Here’s Why Nvidia’s Aggressive Sales Tactics Put It in the Justice Department’s Crosshairs

AI investor favorite Nvidia has been on thin ice in recent weeks, with concerns about its high valuation, new pressure from antitrust regulators, the durability of the AI ​​boom and the impact of the U.S. economic slowdown spooking even some of the chipmaker’s staunchest defenders.

Nvidia shares have fallen about 18% since Aug. 19, with the heaviest losses coming after Tuesday’s 9.5% drop that wiped out a record market capitalization of $279 billion.

Fresh off a dark day of trading for Nvidia, Bloomberg reported that the U.S. Department of Justice (DOJ) has stepped up its antitrust investigation into the company. DOJ officials reportedly sent a subpoena to Nvidia and other companies involved, which includes “legally binding demands requiring recipients to provide information,” according to an anonymous source Bloomberg sources familiar with the matter. Subpoenas often precede the filing of a formal complaint against a company under investigation.

Justice Department officials have raised concerns that Nvidia is making it harder for its customers to switch to new suppliers and penalizing those who do not use its AI chips exclusively, according to BloombergSources. The Justice Department’s investigation into Nvidia began in July, Information This was first reported after similar accusations from competitors regarding Nvidia’s pricing strategy.

In a statement for FortuneNvidia said it “wins on the merits” and that customers have the freedom to choose the solution that works best for them, adding that the company “meticulously” complies with all laws.

“We have asked the U.S. Department of Justice and have not received a subpoena. However, we are happy to answer any questions regulators may have about our business,” the representative added.

Still, the tech world’s problems with the way Nvidia operates seem to be widespread.

“I’ve had complaints from all of Nvidia’s competitors. I’m not going to name them, but you can imagine who they might be,” said Patrick Moorhead, president and principal analyst at Moor Insights & Strategy, a technology analytics and consulting firm. Fortune.

“Nvidia customers I don’t have “We didn’t talk about any of those tactics, but they did talk about wanting to have — what were the words they used — a more ‘sustainable supply chain,’” he added.

Nvidia’s April acquisition of AI computing software company RunAI is also under scrutiny by the Justice Department, according to Bloomberg‘s report. There are concerns that the purchase will further strengthen Nvidia’s control over the entire AI chip supply chain, making it harder for customers to switch to competing products.

Overall, Moorhead believes this could end up being a “very serious investigation” for Nvidia, which could slow its business down slightly, force the company to open up parts of its software platform to competitors, or ultimately lead to a significant fine.

“I say that first of all because technically, Nvidia is a monopoly. Second, AI is super important to society, the economy and business today and in the future. So it’s a super hot topic. And that means regulators are super motivated to do something,” he warned.

Is Nvidia a monopoly?

Nvidia controls about 90% of the market for next-generation chips that are critical to AI. In recent years, the company has made big strides toward vertical integration, building a brand not just as a chip company but as an “AI platform company.”

Many experts say Nvidia’s impressive market share gains and rich offering of AI software and hardware have turned it into a monopoly. But the Justice Department will have to prove more.

“It’s not illegal to be a monopoly. What is illegal is, if you are a monopoly, to suppress competition and harm consumers,” Moorhead noted.

Tying agreements, in which a seller ties the sale of one product to the purchase of another, are one way Nvidia allegedly abuses its monopoly power. These agreements, also known as “tying” sales, are not always illegal but can be challenged under four antitrust provisions, according to the DOJ.

Both Sections One and Two of the Sherman Antitrust Act of 1890, which prohibit “restraint of trade” and make “monopolization” illegal, can be used to challenge binding contracts. Similarly, the DOJ can invoke Section Three of the Clayton Antitrust Act of 1914, which prohibits conduct that will “substantially lessen competition,” or Section Five of the Federal Trade Commission Act of 1914, which prohibits “unfair competition.”

Jim Keller, CEO of Tenstorrent, an AI chip maker and Nvidia competitor, said: Information in August said he believed Nvidia’s sales tactics were not illegal, but acknowledged that customers often “feel pressured to purchase Nvidia networking gear to ensure access to the company’s prized AI server chips.”

