VCs Bet on AI to Remake Service Industries, Face "Workslop"
Venture capitalists are increasingly betting on a new strategy: leveraging artificial intelligence to achieve software-like profit margins in service-oriented businesses. This approach involves acquiring established professional service firms, integrating AI to automate tasks, and then utilizing the increased cash flow to consolidate more companies within the sector.
General Catalyst (GC) is a leading proponent of this strategy. The firm has allocated $1.5 billion from its latest fund to incubate AI-driven software companies in specific industries. These companies then serve as acquisition vehicles, acquiring established firms and their client bases in the same sectors. GC has invested in seven sectors, including legal services and IT management, with plans to expand to 20 industries.
GC believes the potential is significant. Marc Bhargava of GC noted that the global services market generates far more revenue than the software market. The attraction of software investing lies in its high profit margins due to the low cost of scaling. By automating service businesses with AI, particularly in areas like call centers, the profit potential becomes extremely appealing. The increased cash flow from automation enables these companies to acquire competitors at prices traditional buyers can't match, creating a powerful growth cycle.
One example is Titan MSP, a GC portfolio company. The firm invested $74 million to develop AI tools for managed service providers (MSPs). Titan then acquired RFA, an IT services firm. Pilot programs demonstrated that Titan could automate a significant portion of MSP tasks. The company aims to use its enhanced margins to acquire additional MSPs. Similarly, Eudia, another GC incubation, focuses on in-house legal departments. It has attracted Fortune 100 clients by offering fixed-fee legal services powered by AI. Eudia recently acquired Johnson Hanna to expand its service offerings. GC aims to at least double the EBITDA margin of acquired companies.
Mayfield is another venture firm pursuing this strategy, allocating $100 million for "AI teammate" investments. They invested in Gruve, an IT consulting startup that acquired a security consulting company and significantly increased its revenue while achieving an 80% gross margin. Solo investor Elad Gil has been backing similar companies for three years.
However, there are challenges. A study revealed that a significant percentage of employees are burdened with "workslop" – AI-generated work that requires substantial corrections, leading to lost productivity and financial costs.
Bhargava acknowledges the difficulty of integrating AI into existing businesses. He believes the technical expertise required is a key differentiator and a reason why GC's approach of combining AI specialists with industry experts is effective.
The issue of "workslop" poses a threat to the economics of this strategy. If companies reduce staff to leverage AI efficiencies, fewer employees are available to correct AI errors. Maintaining current staffing levels to address AI-related issues could negate the anticipated margin gains.
Despite these concerns, many investors remain optimistic. General Catalyst claims that its "creation strategy" companies are already profitable due to acquiring businesses with existing cash flow. They believe that continued advancements in AI technology will unlock more opportunities for companies to incubate and transform businesses.
