How OpenAI's Former Board Inadvertently Created a New Competitor Inside its Patron
How OpenAI's Former Board Inadvertently Created a New Competitor Inside its Patron
Details of an unusual deal that is part acquihire, part partnership
Microsoft CEO Satya Nadella published a blog post this week stating that Mustafa Suleyman and Karén Simonyan, two of Inflection AI's three co-founders, will join Microsoft to lead a newly created organization, Microsoft AI. According to Nadella:
Mustafa Suleyman and Karén Simonyan are joining Microsoft to form a new organization called Microsoft AI, focused on advancing Copilot and our other consumer AI products and research. Mustafa will be EVP and CEO, Microsoft AI, and joins the senior leadership team (SLT), reporting to me. Karén is joining this group as Chief Scientist, reporting to Mustafa.
According to Forbes:
An unspecified number of engineers and researchers are also departing Infection to help create the group. Most of Inflection’s 70 employees are among that number, a source with knowledge told Forbes.
An Unusual Deal
Many aspects of this announcement are unusual. An entire team of around 70 people departing for another company with no acquisition or equity exchange is unusual. The fact that they were departing for a company that was an earlier investor in the startup is also unusual, as is the fact that one of the co-founders of the start-up is on the board of the company taking on the employees. In addition, Inflection just made a new product launch that suggests it may have established some technical momentum even if market momentum remains elusive. It also has raised a lot of venture funding.
Inflection AI raised $225 million in May 2022 and another $1.3 billion in June 2023. The company is unlikely to have spent all $1.5 billion over the past year. It new Inflection 2.5 model was launched with claims rivals GPT-4 across several public benchmarks.
Inflection also reported six million monthly active users on its Pi personal assistant. Synthedia noted this is not a particularly strong adoption rate compared to ChatGPT or Perplexity. Still, the figure indicated clear progress and was accompanied by users averaging an impressive 33-minute session length.
Many other startups would see Inflection 2.5’s performance and Pi’s user adoption as positive signs. What is going on here?
The Deal
The Information reported that the deal is offering earlier investors a modest return along with the ability to retain their equity. A large licensing deal will soften the blow for investors along with an expected return of capital for unspent funds from last year’s $1.3 billion round.
The software giant has agreed to pay Inflection approximately $650 million, mostly in the form of a licensing deal that makes Inflection’s models available for sale on the software giant’s Azure cloud service, according to a person involved in the transaction. The startup is using the licensing fee to help provide its investors with a modest return on their capital, according to a second person who was briefed on the arrangement.
…
To cushion the blow for its investors, Inflection has promised to pay them more than the value of their original investment while allowing them to retain equity in the startup…
Investors in the company’s first major round of funding, a $225 million investment from venture firm Greylock, hedge fund Dragoneer Investment Group and others, will receive one and a half times their investment, according to the person involved in the deal. Investors in a subsequent $1.3 billion funding round last year will receive 1.1 times their investment, the person said. Microsoft invested in both rounds, but the vast majority of the funding came from other investors such as former Microsoft CEO Bill Gates, former Google CEO Eric Schmidt, Nvidia and Inflection co-founder Reid Hoffman, which together led the later round.
The Ultimate Insider
Microsoft has become the ultimate insider in generative AI, and that was particularly true in this deal. It was an investor already in the company. Reid Hoffman, a Microsoft board member, is an Inflection co-founder and sold LinkedIn to the company. He is also a former parter at venture capital firm Sequoia, which led the earlier funding round with NVIDIA.
Microsoft has undoubtedly benefited greatly from its tie-up with OpenAI. According to IoT Analytics, the arrangement netted Microsoft Azure a 30% market share in the generative AI foundation model segment as of December 2023. That is double the combined market share of its primary rivals, AWS and Google Cloud. Azure’s market share is largely driven by its exclusive access to OpenAI’s models among cloud providers.
