Also, read my review of Martin Ford’s Rise of the Robots

Zero to Some: A Critique of Peter Thiel’s Zero to One

With the inevitable end-of-year review of the year’s books, Peter Thiel’s Zero to One is sure to be mentioned by many as one of the best books on innovation and the startup economy.

And it’s a serious book, full of big and interesting ideas. So it deserves more than the “check out this book” reviews that greeted it when it was published a few months ago. This is a more detailed critique of some of Thiel’s major ideas with, in many cases, counter examples and data.

Thiel has written one of the more literary books on tech that you’ll read, with quotes from and references to Pythagoras, Bob Dylan, the Unabomber, Faust, Tolkien and many others. But in keeping with that, Thiel lets his writing wander as freely as his thinking. Thiel has a curious habit of sliding from huge issues, such as its titular call for major new technology breakthroughs to address critical issues like global warming and dementia, to his ideas on comparative minutiae such as the maximum salary to pay a startup CEO ($150,000/year) or the maximum size for a startup board.

Thiel bemoans a lack of big thinking, saying “big plans for the future have become archaic curiosities” and “in exchange for better insurance contracts, we seem to have given up the search for secrets about longevity.” Yet he also says that too many people are starting new companies while, famously, he’s giving Thiel Fellowships to people to drop out of college and start companies.

But perhaps Thiel thinks that consistency is the hobgoblin of little minds.

I’m going to start with some of the best parts of the book before I get to my criticisms. And then I’ll discuss several particular areas of disagreement:

  • Monopoly is not the only path to profits
  • It’s hard to apply the power law
  • Many of our most innovative companies are incrementalists
  • Competition never ends
  • Technology won’t solve all of our problems

The good parts

Thiel has four lessons that he says we should have learned from the dot com boom/bust of 15 years ago:
1. It is better to risk boldness than triviality.
2. A bad plan is better than no plan.
3. Competitive markets destroy profits
4. Sales matters just as much as product.

He spends a considerable amount of time on the first and last ideas, which are important, even if unevenly developed in the book.

We do need to solve some important problems, such as global warming, hunger, and diseases such as Alzheimer’s and cancer. We don’t need another Farmville or Angry Birds. But many developers see the possibility, however low, of making money by creating games and nice-to-have apps, so they keep getting churned out by the thousands. And 99% sink beneath the waves with hardly a notice.

I was surprised Thiel didn’t spend more time on this idea since that’s what the book’s title is about. Thiel clearly thinks big but, as I discuss below, fails to acknowledge that not every area, or even every tech area, is open to big breakthroughs. Many important innovations are the result of incremental improvements over years.

It was refreshing to read Thiel’s chapter on the importance of sales and distribution. As he discusses, too many people in tech dismiss sales (and marketing) as some slimy activity that doesn’t add value. At a recent tech conference I was amazed to overhear a well-known tech pioneer say to a colleague, “Developers solve problems. Marketing just moves things between people.”

Thiel has some solid ideas on how to incorporate sales in a company. However, he seems to be unaware of the use of inside sales by companies, especially B2B tech companies, to make sales in what he describes as the “dead zone” between $100 and $10,000 sales.

I also liked Thiel’s advice to focus a startup on a narrow market opportunity. It’s similar to Geoffrey Moore’s beachhead strategy for crossing the chasm, but is often not practiced by (young) entrepreneurs who think they can take on the world. Better to succeed in one geo or market segment and move out from there.

An especially interesting chapter is “The Founder’s Paradox”, which describes the nature of tech founders and “why it’s more powerful but at the same time more dangerous for a [startup] company to be led by a distinctive individual instead of an interchangeable manager.” He describes how many successful tech founders combine seemingly opposite traits:

“A normal person can’t be both rich and poor at the same time, for instance. But it happens all the time to founders: startup CEOs can be cash poor but millionaires on paper. They may oscillate between sullen jerkiness and appealing charisma. Almost all successful entrepreneurs are simultaneously insiders and outsiders. And when they do succeed, they attract both fame and infamy.”

