Why Does PE in AI Phase Switch Toward Winner-Take-All?

How Have We Seen Other Industries Evolve?

In many industries, we have observed a natural progression toward market concentration, where a few major players dominate. For example, the tech industry has seen this trend play out in digital advertising, where companies like Google and Facebook captured the majority of the market share by leveraging user data at scale.

Similarly, industries like e-commerce (with Amazon) and social media (with Meta) have followed a similar winner-take-all path. On the other hand, sectors like banking and healthcare have remained relatively fragmented due to regulatory hurdles and localized needs.

What Are the Reasons These Industries Have Gone One Way or the Other?

Source: NFX VC Firm (adopted from Hamilton Helmer)

The key factors driving industries toward a winner-take-all dynamic typically include network effects, economies of scale, and high barriers to entry. For tech giants like Google and Facebook, network effects ensured that more users brought in even more users, reinforcing their position as market leaders. Economies of scale allowed companies like Amazon to cut costs and dominate through operational efficiency, pushing smaller players out of the market. On the flip side, industries like banking have stayed fragmented due to regulatory barriers, localized preferences, and limitations on scalability, making it harder for one entity to capture the entire market.

What Are the Reasons to Believe This Will Occur in a Similar Fashion?

Where is PE Today?

I believe Private Equity in its current form is rather commoditized. Unlike other industries like technology, where you see Google holding large market share, Private Equity leaders need to fight every day to maintain share of returns. 

In the 1980s many of the Private Equity concepts were new and barely replicated. By 2020 there is a lot of marketing energy and lip-service into proprietary deal flow and unique value levers. I would argue this is more marketing than reality for the following reasons:

1. Top consulting firms are concentrated and their playbooks have been shared widely among firms¹

2. The firms themselves have had multiple generations of leadership leave and go start their own firms

3. Regional competitive advantages etc. have decreased as a result of technology allowing firm penetration globally

This is not to say there aren't pockets of alpha, this is to say the reality is likely far closer to commoditization than concentrated defensible value propositions. The data bears this out.

Fat tails in private equity fund returns: The smooth double Pareto distribution https://doi.org/10.1016/j.irfa.2022.102471

Competition Is for Losers. If you want to create and capture lasting value, look to build a monopoly

Peter Thiel

How will PE Market Share Change with AI?

I believe PE will become much more “winner take all” in the future. The reasons for this are:

1. Alpha Generation - Future firms will replace humans with AI for cost reduction and revenue increase

2. Forecast Alpha - The firm that can most accurately model its alpha generation under AI will be able to afford to pay the most for purchase (smallest risk error bars during underwriting)

3. Data Moat - The firm that can afford to purchase the most will inevitably collect the most data

4. Size Flywheel - The firm with the most data, will have the best AI models, which will further solidify its moat

In the case of AI, there are multiple indicators that it will follow a winner-take-all trajectory. First, data accumulation and processing are crucial to AI. The more data a firm has, the more capable its AI becomes. This creates a natural feedback loop similar to network effects in social media. Companies that accumulate large data sets can train better models, leading to superior AI systems, which in turn attracts more users or clients. Second, scale advantages in computing resources and R&D spending mean that the firms with the most capital are more likely to sustain technological advancements that are critical for market dominance.

Think this is theory? Look under the hood of Google. The company effectively rolled up the entire advertising market using this strategy.

Bottom Line: The firms that understand the different components of this and can make intelligent bets now will dominate in a winner take all market².

1. I bring up consulting firms because I view them as somewhat “upstream” on the knowledge management value chain portion of the private equity firm.

2. To be clear: I am not saying this ends with one and only firm. In fact, there will likely be one or two leaders by industry area. That said, this will be an order of magnitude change from the current world (similar to retail pre and post Walmart)