Cutting Through the Noise in the Generative AI Landscape as an Early-Stage Investor

AI (robot) playing piano
January 11, 2024
Perspectives
Written by
Sofia Svanqvist
Junior Investment Analyst
This article is based on publicly available data and some of the sources are built upon previous research. Areas for preferred investments are based on personal analysis and require additional validation from experts in the field and constant iteration.
If you have any additional input or you believe any information has been misinterpreted, please contact hello@scalecapital.com

We have a duty as early-stage investors in the rapidly evolving Generative AI market, a field projected to reach US$66.62bn by the end of 2024, to constantly refine our understanding and boundaries of knowledge. “Cutting Through the Noise in the Generative AI Landscape as an Early-Stage Investor” represents our early hypothesis in understanding and investing in this field, given our current stance as learners.

With the market size expected to grow at a 20.8% CAGR, resulting in a market volume of $207 billion by 2030 (Statista, 2023) this mini market deep-dive seeks to identify and understand key areas of investment opportunities within the Generative AI tech stack, navigating through prevailing uncertainty and noise.

Introduction to Generative AI

Generative AI, also known as GenAI, is a type of artificial intelligence that specializes in creating new content. According to CB Insights (2023) these models learn by recognizing patterns in the data they are trained on and can then create new data, like text, images, videos, and audio, that is similar to what they’ve learned.

Figure 1. GenAI can create new data such as text, image, video and audio.

To begin with, my approach to understanding this field involved a simple but effective method: taking a blank sheet of paper to note down fundamental high-level questions. These questions were instrumental in demystifying the complexities inherent in this domain.

What is the Difference Between Artificial Intelligence and GenAI?

It can take a considerable amount of time trying to detangle this difference. According to Massachusetts Institute of Technology (2023) “Generative AI can be thought of as a machine-learning model that is trained to create new data, rather than making a prediction about a specific dataset” while Artificial intelligence is “one system that learns to generate more objects that look like the data it was trained on”.

Put simply, AI models mainly utilize supervised learning methods, while Generative AI employs both supervised and unsupervised learning techniques. For example, while traditional AI might rely heavily on labeled datasets to train algorithms, Generative AI can generate new data instances, learning from both structured (labeled) and unstructured (unlabeled) data. This capability, especially using semi-supervised learning methods, enables models to learn from a broader spectrum of data. As a result, they become increasingly proficient over time, acquiring the ability to synthesize and interpret complex patterns that might not be immediately apparent in strictly labeled datasets.

AI models mainly utilize supervised learning methods, while Generative AI employs both supervised and unsupervised learning techniques.

What Technology is Generative AI Built Upon?

Dwelling closer into the technologies that form the foundation of Generative AI, we can see that it is primarily built upon two key technologies.

First, there are Large Language Models (LLMs), like GPT-3. These models read lots of text and learn how to make sentences that make sense, similar to how they can complete the phrase “peanut butter and ____” with “jelly”.

The second technology is Generative Adversarial Networks (GANs). According to MIT (2018) GANs use two models that work against one another: one is trained to produce a specific output (such as an image of a flower), while the other one is designed to distinguish. The first model tries to fool the discriminator and in the process learns how to make more realistic output

Is Generative AI Really That Novel?

The short answer is no. Interestingly, the current era of Generative AI, marked by significant technical advancements, began as early as the 1960s. Its roots can be traced back to machine learning, which emerged in the late 1950s when scientists started using algorithms to generate new data.

A significant early contribution in the field of Natural Language Processing (NLP) was highlighted in Joseph Weizenbaum’s book (1976). Weizenbaum developed ‘Eliza’, one of the first NLP programs, which was a groundbreaking step in the evolution of AI. Later, in the 1990s and 2000s, machine learning underwent a major transformation, spurred by advancements in hardware and increasing data availability. By the 2000s and 2010s, the explosion of data and computational power significantly boosted the feasibility and practicality of deep learning.

Eliza chat.

Why has Generative AI been Booming Just Now?

