The annualized method that artificial intelligence startups in Silicon Valley have adopted to measure revenue is drawing scrutiny as some of them prepare to go public. The startup industry argues the approach is unavoidable if companies want to show growth, but critics say it can overstate actual performance. Anthropic and OpenAI have also used this method to convince investors of their growth, and the practice is likely to be tested as they move toward listings.
Business Insider reported on the 8th that AI startups are increasingly interpreting or distorting revenue metrics at their own discretion, a phenomenon known as revenue inflation. The measure AI startups typically use is annual recurring revenue, or ARR, which estimates a full year of performance based on revenue expected to repeat under subscription contracts signed with customers. It is used mainly by software companies.
The problem is that AI startups charge not only monthly subscription fees but also usage-based fees tied to tokens or hours of use. In OpenAI's case, ChatGPT subscription fees, which are set monthly for individual customers, can be counted as recurring revenue. But revenue from usage-based application programming interface, or API, fees, which are mainly used by corporate and developer customers, and revenue from its advertising business are difficult to calculate as recurring.
As a result, a growing number of AI startups are applying the run rate method, which projects a full year of performance based on results from a specific period. The approach varies by company. OpenAI calculates ARR based on subscription revenue while measuring its newly launched advertising business on a run rate basis. Anthropic, by contrast, applies run rate to its entire revenue.
Some startups, however, are abusing the method by announcing run rate figures based on a month in which they posted what amounts to a one-off revenue spike, distorting their performance. Akshay Nariseti, chief executive of Pocket, a maker of AI recording devices, said there is no guarantee that a sudden jump in revenue will continue for a full year.
OpenAI and Anthropic, the most prominent AI startups, are no exception. OpenAI calculates ARR based on subscription revenue while measuring its newly launched advertising business on a run rate basis. Anthropic applies run rate to its entire revenue.
Some companies have gone further and simply padded their revenue figures. Roy Lee, chief executive of AI startup Cluely, told media last year that the company's ARR was $7 million (about 9.4 billion won). After the claim drew controversy, Lee acknowledged eight months later that the statement had been blatantly dishonest and that the actual figure was $5.2 million. But when startup executives are pressed about figures that appear inflated, they often respond with the excuse that everyone else does the same thing, Business Insider said.
In the venture capital industry, some are warning, with a note of self-deprecation, that such unethical behavior by startups mirrors market conditions in late 2021, when the venture bubble was at its peak.
