The rise of the data center ecosystem

Andrew Heaney, Director at Wealth Management Solutions – Ameriprise Financial

Aug. 19, 2024

In the modern digital economy, data centers have become the backbone of countless services that are integral to our daily lives. From streaming entertainment on smartphones to powering mission-critical business operations, virtually all sectors of the economy rely heavily on these facilities to manage and access their digital resources. Further, the rapid adoption of cloud computing and artificial intelligence (AI) is significantly driving the expansion and modernization of data centers.

In all, the competitive and technological landscape of the data center ecosystem can offer significant investment opportunities, but also comes with risk. To help you untangle this complex web, we explore the underlying technologies and opportunities related to data centers that look positioned for growth and expansion.

The rising role of data centers in our economy

Data centers are massive warehouses that house thousands of servers, storage devices and networking equipment. They are meticulously designed to efficiently process, store and distribute the immense volumes of data that fuel our modern digital activities.

The importance of data centers has skyrocketed over the past several years, propelled by the rapid adoption of cloud computing services, the pandemic-driven shift toward remote work and digital service consumption and the recent proliferation of data-intensive applications like AI and machine learning. These converging forces have fueled an acceleration in the projected growth rate of the data center industry, with some forecasts indicating a 20% annual growth by 2027.¹

The data center value chain is a complex ecosystem encompassing everything from chip manufacturing and cloud services to power generation and specialized real estate, all harmonizing to keep the digital world running smoothly. Investments in the construction, enhancement and modernization of these critical facilities have seen a significant uptick over the last several quarters. Remarkably, some projections suggest that global spending on new data center projects could surpass $1 trillion over the next four to five years.² We anticipate this increase in spending will help sustain the rapid growth in demand for infrastructure components, with supply chain constraints likely posing the only near-term obstacle to growth.

Investing opportunities related to the data center ecosystem

Semiconductors

At the core of every data center lies a complex array of semiconductors, including processors and

memory chips, that provide the immense computing power that drives our digital world. These components provide the raw computing power, storage capacity and connectivity that enable data centers to process, store and transmit vast amounts of data. The performance and efficiency of modern data centers are largely determined by the capabilities and limitations of the semiconductors on which they are built. Advances in these processors, particularly in graphics processing units (GPUs) and application-specific integrated circuits (ASICs), have been the driving force behind the recent and ongoing acceleration in AI development. Depending on the scale of the data center, these chips can account for roughly 20% to 40% of the total capital spending involved in a new data center build.³

Networking equipment

Data center networking equipment, including switches, routers and security devices, forms the

connectivity layer of the data center ecosystem. At a basic level, these components facilitate communication and data transfer within and between networks. Though most of the infrastructure interest remains on AI-optimized chips, advanced networking equipment can optimize data flow and enhance network security. In fact, the performance of high-performance GPUs and other processing units will be significantly limited by the efficiency and capacity of the networking components. As a result, modern data centers rely heavily on these components to maintain operational efficiency and secure data management.

Power and sustainability

Electricity and other forms of power are indispensable to data center operations, providing the necessary energy for semiconductors, network infrastructures and other critical components that enable the processing and storage of vast quantities of data. Though traditional data centers have historically managed their energy consumption effectively, the demands of contemporary data centers are significant due to the sheer scale of data, processing and storage for AI and machine learning tasks. While projections about future energy consumption by data centers remain wide-ranging, some estimates suggest that by 2030, these facilities could account for a notable share of global energy consumption, with estimates ranging from 0.5% to as high as 25%.⁴ As data centers become increasingly power-hungry, sustainability and energy efficiency are likely to become major concerns for the industry and society, in our view.

Cooling solutions

Cooling systems play a vital role in the data center ecosystem by maintaining optimal operating temperatures for servers, networking equipment and other hardware. Effective cooling is essential for ensuring the reliability, performance and longevity of data center components, as well as for managing energy consumption and costs. According to the National Renewable Energy Laboratory, cooling systems typically account for up to 40% of a data center's total energy consumption, underscoring the importance of efficiency in these systems.⁵ As data centers continue to evolve and adapt to the demands of emerging technologies, including AI and high-performance computing, the role of advanced cooling solutions could become even more critical.

Server solution providers

Server assemblers are the vital link between component manufacturers and end-users, translating raw technological potential into practical, deployable solutions. The inside of a modern data center reveals a landscape typically filled with rows upon rows of server racks. These racks encapsulate the hardware components into operational server units. Assembly of these intricate systems can be expertly managed by specialized firms which are, in effect, customers of chipmakers, networking equipment firms and cooling solution providers, purchasing their products to assemble, optimize and often customize servers for a diverse group of customers, including enterprises, cloud service providers and governmental agencies. Server assemblers are critical: They harness the capabilities of components like central processing units (CPUs) and GPUs, the connectivity ensured by network switches and routers and the efficiency provided by power and cooling technologies and integrate them into cohesive units ready for deployment. This process demands significant expertise in systems integration, ensuring all components work seamlessly together and optimizing for energy efficiency, heat dissipation and data throughput.