Based on my current understanding and interpretation, the recent boom in Generative AI can be attributed to three primary reasons, particularly evident when reflecting on the developments over the past five years:

Advancements in GPT Models

An NLP data scientist at KDnuggets (2023) points out, there has been a significant scale-up in GPT models over the last five years, growing approximately 8,500 times from GPT-1 to GPT-4. This is due to improved training data size and quality, data source diversity, training methodologies, and an increase in model parameters.

Surge in Data Availability

Data creation has seen a three-fold increase in the past five years, according to Statista (2023). This burgeoning volume of data serves as a vital resource for training and refining GenAI models. IDC’s global datasphere forecast (2023) suggests a yearly 23% increase in global data creation, growing from 64.2 zettabytes in 2020 to an estimated 181 zettabytes by 2025, a significant rise from the 6.5 zettabytes recorded in 2012. To contextualize, one zettabyte equals approximately a trillion gigabytes.

Investor Activity Surge in Generative AI

According to the Pitchbook analyst report (Q4 2023), the past few years have seen significant growth in the valuations of Generative AI companies. Late-stage companies have experienced a 171.7% increase in median valuations, now averaging around $250 million. Early-stage companies, including pre-seed and seed stages, also show notable valuation growth, with a median of around $14.6 million. This trend reflects increased investor confidence and funding in the Generative AI sector.

Figure 2. Global data volume in zetabytes. Data via International Data Corporation (IDC) industry forecast.

Generative AI Tech-Stack Mapping

At Scale Capital, we delve into the GenAI landscape by closely examining various sub-markets and utilizing insights from experts and recent studies. In our journey, akin to ‘peeling the onion’, we have developed a high-level overview of the GenAI tech-stack, drawing upon the comprehensive tech-stack mapping from experts at A16z (2023).

According to A16z, the GenAI tech-stack can be divided into three overarching layers — the infrastructure layer, the model layer, and the application layer.

Infrastructure Layer

The first layer is composed of providers that supply the necessary infrastructure for running inference workloads and training AI models. This layer can, in turn, be categorized into three overall areas.

  • Hardware Providers
    NVIDIA and Google Drive GPT model advancements, operating in a highly competitive space with long R&D cycles. NVIDIA’s data center GPU sales surged from $3.6 billion in Q4 2022 to a projected $16 billion in Q4 2023 (IoT Analytics, 2023).
  • Cloud Providers
    AWS, Google Cloud, and Azure dominate the cloud infrastructure market with approximately 65% market share (Statista, 2023), though emerging competitors like CoreWeave and Lambda Labs offer alternative solutions.
  • Software Providers
    Offer essential tools and platforms for AI model development, training, and deployment, playing a vital role in the Generative AI ecosystem. This segment experienced significant growth, especially after ChatGPT’s release in late 2022, reaching a market value of $3.0 billion by the end of 2023 (IoT Analytics, 2023).

Model Layer

The second layer enables AI products and applications. It offers both proprietary APIs like Large Language Models and open-source models. This layer is pivotal for AI innovation, providing diverse model access and development approaches, and can be further categorized into two high-level areas.

  • Closed Source Models,
    e.g., OpenAI and DALL-E 2, include confidential codes, algorithms, and training data.
  • Open-Source Models
    e.g., Meta’s Llama and Databricks Dolly 2.0, support collaborative development, allowing for code review and modification by the community.

Application Layer

The third layer merges AI models into end-user products, enhancing user experience. This segment has grown substantially, driven by novel applications across various domains. In 2023, companies in this layer raised over $14 billion, signifying strong market momentum. The layer includes companies focused on domain-specific applications and those offering comprehensive, end-to-end solutions.

  • Application Providers
    GitHub Copilot, Jasper AI, offer B2B or B2C applications, typically utilizing existing AI models rather than proprietary ones. Recently, many new players in this space have struggled to differentiate themselves, mainly due to their reliance on similar AI models like ChatGPT.
  • End-to-end Vertical Applications
    Midjourney and Runway integrate proprietary models for tailored, specialized solutions.
Generative AI tech stack. Application Layer, Modal Layer, Infrastructure Layer
Figure 3. GenAI tech stack. Illustration inspired by A16z.

