
|
some use-cases (law is the field least likely to use LLMs). And then there is
|
|
the trend that [8]metadata tends to displace artificial intelligence once
|
|
particular application has been proved out - so as soon as you find a solid
|
|
use-case you stand to be replaced.
|
|
|
|
A single mildly positive point does not make a profitable business. LLM makers
|
|
look a lot more like Netscape - who invented graphical web browsers, then went
|
|
bust - than Google, who made something good that ran on top of the web
|
|
browsers.
|
|
|
|
How are they raising so much money?
|
|
|
|
If LLM makers seem cursed to an airline-style business destiny, how come they
|
|
are able to raise so much money? OpenAI [9]raised $6.6 billion at a valuation
|
|
of $157 billion less than two months ago. That might be the biggest VC round of
|
|
all time.
|
|
|
|
What do they know that I don't? It is a mystery - but let's consider the
|
|
options.
|
|
|
|
Perhaps they are hoping to develop their own chips to reduce their dependence
|
|
on NVIDIA. $6.6 billion is not enough to build a new fab but it might be enough
|
|
to get a new chip designed which allows them to migrate off NVIDIA. That would
|
|
save them paying so much money for GPU time. But, NVIDIA are actually one of
|
|
the investors in the round (although only a fairly small amount) - so it's
|
|
unlikely "develop an NVIDIA competitor" was on any of the pitch deck slides.
|
|
|
|
Perhaps OpenAI are hoping to build a strong brand so that customers won't
|
|
switch to competitors so easily. It's not impossible, there is proof the [10]
|
|
branding and lock-in can work in technology - but it seems difficult to manage
|
|
given that LLMs themselves generically have a textual interface - meaning that
|
|
there is no real API as such - you just send text, and it sends text back.
|
|
|
|
Can they do anything about new entrants? Possibly. If investing $6.6bn allows
|
|
them to develop a major improvement in their model then that would raise
|
|
everyone else's costs considerably and probably force some of their smaller
|
|
competitors out of the market. The trouble is that money is the most fungible
|
|
of all goods (that is the point, after all) and that $6.6bn is not all that
|
|
much of it. So this round wouldn't, by itself, be enough to dissuade others. I
|
|
used to work at a bank and I can tell you that individual bond raises can be a
|
|
lot more than $6.6bn.
|
|
|
|
It's worth saying that even companies that raise huge sums of money sometimes
|
|
turn out to have no viable business. WeWork ultimately raised over $10bn at a
|
|
valuation of $47bn before it was realised that their business simply did not
|
|
make sense. WeWork were valued at just $0.56bn in their most recent financial
|
|
restructuring - having lost well over 95% of what was invested.
|
|
|
|
Not all AI companies are doomed
|
|
|
|
If LLM makers aren't going to be good businesses, does that bode ill for The
|
|
Future?
|
|
|
|
Firstly, it does not mean the technology will be bad. Whether the technology
|
|
ends up being good or not is mostly unrelated to whether Open AI/Anthropic/
|
|
Mistral/whoever makes any money off it. Container virtualisation technology is
|
|
pretty well developed even though Docker made almost nothing on it. Web
|
|
browsers are extremely advanced pieces of software even though making a browser
|
|
is such a bad business that most don't usually count it as a business at all.
|
|
And CRMs are terrible despite the fact that Salesforce is tremendously
|
|
successful. Technology success and business success are mostly unrelated.
|
|
|
|
And then: not all AI businesses are building models. Ideally, if I were running
|
|
an AI business I would avoid building a model at all costs. Building your own
|
|
models looks like an undifferentiated schlep. Using a tiny bit of some
|
|
expensively trained model that Anthropic has produced could be very cost
|
|
effective and might make some business idea work that wouldn't have 5 years
|
|
ago.
