Big Tech Shareholders Play the Waiting Game on AI Returns
The Takeaway
September quarter results from big tech companies show that while corporate customers may be spending more on new AI services, that spending may be offset by reductions elsewhere.
Will Microsoft, Google and Meta's outsize investments in artificial intelligence produce outsize profits? Perhaps, but shareholders realized this week they'll have to wait longer to find out.
September quarter reports from several big tech companies showed that while their business and consumer customers spent more on conversational AI services such as ChatGPT in the third quarter, it's far from going gangbusters. And what growth is being achieved may be offset by slower spending elsewhere, limiting the overall growth tech companies are able to show.
Microsoft, for example, reported a slight dip in growth at its cloud unit Azure and forecast a bigger dip in the current quarter. Meta slightly spooked investors after posting slower revenue growth and higher capital expenditures on servers and other hardware for AI. And Google posted accelerating growth in its cloud unit—but that was thanks partly to factors unrelated to AI.
For instance, Google Cloud earlier this year began enforcing the contracts that some of its biggest customers had signed, in which they promised to spend a certain amount of revenue per year on renting servers, said a person who does business with Google Cloud. In some cases, customers paid a lump sum for the unused cloud services they’d previously committed to purchasing, said the person, who was involved in these deals.
That marked a shift from the past, when Google Cloud would allow customers to roll over their spending commitments to the following year, they said.
The practice appeared to contribute to Google Cloud’s revenue growth of 35% in the third quarter, six percentage points faster than in the second quarter, and its best-ever operating profit. CEO Sundar Pichai also cited spending on AI models by longtime Google Cloud customers such as Snap. The cloud result overcame muted growth in its core ad sales and helped lift Google’s stock price.
Other enterprise software firms have posted results that raise questions about how AI is affecting overall business spending. ServiceNow, for instance, whose software helps customers manage computer systems, said AI revenue grew 50% quarter over quarter, without providing specifics. But ServiceNow’s overall revenue growth didn’t accelerate from the second quarter and was four percentage points slower than in the first quarter.
ServiceNow’s new products include an AI agent that automates repetitive information technology and customer tasks, such as scheduling a service appointment.
At IBM, whose revenue rose just 1% in the third quarter, CEO Jim Kavanaugh said last week that some customers are “reprioritizing their IT budgets” to focus on generative AI but without increasing overall spending. Customers of IBM’s substantial consulting business showed caution around how they use AI, leading to smaller deals, he said.
‘Mindful’ Investment
“Customers still feel that the economy is at a place where they still have to be very mindful about any investment they’re making, including [conversational or generative AI], where overall savings in the business is a very important criteria," said Varun Singh, co founder and president of Moveworks, which sells AI that handles IT support tickets.
At the start of the year, major cloud providers including Amazon Web Services tamped down their internal expectations on AI revenue for similar reasons. While there’s no question the market for conversational AI is growing, it might be coming partly at the expense of other software or cloud spending.
Revenue from Microsoft’s Azure cloud rental group that competes with Google Cloud rose 33% year over year—down 1 percentage point from the prior quarter and 2 percentage points from the first quarter of the year. Microsoft said 12 percentage points of the Azure growth in the third quarter came from AI, which could amount to more than $1 billion, based on prior Azure disclosures about the size of its cloud business. A big portion of the AI contribution figure is the growing payments OpenAI is making to Microsoft to host ChatGPT and other AI products.
Without such AI revenue, Azure's growth would have fallen to its slowest rate in years given the slowdown in spending growth on non-AI cloud services.
Microsoft executives went out of their way to reassure analysts the Azure growth slowdown had nothing to do with weakening customer demand and—particularly in the current quarter—was more about the company’s inability to bring new AI servers online as fast as it had hoped. That’s a problem OpenAI has privately complained to Microsoft about and prompted the startup to pursue other providers. Azure growth should speed up in the March and June quarters, Chief Financial Officer Amy Hood said.
Microsoft investors also have been awaiting word of revenue from the suite of Copilot AI tools that Microsoft is selling as add-ons to its Office 365 software, but that has yet to appear in large numbers as customers remain cautious about the software and its cost. Revenue in the business unit that includes Office rose 12% to $28.3 billion, a slight acceleration from 11% growth in the previous quarter.
Microsoft said that its revenue from all AI products like the sale of OpenAI models through Azure, its GitHub Copilot and Office Copilot subscriptions is on track to exceed $2.5 billion per quarter sometime over the next two months. Microsoft generated $66 billion overall in the third quarter.
Despite the mixed results, the big firms are continuing to ramp up their investments in AI. This week, Microsoft, Google and Meta once again promised to continue increasing spending on servers and other AI-related costs in the quarters ahead. That could further raise the stakes for shareholders eager to see more growth from generative AI.
AWS, another potential barometer of corporate spending on AI, reports third-quarter results Thursday afternoon.