Thiel mentions some of the usual tech luminaries in describing these people: Steve Jobs, Bill Gates, Elon Musk, Sean Parker, Mark Zuckerberg, et al. He also tosses Richard Branson into the discussion, and many entertainers. . Thiel’s ruminations on it are interesting since he’s personally worked with some of these people. I’ve seen similar combinations of contradictory characteristics in far less successful entrepreneurs, too. Some entrepreneurs almost take the jerkiness of a Steve Jobs or Sean Parker as a former of permission for them to act similarly, even though they aren’t nearly as talented or successful.

Now let’s look at some of the parts of Zero to One that are less successful.

Monopoly is not the only path to profits

Thiel is a capitalist who hates competition. He really wants to be running businesses with no real competition. His attitude is similar to that supposed Yogi Berra line about a restaurant, “Nobody goes there anymore since it got so popular.”

He spends a lot of time in Zero to One on Lesson 3 (above): competitive markets destroy profits. He believes that only monopolies can be successful so much that he says in italics, “Monopoly is the condition of every successful business.” Not “every successful tech business”, but every successful business, period. And so, using the airlines as an example, he asserts that competitive companies can’t possibly make money. As he puts it, again with his italics, “Under perfect competition, in the long run no company makes an economic profit.

Maybe in theory, but not in practice.

Starbucks is in a true commodity business: selling coffee. It takes just hot water and a few cents of coffee grounds to make coffee. There are countless coffee shops. Bakeries sell coffee. Restaurants sell coffee. People can make coffee at home for a few cents a cup, or they can pay a bit more for a Keurig and still make it for far less than the cost of a Starbucks grande. But Starbucks made over $2 billion in profits last year on more than $16 billion in sales. Thiel says “monopoly businesses capture more value than millions of undifferentiated competitors.” Starbuck’s profit last year was more than Tesla, Twitter, Box, Salesforce, Amazon and Facebook combined since all those companies except Facebook lost money last year, or barely broke even.

But Thiel says wait for it — their profits will come, someday.

What about ice cream? Another commodity, to be sure. How much more than the store brands do you think brands like Ben & Jerry’s and Haagen Dazs charge? Thirty percent more? Fifty percent more? Twice as much? No, they successfully charge six times what competitors do; look at the cost per ounce of ice cream next time you’re in a supermarket. And so Ben & Jerry’s was sold to Unilever in 2000 for $326 million. Only if you believe that a million dollar isn’t cool, a billion dollar is what’s cool would you consider that to be some kind of failure.

A majority of Tate’s Bake Shop, a maker of another commodity, chocolate chip cookies that are sold nationally, was recently sold to a private equity firm for $100 million. Bed Bath & Beyond paid $200 million to acquire Christmas Tree Shops. And, let’s not forget Dr.Dre selling his headphones company to Apple for $3 billion.

If Thiel was right, how could top lawyers be charging over $1,000 an hour? With an excess of lawyers, and major law firms laying off thousands of attorneys, rates should have plummeted.

Warren Buffett certainly doesn’t agree with Thiel. His very successful portfolio is full of companies such as ConocoPhillips, Costco, General Electric, General Motors, Goldman Sachs, IBM, Kraft Foods, MasterCard, Proctor & Gamble, and Verizon, most of which are in highly competitive industries. In fact, Buffett is famously uninterested in investing in new tech companies because while you can predict that the industry will grow, he feels it’s impossible to repeatedly pick the individual companies that will be the winners.

In his high tech marketing classic, Crossing the Chasm, Geoffrey Moore explains how competition is actually an essential factor to tech companies crossing the chasm into the mainstream market and its profits. The reason is that mainstream tech buyers are inherently conservative. They don’t want to be early adopters; they want proven, industry standard technology. (See: Microsoft) So new tech companies need to frame their competition and (1) show how they displace an existing market technology, and (2) be able to say who their competitors are. Only then are mainstream buyers likely to buy in.

Whether you use the broad industry list from Forbes or for the Inc 5000, you find that the most profitable industries are all competitive.

It’s hard to apply the power law

Thiel spends considerable time throughout the book, returning to it several times, to discuss what he calls “the power law”. The power law is that “a small handful of companies radically outperform all others.” And so VCs should not be looking for any potentially average performers, “every single company in a good venture portfolio must have the potential to succeed at vast scale.”

This kind of struck me like a Geico commercial moment: everybody knows that. Or at least everybody with even a few years of business experience.

