Millions in revenue with chatbots—Has Character.ai stumbled on the first-functioning AI business model?

Fancy a chat with Harry Potter? How about a palaver with Taylor Swift? Or maybe you’d like to tell Santa you’ve been a nice boy or girl? US-based Character.ai can make it happen. The startup wants to become the central point of contact for AI chatbots for entertainment, but also for educational content and helpful AI queries. It could be the first functioning AI business model.

Daniel De Freitas and Noam Shazeer are veritable AI nerds. The two have been working together at Google for a long time on LaMDA technology (Language Model for Dialogue Applications). In other words, working on chatbots at Google. They left the company in 2021 because, as they said in their own words, they were being held back by bureaucratic hurdles. Even back then, they sought to bring AI chatbots to end users.

And because Google didn't succeed, they founded Character.ai together. The tool has been publicly available since September 2022, and an app followed in May 2023. The first basic function: users can chat with all kinds of characters, living, dead or purely products of their imagination. On the other hand, they can also create chatbots themselves, which can then be used by others. Character.ai already has 18 million chatbots available, while over 20 million people have already registered.

Millions of AI friends

Anyone visiting the Character.ai website, or app, is greeted by a large number of chatbots. There are a wide variety of fantasy characters, such as Harry Potter, many manga and anime characters, as well as images of celebrities. Users have also created chatbots that help with creative writing, learning a language or planning a trip. There are also text-based games or book and music recommendation bots. This variety sheds a glimpse on the direction of Character.ai. Above all, the company wants to establish chatbot entertainment and anyone who interacts with the chatbots quickly realizes that we are dealing with a new generation that goes beyond mere traditional dialogues.

The company receives support from the 20 million users who have already created over 18 million bots. Anyone can create chatbots for Character.ai, either for private or for public use. Creators provide the AI software with a welcome message and a description of the character as a basis. Further development then takes place in conversations, with creators rating the answers given by the bot. In this way, the chatbot learns to fill the character with life.

And this seems to work for many users. Individual chatbots such as that of the anime character Sukuna (210 million chats), Yae Miko from the mobile game Genshin Impact (183 million), Harry Potter (34 million) or Albert Einstein (570,000) have an extremely high number of conversations. A random sample with the world's most famous magic student makes one thing clear: the most successful chatbots are not just intended for conversation alone. During a conversation with a Harry Potter bot, a short story about the conversation is told in italics. If you activate the language, you get a Daniel Radcliffe voice that takes you all the way to Hogwarts. If you ask and suggest the right things, you can experience Hogwarts adventures with the chatbot, in which other characters from the wizarding world also come into play. Anyone who tries out Character.ai will quickly realize how much the software could become a leisure activity, especially for fans of certain characters.

Substantial expenditure

Prolonged engagement with the bots is the most important aspect for Character.ai. According to the company, the website recorded over 200 million visits per month even before the app was launched. And what's special is that users spend an average of 29 minutes per visit with the chatbots. The figures are even more impressive for users who have sent at least one chat message. For these users, the average time spent on the platform increases to over two hours. The app could even increase engagement with beloved characters—the learned exchange in a chat environment fits perfectly on the smartphone. According to analytics platform Appfigures, the Character.ai app has been downloaded over eight million times for iOS and 19.5 million times for Android.

Now Character.ai is interested in monetizing its target group. However, many AI companies are currently finding this extremely difficult. ChatGPT maker OpenAI, for example, is on pace to record losses of USD 5b in 2024—mainly due to the high costs generated by data centers, a necessity for AI applications. Mike Volpi, General Partner at Index Ventures, which has invested capital in a Character.ai competitor, estimates that even for a comparatively small AI operation costs for computing power will exceed USD 500m per year.

The first functioning AI business model?

Nevertheless, Character.ai hopes to have found a viable business model. Users can pay EUR 9.99 per month and in return receive faster responses from the bots, earlier access to new functions and guaranteed access even when workloads are high. Based on the subscriptions sold, the startup expects to generate revenue of USD 16.7m in 2024. Character.ai is therefore also on pace for high losses in the coming year. These are to be absorbed with further financing until even more people take out a subscription.

It is conceivable that many functions will disappear behind the paywall in the future, even though the founders have always spoken of the openness of the product. Investors are at least convinced of the future prospects. In March, Andreessen Horowitz, among others, invested USD 150m in the company–at a valuation of USD 1b. The basic technology could fuel countless other applications far beyond chatbots, Sarah Wang, General Partner at Andreessen Horowitz, told the New York Times.

The competition is rife

However, Character.ai is banking on its own entertainment chat applications continuing to generate enthusiasm by millions of users, while large, deep-pocketed internet companies are also looking at AI entertainment as a business model. Meta has just rolled out its new "AI Studio" in the USA. With this tool, users can create their own AI chatbots on Instagram, Whatsapp, Messenger and a website. On the one hand, these can also be used for "private conversations"; the bots can give tips for cooking or an Instagram strategy. On the other hand, the bots can also be used as an extension of companies and creators. But of course there are drawbacks, and the list of inaccurate, insulting and/or poor answers from chatbots is never-ending.

And then there's Replika, the empathetic chatbot designed to combat loneliness. For a long time, all kinds of role-playing chats were possible with it. The development team later switched off the sexual and romantic aspects of the bot, which did not go over well with its community. The danger of people in special life situations developing an unhealthy relationship with the chatbots from Character.ai is also real, as many people chat with their favorite celebrities or characters. One journalist wrote in January 2023 that he burst into tears during a conversation with a Character.ai anime chatbot. On Reddit in particular, users repeatedly speak of genuine love for the highly artificial bots.

This is not a bad development for Character.ai's business success for the time being, as the higher the enthusiasm amongst users, the longer users stay engaged. However, it is difficult to combat the general skepticism towards AI chatbots. And yet, "we see people on Twitter posting things like: 'This video game character is my new therapist. My therapist doesn't care about me, this cartoon does,'" says co-founder Noam Shazeer."We are constantly reminded that we don't know what users really want."

Dare to be more human

In order to set itself further apart from the competition and bring more "humanity" to the platform, the startup also introduced group chats at the end of 2023, in which several people can interact with the AI bots in a chat at the same time.

"The feature is so good that some of our employees have stopped working for us," Character.ai co-founder Daniel De Freitas told Forbes. Ship AI, where several people come together to travel through space as a crew, text-based in a chat, of course, is particularly popular. With such experiences, the start-up wants to set itself apart from the seemingly overpowering meta and ChatGPT competition in the future. We will probably only see in a few years' time whether the first functioning AI business model will emerge.