Microsoft’s complicated wager on OpenAI brings with it potential and uncertainty

Microsoft CEO Satya Nadella attends an interview at the company’s headquarters in Redmond, Washington on March 15, 2023.

Chona Kasinger | Bloomberg | Getty Images

If Microsoft Having first invested $1 billion in OpenAI in 2019, the deal received no more attention than your average corporate venture round. The startup market was hot, and artificial intelligence was one of many areas to attract mega reviews, along with electric vehicles, advanced logistics, and aerospace.

Three years later, the market looks very different.

Startup funding has tumbled following the collapse of multiples in the public market for high-growth tech companies that are losing money. The exception is artificial intelligence, specifically generative AI, which refers to technologies focused on generating automated text, image, and audio responses.

No private company is hotter than OpenAI. In November, San Francisco-based startup introduced ChatGPT, a chatbot that went viral thanks to its ability to create human-like responses to user queries on almost any topic.

Microsoft’s once-under-the-radar investment is now a big topic of discussion, both in venture circles and among public shareholders trying to figure out what it means for the potential value of their shares. Microsoft’s cumulative investment in OpenAI has reportedly grown to $13 billion, and the startup’s valuation has reached around $29 billion.

That’s because Microsoft isn’t just opening its fat wallet to OpenAI. It is also the arms dealer as the exclusive provider of computing power for research, products and OpenAI programming interfaces for developers. Startups and multinationals, including Microsoft, are rushing to integrate their products with OpenAI, which means massive workloads are running on Microsoft’s cloud servers.

Microsoft integrates the technology into its Bing search engine, sales and marketing software, GitHub coding tools, Microsoft 365 productivity pack, and the Azure cloud. Michael Turrin, Analyst at Wells Fargosays it all could add up to over $30 billion in new annual revenue for Microsoft, with about half coming from Azure.

What does this mean for Microsoft’s investments and broader positioning?

“It’s so good that investors are asking me how they did it or why OpenAI would do it in the first place,” Turrin said in an interview.

However, the financial implications are far from simple.

Bragging rights

OpenAI was founded in 2015 as a non-profit organization. The structure changed in 2019 when two top executives published a blog post announcing the formation of a “capped profit” company called OpenAI LP. The current setup is preventing the startup’s early investors from making more than 100x their money, with lower returns for later investors like Microsoft.

After Microsoft’s investment is repaid, Microsoft will receive a percentage of OpenAI LP’s profits up to the agreed cap, with the remainder going to the nonprofit, an OpenAI spokesman said. A Microsoft spokesman declined to comment.

Greg Brockman, co-founder of OpenAI and one of the blog post’s authors, wrote in a 2019 Reddit comment that the system “feels reasonable to investors for what they could earn by investing in a fairly successful startup (but less than what they could do themselves). d invest in the most successful startups of all time!).”

It’s an unfamiliar model in Silicon Valley, where maximizing returns has long been the priority of the venture community. It also doesn’t make sense to Elon Musk, who was one of the founders and early supporters of OpenAI. Several times this year, Musk has tweeted his concerns about OpenAI’s unconventional structure and its impact on AI, especially given Microsoft’s ownership.

“OpenAI was created as an open source (which is why I called it “Open” AI), a non-profit company to serve as a counterbalance to Google, but it has now become a closed-source, maximum-profit company that operates effectively controlled by Microsoft. Musk tweeted in February. “Not at all what I intended.”

Brockman said on Reddit that if OpenAI is successful, it “could create orders of magnitude more value than any company has to date.” As a large OpenAI investor, Microsoft would benefit.

Aside from its investment, leaning on OpenAI has the potential to help Microsoft dramatically reverse its fortunes in AI, where it has publicly stumbled and failed to build a meaningful business of its own. Microsoft pulled the Clippy assistant from Word, Cortana from the Windows taskbar, and its Tay chatbot from Twitter.