Developers and enterprises can access OpenAI models directly from OpenAI or Azure. Many choose the Azure OpenAI Service because of its reliability, scalability, and backing by Microsoft. Azure trails only OpenAI in terms of generative AI model market share.
Similarly, OpenAI has greatly benefited from the Microsoft arrangement. In 2023, Microsoft invested a reported $10 billion for a 49% ownership stake, following earlier investments totaling more than $1 billion. The availability of OpenAI through a trusted cloud hyperscaler made it easier for many enterprises to adopt since they could avoid the hassle of validating OpenAI’s security and scalability capabilities. It has been a win-win for the companies, but that does not mean Redmond is betting on the status quo.
The Persistance of an Idea
Was OpenAI responsible for this development? Probably. Microsoft was moving ahead with its partnering strategy led by its exclusive OpenAI relationship despite having invested more than $10 billion in internal efforts. However, after Sam Altman was fired by OpenAI’s board and negotiations broke down to bring him back, Satya Nadella announced on X that Altman and OpenAI’s President, Greg Brockman, would be joining Microsoft to head a new AI division.
Following that post, Microsoft reportedly converted existing office space in San Francisco to house as many as 700 OpenAI employees that were expected to follow Alman and Brockman to Microsoft. Two days later, OpenAI announced that Altman and Brockman would return to the company and Nadella graciously offered his support to the company after it had also appointed two new board members removed three others and offered Microsoft a board observer seat.
Nadella was a “steady hand” during the crisis and ready to support a return to normalcy or embark on a new path despite the $10 billion the company had invested earlier in 2023. However, he almost had two of the leading figures in generative AI join Microsoft along with hundreds of experienced engineers.
Microsoft had a lot to lose from an implosion of OpenAI and the near catastrophe certainly left a lasting impression. In addition, Nadella had planned to set up a “new advanced AI research team.” That meant he had a plan in place that could be executed at a later date with other high-profile AI industry leaders.
Inflection AI models will now compete side-by-side with OpenAI models within Azure. Nadella reiterated this week that OpenAI is the company’s “most strategic and important partnership.” Still, the loyalties are now divided and executives inside the company were the creators of the OpenAI alternative. Inflection had very little momentum for foundation model access. It now has new life and influential allies inside of Microsoft leading making daily decisions about AI research.
This was less likely to happen if the idea had not already been formulated. It would seem like too much of a distraction and redundant given the momentum of Microsoft’s OpenAI partnership in early November 2023. However, the idea was fomulated and Microsoft was offered an important reminder that mitigating vendor risk is important for strategy product offerings.
The Inflection deal is also something of a perfect storm. Bill Gates was a big investor. Microsoft board member Reid Hoffman is a co-founder of Inflection AI. Microsoft was willing to infuse a significant amount of cash into Inflection to pay off investor and allow them to keep their equity. With that said, the likelihood of this happening without the OpenAI meltdown of November 2023 was very low. OpenAI created this opportunity for Inflection and their own competitor.
It may not matter much to OpenAI given its tremendous market momentum and what looks like a technology lead will endure with another model release. It will matter a lot to Microsoft. It is now carving out its own path in generative AI with OpenAI as a pillar, but not the only pillar.
A bigger loser in this deal may be CoreWeave. Inflection previously trained its models on the specialty AI cloud computing provider. It appears likely that Azure will be the first stop for AI training workloads going forward.
"It may not matter much to OpenAI given its tremendous market momentum and what looks like a technology lead will endure with another model release. It will matter a lot to Microsoft. It is now carving out its own path in generative AI with OpenAI as a pillar, but not the only pillar."
Well put. I wonder if the internal devision, led by Suleyman, will be focusing on improving the core products more than leading the research inside Microsoft. Inflection has shown it can do it, with their models. But with OpenAI's technology becoming instantly available to Microsoft, due to the nature of their partnership, I wonder if Microsoft feels the need to match on that front and really push the frontier in-house in parallel. I also don't see Microsoft's Copilot products ran on Inflection models anytime soon.