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NVIDIA’s Competitive Structure May Be More Fragile Than Its Valuation Implies

Advances in artificial intelligence have created an AI gold rush, and one company—NVIDIA—supplies the necessary picks and shovels. With a dominant position in a fast-growing market, shares of NVIDIA have soared. However, NVIDIA’s competitive advantage may be more fragile than its stock price indicates.

At Harding Loevner, we believe that whether a business thrives largely depends on the competitive structure of its industry, which we evaluate using Michael Porter’s Five Forces framework. NVIDIA has an estimated 95% share of the market for AI chips. Its graphics processing units (GPUs), which were originally used to power video games, have been adapted to become the key engine of AI computation. The customer base for these chips is highly concentrated and primarily consists of “hyperscalers”—companies such as Alphabet,, Meta, and Microsoft that operate large networks of data centers with immense computing power and storage needs. More than half of NVIDIA’s data-center revenue for its fiscal quarter that ended in January came from large cloud-services providers, and one company alone accounted for 19% of last year’s total company revenue.

From the Porter perspective, a key factor in the bargaining power of buyers is their ability to backward integrate. All of the aforementioned customers have this capability, which threatens to diminish their reliance on NVIDIA. In our view, it’s only a matter of time before this manifests. In fact, Amazon, Google, and Microsoft each have unveiled custom data-center chips as potential substitutes for NVIDIA’s general-purpose GPUs. Because each server in a data center performs only a few specific functions that are repeated over and over, these custom chips, called application-specific integrated circuits (ASICs), are tailored to just the tasks the companies need them to perform.

Industry rivalry is also likely to increase. As the frenzied pace of spending on AI infrastructure eventually eases, companies will begin to look for less expensive options from new suppliers, which may include NVIDIA’s own customers.

NVIDIA is a high-quality company led by skillful managers. Its revenue more than doubled over the past fiscal year, and net profit rose fivefold. But the high potential for increased rivalry and backward integration among key customers suggest that it is unlikely NVIDIA can continue growing at these rates with these margins while maintaining its grip on 95% of the AI-chip market. The fragility of its competitive structure limits our valuation tolerance, which is why we exited the stock in the first quarter after holding it for more than five years.

While it is possible that NVIDIA will continue to exceed increasingly aggressive consensus earnings forecasts for some time, we own other more attractively priced businesses that allow us to invest in AI’s potential. For example, Microsoft and other providers of software and services have the advantage of being able to monetize generative-AI technology without regard for whose GPUs or ASICs are used in the future. Microsoft’s customers also don’t appear to have the ability or interest to try to backward integrate; in fact, AI functionality such as its Copilot chatbot are helping to lock in users. In general, as the applications for AI evolve, value is likely to shift from hardware, such as NVIDIA’s GPUs, to the software and services built upon this infrastructure.

Read more about our software and services holdings in the first quarter Global Equity report.

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Chips of the Trade: TSMC, Samsung Benefit from AI Demand

In international markets, a big theme of investor interest relates to companies developing the underlying technology that powers AI. This includes the designers and manufacturers of the advanced semiconductors necessary to run AI, as well as producers of semiconductor manufacturing equipment and providers of the critical computing infrastructure required by AI systems.

Expectations are that semiconductor industry revenue growth will accelerate to annualized double-digit levels this decade, spurred by demand for AI chips. This would be a growth rate well above levels that we’ve seen since the mid-1990s, with predictions that the roughly US$50 billion dollars of AI chips sold in 2023 could rise to US$400 billion dollars of sales before the end of the decade.

Analyzing Industry Structure through Porter’s Five Forces Model

As bottom-up investors, we aim to invest in high-quality growth businesses at reasonable prices to provide superior risk-adjusted returns over the long term. To determine what constitutes a high-quality growth business, we research a company’s management, financial strength, growth prospects, and we closely examine the industry in which it operates to determine the company’s competitive advantage.

It’s as important to examine a company’s industry as it is to examine the fundamentals of a company. An analysis of industry structure can inform how well-positioned a company is relative to competitors, as well as the profit potential for the company.

Our analysis is guided by Harvard University professor Michael Porter’s Five Forces, which were first introduced in a 1979 issue of Harvard Business Review and later detailed in his 1980 book, Competitive Strategy: Techniques for Analyzing Industries and Competitors.

In this six-part video series, we examine each Porter Force and discuss how we use them to analyze industries. Watch the series introduction below and click through to see how we leverage Michael Porter’s Five Forces framework for industry analysis.

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NVIDIA and the Cautionary Tale of Cisco Systems

NVIDIA, the giant semiconductor company founded by Taiwanese American Jensen Huang, seems invincible these days. Annual revenue has more than doubled since 2020. Its stock price has more than doubled this year and is up more than 700% over the past five years. It is one of the rare trillion-dollar market-cap companies.