Broadcom's AI-Driven Margin Compression: A Strategic Trade-Off for Long-Term Growth

The artificial intelligence (AI) revolution has ignited a frenzy in the semiconductor industry, with companies like Broadcom (AVGO) and NVIDIA (NVDA) at the forefront. However, as AI-driven revenue surges, so too does the scrutiny of margin compression-a critical question for investors: Is this a temporary cost of capturing the AI boom, or a structural risk to long-term profitability? For Broadcom, the answer lies in dissecting its strategic choices, backlog strength, and competitive positioning against peers like NVIDIA and AMD.

The AI Growth Engine: Revenue Momentum vs. Margin Dilution

Broadcom's Q3 2025 results underscore its dominance in the AI semiconductor market. AI semiconductor revenue hit $5.2 billion, a 63% year-on-year increase, with a projected $6.2 billion in Q4 2025. This growth is fueled by a $10+ billion AI rack order backlog from a new customer and a total AI-related backlog exceeding $73 billion. Such a backlog suggests robust near-term visibility, with demand for custom accelerators (XPUs) and AI infrastructure software (e.g., VMware Cloud Foundation) driving revenue.

Yet, this growth comes at a cost. CFO Kirsten Spears warned that gross margins may decline in Q4 2025 due to a higher mix of system-level AI sales, which include pass-through costs for third-party components. This margin compression is a strategic trade-off: by offering end-to-end solutions, Broadcom captures a larger share of customer spend but sacrifices short-term profitability. The company expects a 100-basis-point drop in gross margins for Q1 FY2026, attributed to AI's growing revenue contribution.

Peer Comparison: Is Margin Compression Structural or Cyclical?

To assess whether Broadcom's margin compression is unique or industry-wide, we turn to its peers. NVIDIA reported GAAP gross margins of 73.4% in Q3 2025, with projections of 74.8% in Q4. While NVIDIA's margins remain robust, its dominance is under threat. AMD's MI300 series undercuts NVIDIA by 30-40%, and hyperscalers like Google and Meta are investing in custom silicon to reduce dependency on third-party vendors. AMD's AI segment faces margin compression from aggressive discounting and U.S. export restrictions to China.

Broadcom's margin dilution, however, differs. Unlike NVIDIA's pricing power or AMD's cost pressures, Broadcom's compression stems from its deliberate shift toward system-level sales-a move to lock in long-term customer relationships. This strategy mirrors NVIDIA's recent foray into full-stack AI solutions but with a higher pass-through cost structure. The key distinction is that Broadcom's margin hit is tied to its business model, not industry-wide pricing wars.

Backlog Durability and Cash Flow Resilience

A critical test of Broadcom's strategy is the durability of its AI backlog. With $73 billion in AI-related orders spread across six quarters, the company has a clear runway for revenue growth. This backlog includes follow-on orders from existing customers and a fifth major XPU client, indicating strong customer retention and market penetration. Infrastructure software revenue grew 19% year-on-year to $6.9 billion in Q3 2025, further diversifying Broadcom's cash flow.

While system-level sales may lower gross margins, Broadcom's operating leverage remains intact. Management expects operating margin dollars to grow despite the margin hit, suggesting that the company's cost structure can absorb the dilution. This resilience is bolstered by its infrastructure software segment, which provides recurring revenue and high margins.

Valuation: Is the Market Pricing in Growth or Margin Risk?

Broadcom's valuation multiples reflect optimism about its AI-driven growth. As of November 2025, the company traded at a forward EV/EBITDA of 48.9x and a forward P/E of 30x. These metrics are lower than AMD's 53.73x EV/EBITDA and 103.04x P/E but higher than NVIDIA's 36.25x EV/EBITDA and 43.77x P/E (https://fullratio.com/stocks/compare/nasdaq-nvda/nasdaq-amd). The disparity highlights divergent investor sentiment: AMD's high multiples reflect speculative growth bets, while NVIDIA's lower multiples suggest margin concerns are already priced in.

Broadcom's valuation appears balanced. The market is rewarding its AI backlog and infrastructure software growth but not excessively so. If margin compression proves temporary-as suggested by the company's backlog and operating leverage-the current multiples could justify the trade-off. However, structural risks emerge if competitors like AMD or NVIDIA erode Broadcom's pricing power or if AI demand slows.

Conclusion: A Calculated Bet on the AI Future

Broadcom's margin compression is a strategic trade-off, not a structural risk. By prioritizing system-level sales and customer relationships, the company is positioning itself to dominate the AI infrastructure market, even at the expense of short-term margins. Its $73 billion backlog and infrastructure software growth provide a durable cash flow foundation, while valuation metrics suggest the market is fairly balancing growth and risk.

For investors, the key question is whether Broadcom can sustain its AI momentum while mitigating margin dilution. If the company executes its strategy-leveraging its backlog, expanding its customer base, and optimizing its cost structure-the trade-off may prove well worth it. However, if margin compression becomes entrenched or AI demand falters, the current valuation could become precarious. In the AI arms race, Broadcom has made its bet; now, the market will decide if it's a winner.