|
|
|
|
Beware software companies that aren't software companies
|
|
|
|
Software companies are really good businesses. You have no real suppliers, your
|
|
software is often unique (so no competitors) and the substitute is just users
|
|
doing the job themselves. For this reason, software companies tend have really
|
|
great margins.
|
|
|
|
The problem is that not all technology companies are software companies. If you
|
|
have a hugely powerful single supplier like NVIDIA then the economics of your
|
|
company are going to look less like Microsoft Office and more like [11]Pan-Am.
|
|
|
|
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
|
|
|
|
Contact/etc
|
|
|
|
Write to me at [12]cal@calpaterson.com about this article, especially if you
|
|
disagreed with it.
|
|
|
|
See [13]other things I've written or learn more about me on [14]my about page.
|
|
|
|
Get an alert when I write something new, by [15]email or [16]RSS[17] rss-logo.
|
|
|
|
I am on:
|
|
|
|
• [18]Bluesky
|
|
• [19]Mastodon
|
|
• [20]Twitter
|
|
• [21]Github
|
|
• and [22]Linkedin.
|
|
|
|
━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━
|
|
|
|
Other notes
|
|
|
|
The AI safety movement is a fantastic hypeman for LLMs as a technology.
|
|
Implying (pretty dubiously) that we are [23]10 minutes from midnight in some
|
|
kind of Ghost-in-The-Shell style AI crisis is in fact an extremely effective
|
|
form of product marketing. Perhaps that is why OpenAI and others employ so many
|
|
AI safety specialists.
|
|
|
|
The Coca-Cola company mainly sit back and rake in the megabucks - but they do
|
|
spend a little bit of their earnings on research. And a little bit of a lot is
|
|
still significant. It's interesting that coke's market research has discovered
|
|
that coke works better as a gender segregated product: Coke Zero is Diet Coke,
|
|
but for men.
|
|
|
|
If you want to read more about industry structure and market strategy, the
|
|
place to start is with Michael Porter. He reworked his famous essay [24]The
|
|
Five Forces that Shape Corporate Strategy in 2008. It's not the last word, but
|
|
it probably should be the first word you read if you want to learn more. And if
|
|
you like it, he has a lot more.
|
|
|
|
|
|
References:
|
|
|
|
[1] https://calpaterson.com/
|
|
[2] https://calpaterson.com/services.html
|
|
[3] https://calpaterson.com/about.html
|
|
[4] https://en.wikipedia.org/wiki/Railway_Mania
|
|
[5] https://en.wikipedia.org/wiki/Hopper_(microarchitecture)
|
|
[6] https://a16z.com/llmflation-llm-inference-cost/
|
|
[7] https://en.wikipedia.org/wiki/Browser_wars#First_browser_war_(1995%E2%80%932001)
|
|
[8] https://calpaterson.com/metadata.html
|
|
[9] https://www.reuters.com/technology/artificial-intelligence/openai-closes-66-billion-funding-haul-valuation-157-billion-with-investment-2024-10-02/
|
|
[10] https://calpaterson.com/amazon-premium.html
|
|
[11] https://en.wikipedia.org/wiki/Pan_Am
|
|
[12] mailto:cal@calpaterson.com
|
|
[13] https://calpaterson.com/
|
|
[14] https://calpaterson.com/about.html
|
|
[15] https://calpatersonltd.eo.page/calpaterson
|
|
[16] https://calpaterson.com/calpaterson.rss
|
|
[17] https://calpaterson.com/calpaterson.rss
|
|
[18] https://bsky.app/profile/calpaterson.bsky.social
|
|
[19] https://fosstodon.org/@calpaterson
|
|
[20] https://twitter.com/cal_paterson
|
|
[21] https://github.com/calpaterson/
|
|
[22] https://www.linkedin.com/in/calpaterson
|
|
[23] https://en.wikipedia.org/wiki/Doomsday_Clock
|
|
[24] https://hbr.org/2008/01/the-five-competitive-forces-that-shape-strategy
|