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AI share plus market share
The AI score
In software, a company with 20 percent growth and a 20 percent operating margin scores 40, which is good. In the AI version, a company with 30 percent of its sales from AI and a 30 percent market share in that category scores 60. A company at 60 has exposure to AI and a strong market position.
Software scores low
Software companies score low on this measure, since AI is only 1 or 2 percent of their sales at this stage. Salesforce has $40 billion in sales, so its AI revenue is small against a huge base, and even if AI starts to work for it, that takes a while.
Rate of change
Rate of change matters too. In a 2024 presentation that listed everybody's market share, Claude was asked to plot the numbers and got it wrong, because it missed the rate of change. When a company goes from 10 percent to 30 percent, its growth rate accelerates and its margins accelerate.
Where did the rule of 40 come from?
The rule spread through software investing in the early 2010s and was written up by venture capitalist Brad Feld in 2015. It says a healthy software company's growth rate plus its profit margin should reach 40 percent. A fast-growing company can spend heavily and still pass, and a slow grower passes by being very profitable. Public-market investors now use it to compare software companies.
Why do chip margins rise with volume?
Designing a chip and making its photomasks are fixed costs that must be paid no matter how many chips ship. Selling more units spreads that cost across each one. Economists call this operating leverage. A company with large fixed costs sees profit grow faster than sales once volume climbs.
Why does the rate of change matter on an S-curve?
On a logistic S-curve, growth is steepest at the midpoint and slows after it. A snapshot of 30 percent share cannot tell a company rising fast from one that has stalled, so analysts look at how share changes from period to period. The logistic function was introduced by Pierre François Verhulst in the 1830s to model population growth.
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