Hyperscale data center operators

While financial institutions, governments, large corporations and research institutions have all traditionally been builders and buyers of data centers, since 2015, the industry has become dominated by a small number of hyperscale data center operators. These companies — such as Amazon Web Services (AWS), Microsoft Azure, Google Cloud and Meta — build and operate massive data centers that form the backbone of the cloud infrastructure, enabling businesses and consumers to access a wide range of services, from storage and computing to AI and machine learning. Their business model offers computing and storage resources on a flexible and scalable basis, often referred to as Infrastructure-as-a-Service (IaaS) or Platform-as-a-Service (PaaS). This service model generates significant revenue and catalyzes partnerships, and often investments, in cutting-edge developers and leading software development companies.

Real estate and investment platforms

Real estate investment trusts (REITs) and alternative investment platforms play a vital role in the data center ecosystem by providing the physical infrastructure and capital resources needed to support the growth of the digital economy. REITs own and operate data center properties, leasing space to enterprise customers and service providers. Similarly, alternative investment managers offer exposure to the data center market through specialized funds and investment vehicles. The high costs associated with data center construction and maintenance make these firms essential yet capital-intensive participants in the industry, requiring significant financial resources and expertise to effectively navigate the market.

Risks and challenges in the investment landscape

While the data center industry presents potentially significant growth opportunities, it has risks and challenges:

Intense industry competition: The highly competitive nature of the industry, including new entrants, could increase pressure to differentiate through innovation, pricing or specialized offerings. This could lead to margin compression and potential consolidation within the industry.
Geopolitical factors: Trade tensions, tariffs and foreign investment restrictions could disrupt global supply chains and impact the ability of companies to source critical components or expand into new markets. Additionally, the concentration of data center operations in certain regions may expose companies to localized risks, such as natural disasters, power outages or political instability.
Increasing regulatory scrutiny surrounding data privacy, security and environmental impact is also a growing concern and data centers may soon face increased regulatory pressure.
Rapid pace of technological change: Companies that fail to keep up with emerging trends, such as the adoption of new computing architectures, advanced cooling technologies or innovative power solutions, may find themselves at a competitive disadvantage.

Bottom line

The data center ecosystem is a complex and rapidly evolving landscape that plays a crucial role in powering the digital economy. From the cutting-edge semiconductors that drive computing performance to the massive hyperscale facilities that host cloud services, each component of this ecosystem presents unique opportunities and challenges for investors. As the demand for data processing, storage and transmission continues to grow — driven by the adoption of AI, machine learning and other data-intensive applications — we believe the data center industry may be poised for significant expansion.

Make sense of the market impact

Your Ameriprise financial advisor is here to help you determine if these and other new investment opportunities, aligned with your risk tolerance, time horizon and financial goals might make sense for you

¹ Five trends driving the booming data center economy in 2024, Forbes, Jan. 22, 2024.

² Goldman Sachs: $1tn to be spent on AI data centers, chips, and utility upgrades, with "little to show for it so far", Data Center Dynamics, July 9, 2024.

³ Demand for AI sparks increase in data center server spending, even as shipments fall, SiliconANGLE, Nov. 7, 2023.

⁴ Arm CEO warns AI's power appetite could devour 25% of US electricity by 2030, April 9, 2024.

⁵ NREL joins $40 million effort to advance data center cooling efficiency, Dec. 14, 2023.

This information is being provided only as a general source of information and is not a solicitation to buy or sell any securities, accounts or strategies mentioned. The information is not intended to be used as the primary basis for investment decisions, nor should it be construed as a recommendation or advice designed to meet the particular needs of an individual investor. Please seek the advice of a financial advisor regarding your particular financial situation.

Like real estate, REITs are subject to illiquidity, valuation and financing complexities, taxes, default, bankruptcy and other economic, political or regulatory occurrences.

Alternative investments cover a broad range of strategies and structures designed to be low or non-correlated to traditional equity and fixed-income markets with a long-term expectation of illiquidity. Alternative investments involve substantial risks and may be more volatile than traditional investments, making them more appropriate for investors with an above-average tolerance for risk.

The products of technology companies may be subject to severe competition and rapid obsolescence, and their stocks may be subject to greater price fluctuations.

Amazon Web Services (AWS), Microsoft Azure, Google Cloud and Meta are not affiliated with Ameriprise Financial, Inc.

Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.

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