As the Justice Department investigates the claims of tying agreements, it will likely have to prove that the tying was done through formal agreements and not just under the influence of “pressure.”

But that could be difficult, according to Scott Bickley, practice manager and chief research officer at Info-Tech Research Group, a technology research and consulting firm. He noted that semiconductors have always been allocated on allocation schedules, with contracts agreed to in advance by both parties, and Nvidia has not been accused of breaking any agreements.

“Of course they’re going to try to sell their hardware — which they’re probably going to say is more compatible, that you’re going to get a better quality of experience if you run Nvidia chips with Nvidia racks and things like that. But from what I understand and from what I hear, they’re not enforcing it. They’re very encouraging it, but they’re allowing their largest customers to use their own hardware and their hardware for data center projects,” he explained.

Bickley argued that the tie-in contract dispute is largely a pricing game between Nvidia and its highly influential and powerful technology customers in a sector where there is no serious competition.

“I don’t think Nvidia is doing anything — at least on its face — that violates the law,” he said. “I think they’ve just become the 800-pound gorilla in a space where there’s no other 800-pound gorilla that can stand up to them at this point.”

The potential use of exclusionary discounts is likely another reason the DOJ could be investigating Nvidia for antitrust violations. “(They’re telling you) I’m only going to give you this good price if you don’t buy the competition. That’s not volume pricing, that’s exclusionary pricing,” Moorhead explained, noting that “you can’t do that if you’re a monopoly.”

Nvidia’s software platform, CUDA, could also come under scrutiny. CUDA is used in everything from low-level drivers to generative AI models, and it’s not available to competitors like AMD and Intel.

“Now, if you’re not a monopoly, that’s fine. If you have monopoly powers, people might look at that and say, ‘You’re more in the market business, right?'” Moorhead explained, “Then you have so much power that you have to open it up, even if it’s your competitors.”

Still, Bickley argued that Nvidia was simply using its technological advantage to increase profits and gain market share, rather than engaging in anti-competitive behavior. Attempting to punish, break up or slow Nvidia down would only hinder AI development, he said.

“We need good old-fashioned innovation,” Bickley argued. “You know, have other companies come out with competing products and technologies that start to siphon some of the investment away from Nvidia.”

The potential fallout from the Justice Department’s Nvidia investigation

Nvidia could face significant challenges if the DOJ investigation finds antitrust violations, experts say. But even if there are no violations, the chipmaker’s business operations could be slowed, at least slightly, by the investigation.

“When you have the Justice Department in your sights, it slows everything down,” Moorhead explained, comparing it to pouring small pieces of sand into a gas tank. “You have to have a lawyer approve your allocations. You have to have a lawyer approve your prices. You have to have a lawyer—in meetings where you don’t normally have a lawyer.”

Nvidia could also be forced to open up its CUDA software platform to competitors in the worst case, which would lead to increased competition. “Apple had to open up an app store, and Microsoft had to open up its API with Internet Explorer, probably something like that, which would allow AMD, Intel and others… to use CUDA on an equal basis,” Moorhead explained.

If the DOJ is able to prove that Nvidia acted illegally, it could also face hefty fines, and not just in the U.S. “I think this will spread to the EU, Korea, Japan, and probably Taiwan — probably not China — which, again, just increases scrutiny even more. But it’s basically paying a fine,” Moorhead said.

However, neither Moorhead nor Bickley believe the fines will dramatically impact Nvidia’s business, in large part because of the company’s clear technological advantage and growing revenue. Both experts also noted that it will take months, if not years, for the Justice Department’s investigation to conclude.

“By the time they reach a conclusion, whatever it is, the money is going to be made by NVIDIA, so any fine they issue will be basically a small fine,” Bickley said. “I don’t think it will have any material impact on them, their earnings, their financial situation.”

Bickley also doesn’t think the DOJ case has much chance of success, despite investors’ negative reaction to news of the investigation. “I really don’t see a path for them to develop any real anticompetitive ruling,” he said. “I don’t think that happens very often.”

This story was originally published on Fortune.com