Unlike areas like advertising or security, Microsoft hasn’t disclosed the scope of its AI business, though CEO Satya Nadella said in October that revenue from its Azure Machine Learning service had doubled for four straight quarters.

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Last but not least, working with OpenAI gave Nadella the right to show off. Here’s what he said at Microsoft’s annual shareholder meeting in December, a month after ChatGPT’s launch:

“When I think about Azure, one of the things we actually did related to ChatGPT, which is one of the most popular AI applications today, you know what? It was all trained on the Azure supercomputer. “

In February, Microsoft held a press event at its Redmond, Washington headquarters to announce new AI-powered updates to its Bing search engine and Edge browser. Altman was one of the keynote speakers.

It’s been a bumpy ride since then, as the Bing chatbot has had some high-profile and creepy conversations with users, and also provided some wrong answers upon launch. Somewhat fortunately for Microsoft, Google’s launch of its rival Bard AI service was underwhelming, leading employees to label it “rushed” and “botched.”

Despite initial difficulties, enthusiasm for new technologies based on Large Language Models, or LLMs, can be felt across the technology industry.

At the heart of the OpenAI bot is an LLM called GPT-4, which has learned to compose natural-sounding text after being trained with extensive online information sources. Microsoft has an exclusive license for GPT-4 and all other OpenAI models, the OpenAI spokesman said.

There are many other LLMs available.

Last month, Google said it gave some developers early access to an LLM called PaLM.

Startups AI21 Labs, Aleph Alpha, and Cohere offer their own LLMs, as does Google-backed Anthropic, which Google has chosen as its “preferred” cloud provider. Like Altman and Musk, Anthropic co-founder Dario Amodei, who was previously vice president of research at OpenAI, has expressed concerns about the unbridled power of AI.

In 2021, Anthropic was registered as a non-profit corporation in Delaware, demonstrating its intent to make a positive impact on society while seeking profit.

“We have been, and continue to be, focused on developing innovative structures to incentivize the safe development and deployment of AI systems, and will have more to say about that in the future,” an Anthropic spokesman said in an email to CNBC.

One thing is clear across the industry: we are still in our infancy.

Quinn Slack, CEO of code search startup Sourcegraph, said he hasn’t seen evidence that the OpenAI partnership has given Microsoft a notable advantage, although he did cite OpenAI as the leading LLM vendor.

“I don’t think people should look to Microsoft and say they’ve completely banned OpenAI and OpenAI is doing their bidding,” Slack said. “I really think people there are motivated to create amazing technology and use it as much as possible. They see Microsoft as a great customer, but not someone in control. That’s good and I hope it stays that way.”

OpenAI has many skeptics. Late last month, the nonprofit Center for Artificial Intelligence and Digital Policy asked the Federal Trade Commission to block OpenAI from releasing new commercial versions of GPT-4, describing the technology as “biased, deceptive, and a risk to privacy and… public safety”.

When it comes to possible exits for OpenAI, the natural buyer would be Microsoft – which does not hold an OpenAI board seat – due to its close ties. But that sort of deal would likely draw regulatory scrutiny amid concerns about AI and Microsoft’s stifling of competition. By remaining an investor and not owning OpenAI, Microsoft could avoid Hart-Scott-Rodino scrutiny by US competition authorities.

“I’ve been through it. It’s painful,” said David Zilberman, a partner at Norwest Venture Partners.

Based on the existing valuation, the more likely path for OpenAI is an eventual IPO, said Scott Raney, managing director at Redpoint Ventures.

According to PitchBook data, OpenAI is on track to hit $200 million in revenue this year, up 150% from 2022, and then $1 billion in 2024, which would represent 400% growth .

“When you raise at a valuation of $30 billion, it’s like there’s no going back at that point,” Raney said. They say, “Our plan is to become a large, independent, standalone company.”

OpenAI spokesman said there are no plans to go public or be acquired.

REGARD: Why ChatGPT is a game changer for AI