Last week’s piece discussed a way to think about Artificial Intelligence (AI) as a mechanism for advancing knowledge quicker from vexatious mysteries to ubiquitous heuristics. In this week’s Playing to Win/ Practitioner Insights piece,

I am turning to a way for companies to think about their investments in AI, which is important because they are all investing aggressively in the domain. It is called Investment Strategy & Artificial Intelligence: Horizontality vs Verticality.Wasted InvestmentWhen anything arrives new on the scene in the world of business, vast sums of capital will inevitably be wasted because it starts as a mystery — which, as discussed last week, is at the top of the Knowledge Funnel. A knowledge domain is a mystery when we don’t yet know how to think about it. AI is a mystery because we don’t know how it is going to play out and are just starting to figure out how to think about it (the subject of last week’s piece). When it is exciting and new, a business mystery is a flame to which capital moths are drawn.For example, automotive OEMs are completely wasting billions of dollars in autonomous vehicles because it is the exciting new thing. Ford invested $1 billion in Argo because autonomous vehicles were ‘the future’ and Volkswagen bought into Argo at $2.6 billion.

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hen in 2022, when they figured out it was a black hole, they shut it down five years after the first investment (the shutdown was a wise decision, by the way). Microsoft and LG wasted many billions on smartphones when ‘you had to be in smartphones.’This is not new. Investors wasted billions (in current dollars) in the early days of rail transportation and automobile manufacturing. Most recently, billions were tossed away in the early days of the Internet. So, it always happens. When the new new thing comes along, vast sums will be wasted because if you aren’t willing to invest, you can get left behind — FOMO in spades!The real enemy is not inevitable waste; it is avoidable waste. I really hate pissing capital down the toilet when there is no chance of it ever producing a positive outcome.The Context for AITo have a chance to identify avoidable waste in AI spending, it is important to understand the context for AI. It is part of the high-fixed-cost world of modern tech, as I have written about before. In modern tech, especially in software and Internet services, the cost of producing and selling an incremental unit is zero or close to it. These are businesses dominated by their fixed costs.

The company spends often an enormous amount on creating the first unit of its product — working software — and subsequent variable costs are miniscule.This means that scale is an imperative. The greater the scale, the more broadly the fixed costs are spread and the lower the overall cost position of the company’s offering. That is the encouraging side of scale dynamics. The intimidating side is that in the definable domain in which you compete, if you don’t have the greatest scale, you will have a cost disadvantage to any company that does.Then the only way to survive competitively is for your offering to be demonstrably superior to competitors in the eyes of your customers. But that is hard to do because you will have fewer resources to spend on your differentiation because your underlying cost position is inferior.Apple iPhone provides an excellent lesson on this front. Apple’s iPhone business is legendarily successful. But how could it be? It was never the market share leader in smartphones until 2023, sixteen years after its release. Samsung had #1 market share for the previous twelve years. And it categorically lost the operating system battle to Android, with iOS facing a 71% to 28% deficit at last count. Shouldn’t have Samsung and Android been able to spread their fixed costs wider and crush iPhone?No. It is because fixed costs are both incurred in and spread across dollars — that is revenue dollars, not unit sales.

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