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How the economic downturn is affecting the AI sector

Enterprise budget cutting is slowing AI projects. Vendors may not feel the impact now but likely won't be spared. Meanwhile, venture capitalists have cut back investments.

Amid an economic downturn, recession fears and inflation that is buffeting the stock market, the future of AI software vendors is uncertain.

Big and small technology companies alike are feeling the effects. In July, both Microsoft and Google's parent company, Alphabet Inc., missed their goals on their quarterly financial reports. Alphabet reported its slowest quarterly growth in two years, while Microsoft failed to meet Wall Street expectations for its income and revenue.

In May, independent AI vendor DataRobot laid off about 7% of its workforce even though the vendor raised $300 million last year.

Argo AI, the autonomous vehicle startup that has a partnership with Volkswagen and Ford, laid off about 150 employees in July.

AI and the downturn

A difference between this economic downturn and previous recessions and bear markets is that AI and automation are now an integral part of the economy. And many enterprises see AI as a tool to survive the slowdown, said Kashyap Kompella, analyst at RPA2AI Research.

"In a slowdown, organizations look to optimize cost and increase efficiency, and AI and automation can help do both," he said.

This does not mean the AI sector is not being hurt, but most organizations already have plans to combat the slowdown.

Enterprises, technology vendors and venture capitalists all have their playbooks and strategies for a slowdown.
Kashyap KompellaAnalyst, RPA2AI Research

"Enterprises, technology vendors and venture capitalists all have their playbooks and strategies for a slowdown," Kompella said.

Many enterprises are starting to cut their budgets for next year. This will likely put the brakes on new AI projects, hiring and technology procurement.

"For any large enterprise, their AI portfolio consists of projects in different stages -- from the lab stage to ready-to-deploy stage," Kompella said. "Experimental AI projects will go on the back burner now."

The effect on vendors

The impact of the economic slowdown for vendors depends on the type of vendor. Some large technology companies, including Google, have frozen nonessential hiring.

However, some vendors have yet to feel the impact of the economic slowdown.

Pecan AI, a vendor that provides a deep learning platform designed to build predictive models for enterprises, has raised about $100 million in the past year. The Israel-based company raised $66 million in its last funding round in February.

"We feel there's a change of sort; everybody feels it around," said Noam Brezis, co-founder and CTO at Pecan. "At the moment, this is just not relevant for Pecan."

The vendor said it has already budgeted its plans for the year, and so it does not expect the economic downturn to slow its hiring or R&D efforts.

It is not surprising that some vendors have not yet experienced the impact of the economic slowdown, especially if their fiscal year starts later or if they already signed contracts with enterprises, Kompella said.

"But what happens after those contracts run their course?" he continued. "So, even though companies have already allocated budgets, they see these gathering clouds on the horizon."

VCs feel it too

Venture capitalists are also watching the market closely and changing the process they use to determine the type of companies that they want to invest in, Kompella said. The process has now become stricter and longer.

"It's taking much longer to cut checks," Kompella said.

Usually when venture capitalists want to invest in a startup, they look at the product and the potential customers and how much the startup has raised in the past. After examining all these factors, they give the startup a term sheet that states how much they plan on investing and how much money is at stake. Usually, the process takes about a few weeks, but now, it is taking months, which means many startups are unable to fundraise as quickly as they want to.

Pile of money
Venture capitalists will become stricter when considering AI companies they want to invest in.

Venture capital firm IVP invests heavily in tech companies, including AI vendors.

The firm, which has invested in more than 400 companies since 1980, said its investment philosophy for AI has not changed despite the changing economic markets. IVP said it will continue to invest in the best new AI products and teams that find strong customer bases and commercial adoption.

"While the public markets … have shifted in the past few months, our conviction holds that the leading-edge AI companies of the next decade are being built today," IVP partner Karthik Ramakrishnan said.

Hope for the future

As organizations make changes due to the economic downturn, some AI projects will pause, yet there is hope for many AI projects.

"A year to a year and a half is a lifetime in the AI world," Kompella said.

The next generation of AI technologies will emerge in the next few years, even during turbulent economic times.

"There's already greater enthusiasm coming out of the recession to adopt those next-generation AI technologies," such as large language models, which show no sign of slowing in terms of technological advancement, Kompella said.

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