For the past 30 years, investors haven’t lacked for next-big-thing trends to latch onto. In 2023, absolutely nothing has captivated investors’ attention more than artificial intelligence (AI).
The AI revolution: A trillion-dollar opportunity
In simple terms, AI utilizes software and systems to handle tasks that would normally be overseen or completed by humans. The key to the success of AI is the incorporation of machine learning, which allows software and systems to learn and become more efficient at their tasks over time. This ability to evolve gives AI-powered solutions applications across virtually all sectors and industries.
As you might imagine, the dollar figures associated with AI are as grand as investors’ expectations. A report from PwC pegs the added economic contribution from artificial intelligence at $15.7 trillion by 2030. This includes an estimated $6.6 trillion in increased productivity, as well as a $9.1 trillion consumption-side boost. While there are a number of companies that have benefited from the rise of AI, none stands out more than graphics processing unit (GPU) specialist Nvidia (NVDA -2.89%).
Nvidia’s meteoric rise in the AI space
When Nvidia’s fiscal 2024 began (Nvidia’s fiscal year begins in early February), Wall Street expected the company to generate high-single-digit sales growth for the year. After just two quarters, analysts’ consensus estimate now calls for 103% sales growth in 2024. We’re talking about sales estimates being taken from shy of $30 billion to nearly $55 billion in about seven months. That’s not pocket change.
Though Nvidia has enjoyed a modest rebound in its gaming segment, virtually all of this increase has to do with data center revenue. The company’s A100 and H100 GPUs are dominating high-compute data centers. Since AI software and systems require split-second decision-making, Nvidia looks to have cemented itself as the infrastructure backbone of the AI revolution.
The unintended consequences of success
However, despite Nvidia’s overwhelming success, it has the potential to massively underperform next year for a very ironic reason: AI GPU production expansion.
The primary reason Nvidia’s data center sales have soared is because production of its A100 and H100 GPUs is maxed out. A quick look at the company’s fiscal second-quarter operating results shows that the first-half cost of revenue (across all segments) actually declined from the prior-year period. What this tells investors is that AI-accelerated GPU scarcity and significant pricing power are what have collectively sent Nvidia’s gross margin higher.
The paradox of success: Nvidia’s AI GPU shortage
While Nvidia’s dominance in the AI space is evident, there’s a catch-22 lurking in the shadows. The very success that has propelled the company to the forefront of the AI revolution may also be its Achilles’ heel in 2024.
The growing demand for AI GPUs
The soaring demand for AI applications has put immense pressure on Nvidia to produce more AI-specific GPUs. With its A100 and H100 GPUs being the go-to choice for data centers, the company has struggled to keep up with the demand. As a result, the scarcity of these GPUs has driven up prices, contributing significantly to Nvidia’s robust gross margins.
Maxed-out production capacity
One of the telltale signs of Nvidia’s production constraints is its declining cost of revenue in the fiscal second quarter. This suggests that Nvidia is producing GPUs at full capacity, leaving little room for further expansion. In essence, Nvidia’s inability to meet the surging demand for AI GPUs due to production limitations could hinder its growth potential in 2024.
Potential supply chain disruptions
As Nvidia pushes its production capabilities to the limit, it becomes more susceptible to supply chain disruptions. Any hiccups in the supply chain, such as semiconductor shortages or manufacturing bottlenecks, could have a cascading effect on Nvidia’s ability to deliver AI GPUs to its customers promptly.
The risk of competitors gaining ground
With Nvidia’s production capacity maxed out, competitors may see an opportunity to gain market share in the AI GPU space. Rivals like AMD and Intel could capitalize on the supply-demand imbalance by offering alternative solutions, potentially eroding Nvidia’s dominant position.
For Nvidia, the year 2024 poses a unique set of challenges despite the immense opportunities presented by the AI revolution. To navigate these challenges successfully, Nvidia may need to consider several strategies:
Invest in production expansion: To meet the surging demand for AI GPUs, Nvidia should consider significant investments in production capacity expansion. This would not only help alleviate supply shortages but also position the company for sustained growth in the AI market.
Diversify product offerings: Nvidia should explore diversifying its AI product offerings to cater to a wider range of customers. This could involve developing more cost-effective GPUs for smaller enterprises and startups, thus broadening its customer base.
Strengthen supply chain resilience: Proactively addressing potential supply chain disruptions is crucial. Nvidia should work on building a more resilient supply chain by diversifying its suppliers and securing critical components.
Continue research and development: Staying at the forefront of GPU technology is essential. Nvidia should continue investing in research and development to innovate and maintain a competitive edge over rivals.
Nvidia’s journey to the top of the AI GPU market has been nothing short of remarkable. However, as demand for AI accelerates, the company faces the irony of potentially underperforming due to its own success. Addressing production constraints and supply chain vulnerabilities will be pivotal in determining whether Nvidia can continue to thrive in the AI revolution of 2024 and beyond. As investors watch closely, Nvidia’s ability to adapt and overcome these challenges will be critical in shaping its future in the AI landscape.