Tech giants like Google and Meta are positioned to offer their premium AI models for free, leveraging their massive ad-based business models. This strategy aims to cut off OpenAI's primary revenue stream from $20/month subscriptions. For incumbents, subsidizing AI is a strategic play to acquire users and boost market capitalization.

When evaluating AI companies, focus on customer love (gross retention) and efficient acquisition over gross margins. High margins are less critical initially, as the 99%+ decline in model input costs suggests a clear path to future profitability if the core product is sticky.

Rabois argues that unlike foundational model or infrastructure plays, AI application startups shouldn't need to burn cash on compute. He believes they should be able to pass these costs through to customers and demonstrate healthy unit economics immediately.

The compute-heavy nature of AI makes traditional 80%+ SaaS gross margins impossible. Companies should embrace lower margins as proof of user adoption and value delivery. This strategy mirrors the successful on-premise to cloud transition, which ultimately drove massive growth for companies like Microsoft.

Counterintuitively, very high gross margins in a company pitching itself as "AI" can be a warning sign. It may indicate that users aren't engaging with the core, computationally expensive AI features. Lower margins can signal genuine, heavy usage of the core AI product.

New AI companies reframe their P&L by viewing inference costs not as a COGS liability but as a sales and marketing investment. By building the best possible agent, the product itself becomes the primary driver of growth, allowing them to operate with lean go-to-market teams.

In rapidly evolving AI markets, founders should prioritize user acquisition and market share over achieving positive unit economics. The core assumption is that underlying model costs will decrease exponentially, making current negative margins an acceptable short-term trade-off for long-term growth.

Unlike SaaS, where high gross margins are key, an AI company with very high margins likely isn't seeing significant use of its core AI features. Low margins signal that customers are actively using compute-intensive products, a positive early indicator.

Contrary to traditional software evaluation, Andreessen Horowitz now questions AI companies that present high, SaaS-like gross margins. This often indicates a critical flaw: customers are not engaging with the costly, core AI features. Low margins, in this context, can be a positive signal of genuine product usage and value delivery.