Super Micro Computer just made a game-changing move. Here’s what you need to know.

As this earnings season has shown, big companies continue to invest heavily in AI. But one problem was the massive electricity needs of these energy-hungry AI servers. And with even more powerful AI chips coming next year, this problem will only get worse.

To mitigate AI’s massive power needs, data center operators are just beginning to adopt direct liquid cooling (DLC) for AI server racks, as opposed to the traditional air-cooled racks used in the vast majority of data centers today.

Liquid-cooled data centers only accounted for about 1% of the market earlier this year, but are now poised to take off, potentially leading to a major upheaval in the fast-growing AI server industry. With its long history as a leader in new energy-efficient technologies, it’s no surprise that Super Micro Computer (SMCI -0.23%) is positioning itself to dominate this industry disruption.

From 1% to 15% in the blink of an eye

Liquid cooling has accounted for only 1% of the data center market so far because it traditionally takes a long time to implement, costs more, and leaks can cause component failure. Additionally, managing liquid cooling systems requires a different kind of expertise than managing air cooling systems.

However, it looks like Supermicro may have cracked some sort of code in implementing liquid-cooled racks at scale. And that could be a big problem.

While analysts agonized over Supermicro’s declining gross margins last quarter, the decline may actually be good news for long-term investors. According to management, since unveiling its new liquid-cooled solutions at Computex in early June, the company has seen stronger-than-expected demand for its liquid-cooled racks. As a result, the company had to pay for expedited shipping on liquid cooling components, which cost more and hurt gross margins last quarter.

However, stronger than expected demand is not a bad problem. On the recent earnings conference call, Supermicro CEO Charles Liang said the company shipped about 1,000 liquid-cooled racks in June and July, which Liang said represented more than 15 percent of all new global deployments of data centers globally in those two months. Liang also noted that Supermicro estimates that 25% to 30% of all new data center deployments will use DLC solutions in the next 12 months, “we believe the majority of deployments will come from Super Micro.”

Supermicro is investing to dominate this market

In the pre-AI world of traditional servers, Supermicro’s custom premium servers tended to have a relatively low market share in the fragmented enterprise server industry at around 5%. However, Liang believes that Supermicro accounts for “at least” 70% to 80% of all DLC servers shipped in recent months.

While Supermicro is unlikely to retain that much market share over time, the company is clearly making the investments today to maintain a leading DLC ​​market share.

This could turn the enterprise server industry upside down, considering that DLC is moving very quickly from 1% to potentially 30% of the server market in just one year. The explosion in DLC revenue is why Supermicro is projecting $26 billion to $30 billion in revenue over the next 12 months, roughly double the $14.9 billion it just earned in the 12 months ending in June.

Image source: Getty Images.

Why doesn’t Supermicro charge more

When done well, without leaks, the benefits of DLC include up to 40% lower power consumption, better computing performance and faster connection time due to not having to install large air conditioners, all while reducing the carbon footprint of a data center.

With that in mind, analysts are wondering why Supermicro isn’t charging more. The company saw its gross margins fall to 11.3 percent in the quarter, partly due to accelerated shipping costs, but it aims to return to its traditional gross margin range of 14 percent to 17 percent by the end of this year.

But if you have a value-added solution like DLC, you have two options: either charge a higher price, or try to disrupt the industry with high volumes at a lower price. Supermicro seems to be following the latter disruptive path, at least in this early stage of the liquid cooling era.

This may turn out to be the smart strategy in the long run as it could pave the way for greater market share. AI is a revolutionary technology, but it is expensive. So keeping Supermicro’s prices low could open up more overhead for its customers’ AI servers. And if DLC eventually costs only on par with air-cooled servers, it could also be deployed in traditional data centers.

As Supermicro will also deploy a new Data Center Block Solution (DCBBS) later this year — which incorporates end-to-end data center construction, including software and maintenance services — the company can generate more recurring maintenance/software revenue associated with it. implementations than it did in the past when it was just a supplier of hardware parts.

So getting more high-volume customers upfront could be a smart move. In addition, Supermicro’s costs are likely to drop next year as its new Malaysian manufacturing plant goes live in November with dramatically lower costs.

While many Supermicro investors seem to want more profits now, the company’s big investment in taking the lead in direct liquid cooling for AI data centers — perhaps a big advance — could prove to be a game changer.