Nvidia‘s (NASDAQ: NVDA) dominance has created a difficult problem for competitors, however building an artificial intelligence (AI) chip is no longer enough to compete. Even if a rival develops a faster processor at a lower price — already very difficult — it still faces a much bigger challenge: convincing developers to leave Nvidia’s ecosystem.
That’s because Nvidia’s most important product may not be a chip at all. It is the software platform that sits behind it. Understanding those differences can help investors better understand why Nvidia continues to dominate the AI market.
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Investors may be thinking about Nvidia the wrong way.
Most investors view Nvidia as a semiconductor company. That makes sense. The company’s graphics processing units, or GPUs, have become workhorses powering everything from ChatGPT to self-driving technology. But focusing only on hardware risks misses the bigger picture.
A useful comparison might be an apple. People don’t buy iPhones just for the hardware. They buy into an ecosystem of apps, software, services, and tools that work together seamlessly. The ecosystem is what keeps users coming back.
Increasingly, Nvidia seems to be following the same playbook.
CUDA is Nvidia’s hidden tunnel
At the heart of Nvidia’s ecosystem is a software platform called CUDA.
Most consumers have never heard of it. Yet CUDA may be one of the most important assets in the entire field of AI.
CUDA allows developers to write software that runs efficiently on Nvidia hardware. Over the past two decades, researchers, engineers, universities, and technology companies have developed dozens of AI-based tools.
Surprisingly, many of the most advanced AI applications in the world today are developed for the Nvidia platform. That’s an important point to note, because developers rarely want to rebuild years of work from scratch.
The result is a powerful network effect. When developers use CUDA, the ecosystem becomes more valuable. And the more valuable the ecosystem becomes, the more attractive Nvidia hardware becomes. And that convinces many developers that CUDA software is essential to their work.
The result of this vicious cycle is the ever-increasing switching costs for customers.
Why can’t competitors beat Nvidia, even with a better chip?
Consider that the company has spent years building AI models using Nvidia’s software tools. Its engineers understand the platform. It organizes its workflow around Nvidia hardware, and its applications work within the Nvidia ecosystem.
Now imagine a competitor introducing a slightly faster or slightly cheaper chip. Moving from Nvidia is more difficult than comparing chip specifications. The company may need to retrain engineers, rewrite software, test applications, and potentially accept disruptions along the way. In other words, customers are choosing between ecosystems, not just chips.
And that may explain why Nvidia continues to grow rapidly and generate huge profit margins, even as competitors struggle to gain share. In the most recent quarter, revenue nearly doubled from $44 billion to $82 billion, while margin grew from 61% to 75%!
There is a risk that investors should not ignore
Of course, no competitive advantage lasts forever. The world’s biggest tech companies are investing billions of dollars in alternative AI platforms and software platforms.
For example, OpenAI works with AMD although it is Nvidia’s biggest customer. Amazon again Alphabets produce their own custom chips (Trainium and TPU). These are different strategies, but they all aim to create market alternatives.
If developers finally embrace competing ecosystems, Nvidia’s profits may shrink over time. For now, the company’s software lead remains one of its strongest assets.
What does it mean for investors?
Most investors think that Nvidia dominates AI because it makes the best chips in the world. There is certainly some truth to that. But the bigger story may be the ecosystem Nvidia has quietly built around those chips. The real moat of the company is very similar to the ecosystem that makes Apple, Microsoftand Amazon to achieve permanent leadership positions.
Hardware may attract headlines. However, Nvidia’s software platform may be the reason the company stays ahead in the coming years.
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Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Advanced Micro Devices, Alphabet, Amazon, Apple, Microsoft, and Nvidia. The Motley Fool has a policy of disclosure.
Nvidia’s Most Important Product Isn’t a Chip. This is it. was first published by The Motley Fool
