AI coding startup Windsurf was in talks to raise a large funding round at double its previous valuation earlier this year, but the deal did not go through.

The company then explored a sale to OpenAI at a similar valuation, but that acquisition also collapsed.

Insiders say high operational costs and negative gross margins, mainly from using external large language models, made the business unprofitable.

Windsurf faced competition from Anysphere Cursor, which is building its own model to reduce costs, and GitHub Copilot, which relies on OpenAI models.

After the failed OpenAI deal, Windsurf’s founders and key employees joined Google, while the remaining business was wound down.

Anysphere, another AI coding startup, recently adjusted its pricing structure to reflect rising model costs, and continues to develop its own model.

Industry insiders note that most AI coding assistants face similar financial pressures, with margins reported as neutral or negative.

🔗 Source: TechCrunch

🧠 Food for thought

1️⃣ AI intermediary startups face a fundamental margin squeeze

Windsurf’s negative gross margins reflect a broader challenge for companies building applications on top of large language models.

The business model problem is structural: these startups must use the most advanced and expensive AI models to remain competitive, but they can’t pass the full costs to customers without losing market share.

Over 55% of developers now use AI-powered code suggestions regularly, creating massive demand, but the underlying economics remain challenging for companies that don’t control their own models 1.

This creates a dependency where success in user adoption doesn’t translate to profitability, forcing companies like Windsurf to either invest heavily in building their own models or risk being squeezed out by suppliers who can afford to operate at break-even or losses.

The pricing pressure is evident in the market: GitHub Copilot charges $10 per month while Cursor charges $20, yet both rely on similar underlying model costs, suggesting limited room for sustainable margins 1.

2️⃣ Supplier competition creates existential threats for AI application companies