As Early-Stage Investors, Where Are We Most Likely to Invest?

In our role as early-stage investors delving into the Generative AI tech stack, we have developed a preliminary hypothesis for deal sourcing. Currently, the software infrastructure layer and the end-to-end vertical application layer appear to offer the most attractive investment opportunities (I’ll expand on the reasoning for this later). However, it’s crucial to acknowledge the inherent uncertainty in this rapidly evolving sector. The rapid pace of change means that our current investment strategies could soon be outdated, underscoring this market’s dynamic and unpredictable nature.

Opportunity 1: Software Infrastructure Layer

In the software infrastructure layer, the market is less dominated by large players, presenting a unique opportunity in its fragmented state. This area is ripe for innovative companies to address unmet needs. However, entering this sector requires significant capital for technological development.

At Scale Capital, we assess long-term viability by focusing on the team and technology behind startups. Patience is key, as overcoming entry barriers can eventually lead to market stability. Rapid technological evolution remains a risk, necessitating a strategy that diversifies investments and stays adaptable to emerging trends. Our goal is to identify companies that offer substantial value, ensuring their long-term defensibility and customer loyalty.

Opportunity 2: End-to-end Vertical Application Layer

In the end-to-end vertical application layer, significant growth driven by diverse use-cases is noteworthy. Companies integrating proprietary models with applications, utilizing unique data for value-adds and AI enhancement, are particularly interesting. These companies stand out by continually refining user experiences and keeping technology in-house, which is key for long-term market success.

Challenges include high development costs, lengthy R&D, and effective data management. At Scale Capital, we mitigate these risks by focusing on companies with clear monetization strategies, strong data infrastructure, and a culture of innovation, essential for maintaining competitive advantage.

Our current lens, when looking for companies in the Generative AI landscape, focuses on end-to-end vertical application solutions and software infrastructure solutions.

Final Remarks

As an early-stage investor, effectively cutting through the noise is about being well-informed on technological advancements and trends. Though early in my VC career, I’ve learned the importance of not being swept away by every innovative idea within the field. Focusing our energy efficiently is key to identifying tomorrow’s leaders, especially those expanding from Europe to the US market.

At Scale Capital, our current lens when looking for companies in the Generative AI landscape focuses on end-to-end vertical application solutions and software infrastructure solutions. Still, we remain open to adapting our approach as the market evolves. The landscape is dynamic, and while we prioritize certain tech stack areas, we’re always ready to explore emerging opportunities, adapting as new layers of the ‘onion’ unfold and shape the future of sustainable business development.

To investors venturing into the generative AI space, we invite your insights and perspectives. If you’ve developed a hypothesis for deal-seeking within the technology stack that aligns or diverges from ours, your expertise and viewpoints are invaluable. Please feel free to connect with us and share your thoughts.

To entrepreneurs navigating the burgeoning field of generative AI, seeking to align with investor expectations: we welcome your outreach. If you are exploring how certain areas within this domain may attract funding more readily, or if you have a venture in this sphere seeking investors adept in scaling operations to the US market, reach out to us, and let’s talk, exchange ideas and insights.

Read also
Generative AI Chronicle: Q1 2024 Insights
AI Will Change the World More Than the Internet Ever Did

About
Sofia Svanqvist
Sofia is part of the investment team based in Copenhagen and is responsible for accelerating the fund’s presence in Sweden. She is an operator, explorer, dog lover and foodie at heart with a flair for staying updated about new topics in the field of Data Analytics, Automation and AI.
Scale Capital
Scale Capital a Danish venture fund investing in digitization and disruptive technologies within B2B. €1–3M in Nordic and German B2B tech startups at Seed and Series A, and helping them win in the US. Scale is headquartered in Copenhagen with a presence in the Nordic countries and Silicon Valley.