AI is reshaping how companies allocate software budgets, creating potential gains for Microsoft, Palantir and Snowflake while putting Adobe and smaller application-software vendors under pressure, Citi co-head of U.S. software equity research Tyler Radke said.
The shift goes beyond adding another software category: as businesses direct more IT spending toward AI projects, vendors must show they can turn AI capabilities into revenue. For investors, growth and valuation differences across the sector may increasingly depend on that ability, rather than simply on whether a company offers AI-related products.
Microsoft has room to monetize AI
Radke cited Microsoft as a potential beneficiary. Its Office subscriptions cost less than $100 a month, and the company can bundle them with security services and its Copilot AI assistant. Some competitors charge hundreds of dollars per month, leaving Microsoft room to increase monetization of its AI products, he said.
Microsoft's revenue rose 18% year over year in the quarter ended June 30. Radke expects its revenue growth could exceed 20%. He also pointed to a Citi survey of chief information officers indicating that Microsoft's internally developed AI models are approaching the level of leading industry labs, a factor that could help build enterprise customers' confidence in its AI offerings.
Microsoft also has an established base of corporate customers. Office, security, cloud computing and Copilot can be sold through the same procurement relationships, giving the company opportunities to grow AI revenue through cross-selling. That position may be more secure than that of application-software vendors that must compete for separate budget approvals.
Adobe and smaller vendors compete for a tighter budget
Radke said Adobe and smaller application-software providers face greater pressure. Corporate IT budgets are finite: as companies commit more spending to AI infrastructure, models and related tools, other software categories may have to compete for what remains.
That does not necessarily mean demand for their products will disappear. Customers could, however, delay renewals, limit additional user seats or ask vendors to demonstrate that AI features deliver clear productivity gains. The budget shift may be felt more directly by companies reliant on a single application, higher prices or a limited enterprise distribution network.
Adobe also faces the expansion of generative AI into image, design and content-production workflows. If customers believe new AI tools can perform some existing functions, traditional software pricing and product differentiation may come under closer scrutiny. Radke's view is that AI projects are absorbing corporate spending, making it harder for application vendors to rely on existing subscription revenue alone to support growth expectations.
Software stocks lagged chip shares earlier this year
Radke said performance within the software sector had already diverged sharply earlier this year. At the time, even the weakest-performing chip stocks had gained more than the best-performing software stocks. The gap reflected investors' greater focus on AI computing infrastructure, while software companies' ability to generate revenue from AI had yet to receive comparable recognition.
As businesses move AI from pilots into actual spending, investor attention may broaden from chip supply to cloud platforms, data services and enterprise software. The benefits will vary by company, depending on revenue growth, customer adoption, pricing and AI development costs. Microsoft, Palantir and Snowflake are seen as better positioned to capture new AI budgets, while Adobe and smaller application vendors face pressure as customers reorder spending priorities.
The next test for software companies is whether AI features lead to new contracts and greater willingness to pay, and whether that revenue can offset model development and infrastructure costs. Radke's case for Microsoft rests on its revenue growth, bundled products and CIO survey findings. For Adobe and other application-software vendors, the pressure is tied to the changing destination of corporate IT budgets.