VCs Bet Big on AI-Powered Roll-Ups: Transforming Traditional Services Industries with Automation and Improved Margins
Venture capital firms are increasingly betting on artificial intelligence (AI) to boost profits in traditionally labor-intensive service sectors. The strategy involves acquiring established service companies, using AI to automate tasks, and then consolidating multiple businesses.
Leading this charge is General Catalyst, which has allocated $1.5 billion from its latest fund to invest in AI-native software companies within specific verticals. These companies are then used as acquisition vehicles to buy established firms and their customers within the same sectors. To date, General Catalyst has made investments across seven industries, with plans to expand to up to 20 sectors.
“Services globally is a $16 trillion revenue market annually,” said Marc Bhargava, who leads General Catalyst’s related efforts, during a recent interview. “In comparison, software is only $1 trillion globally.” The allure of software investing has always been its high margins, he noted.
If successful, automating services businesses could significantly increase profits. By tackling 30% to 50% of companies with AI and automating up to 70% of core tasks in call centers, the mathematics become compelling.
This strategy appears to be bearing fruit. One of General Catalyst’s portfolio companies, Titan MSP, received $74 million in funding to develop AI tools for managed service providers. It then acquired RFA, an IT services firm, and demonstrated the ability to automate 38% of typical MSP tasks through pilot programs. With improved margins, Titan now plans to acquire additional managed service providers using a classic roll-up strategy.
Similarly, General Catalyst incubated Eudia, which focuses on in-house legal departments rather than law firms. Eudia has signed up Fortune 100 clients including Chevron, Southwest Airlines, and Stripe, offering fixed-fee legal services powered by AI instead of traditional hourly billing. Recently, the company acquired Johnson Hanna, an alternative legal service provider, to expand its reach.
General Catalyst aims to double – at least – the EBITDA margin of the companies it acquires.
Other venture firms are also embracing this strategy. Mayfield has allocated $100 million specifically for “AI teammates” investments, including Gruve, an IT consulting startup that acquired a $5 million security consulting company and grew it to $15 million in revenue within six months while achieving an 80% gross margin.
Navin Chaddha, Mayfield’s managing director, explained, “If 80% of the work will be done by AI, it can have an 80% to 90% gross margin. You could have blended margins of 60% to 70% and produce 20% to 30% net income.”
Elad Gil, a solo investor, has been pursuing a similar strategy for three years, backing companies that acquire mature businesses and transform them with AI. According to Gil, “If you own the asset, you can [transform it] much more rapidly than if you’re just selling software as a vendor.”
However, early research suggests this service-industry transformation may be more complex than anticipated. A recent study by researchers at Stanford Social Media Lab and BetterUp Labs found that 40% of employees are having to shoulder more work due to AI-generated work that appears polished but lacks substance. This work, referred to as “workslop,” creates additional work and headaches for colleagues.
Employees involved in the survey reported spending an average of nearly two hours dealing with each instance of workslop. Based on these participants’ estimates of time spent and their self-reported salaries, the authors of the study estimate that workslop carries an invisible tax of $186 per month per person for an organization of 10,000 workers.
Bhargava counters that AI is not overhyped but rather underutilized, arguing that the technical sophistication required in AI is the missing piece. He emphasized the need for applied AI engineers with a deep understanding of various models and their nuances to build companies from the ground up effectively.
Despite the challenges presented by workslop, General Catalyst remains optimistic about the potential for AI in services industries. Bhargava concluded, “As long as AI technology continues to improve, and we see this massive investment and improvement in the models, I think there’ll just be more and more industries for us to help incubate companies.”