For example, even though the NASDAQ index is up for the year, the vast majority of NASDAQ stocks are down. But a small number of great performers drive the overall average up.

Thiel seems to think that investors and VCs diversify their portfolios because they don’t understand the power law. But the real reason is that it’s really hard to predict the future, even if you’re supposedly on the inside and in the know.

And so the vast majority of mutual fund managers underperform the market indexes. Robert Metcalfe was wrong when he predicted the Internet would collapse in 1996; David Pogue was wrong when he said in 2006 that Apple would probably never come out with a cell phone. And most financial analysts predicted the economy would continue to grow in 2008, missing the severe financial collapse that was just months away. The big changes are the hardest to predict.

While TED conferences are now everywhere, originally there was only one, national TED conference a year. Then, as now, all attendees go to all sessions in one large auditorium; there are no breakouts. I had a client who went to the 1993 TED conference and wrote an in-depth, 50-page (single-spaced) report for his company. A few years after the conference I read his report and was amazed that these speakers, who comprised the most advanced thinkers in technology, entertainment and design, barely mentioned the Internet. A 500-ton train was coming down the tracks at them and they were almost oblivious to it.

Thiel’s far from perfect, either. Consider this Wikipedia description of the performance of his Clarium fund:

Clarium was down 4.5% in 2008, down 25% in 2009, and down 23% in 2010. For the first half of 2008, the fund had a YTD return of 57.9%. At the start of 2008, the fund had $4 billion in assets under management, raised to $7.8 billion in June 2008, then dropped to $1.5 billion in July 2009, after investors withdrew money from the fund. The fund lost most of its value in 2008 due to large bets against the US dollar, in the hopes that it would drop in value… Subsequent down years have reduced the fund’s assets under management to $681M as of December 2010. Clarium Capital Management was reported to have had big losses in 2010. The firm has continued to struggle with bets that it made on inflation and the US dollar.

His application of the power law to the choices that people make about their lives is more interesting. After all, funds and even individuals can invest in many companies, but we can only apply our time to, usually, one job, or maybe two. (And most of us will only marry one person, if we marry at all.) Since there is such a potentially huge difference between the returns from different jobs, making that choice thoughtfully can be very important in the direction of one’s life.

Many of our most innovative companies are incrementalists

I knew immediately that I was going to have a quarrel with Thiel when he started his preface with this explanation of originality:

Every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. And the next Mark Zuckerberg won’t create a social network. If you are copying these guys, you aren’t learning from them.

Actually, all those guys got successful by copying others.

Bill Gates didn’t create the first operating system, by a long shot, and he bought DOS from another developer.

A key component of Microsoft’s success has been waiting for others to define a market and then to come in with good enough technology. (Microsoft had $21 billion in profits last year on $91.5 billion in sales. That’s close to Facebook’s profit rate. Microsoft is worth $400 billion, making it one of the five largest public companies in the world.)

When Google launched in the late 1990s it competed with many other search engines including Lycos, LookSmart, HotBot, Ask.com, MSN, Overture and others. So theirs was not a bold new technology: it was an incremental improvement in a crowded field. But they executed better, kept improving on their advantage, and eventually took over two-thirds of the search market, and an even larger share of search advertising dollars.

Zuckerberg was standing on the shoulders of CompuServe, AOL, Friendster, Classmates, Myspace and others when he launched Facebook which, of course, wasn’t even his idea.

This is a social media map drawn in 2007 by the great XKCD, three years after Facebook was founded. How long does it take you to find Facebook?

But that didn’t stop Thiel from investing in Facebook.

When Steve Jobs left Apple he did start a new company, NeXT, and created a new operating system which later was bought by Apple and became the core of iOS.

Apple didn’t create the first MP3 players, tablet computers or mobile phones, but it greatly improved on what had come before.

Tesla didn’t invent the electric car. They sold 20,000 sedans in 2013; Toyota sold over one million hybrids.

SpaceX didn’t invent rockets and, literally, it’s not doing a moon shot. It is building a real business by making space flight routine. And it won’t have a monopoly.

Anyway, not all problems lend themselves to grand scale solutions. Many of our most important developments have happened incrementally over time. For example, improvements in public health, sanitation, pharmaceuticals, cancer treatments, operating room sanitation, vaccinations, and many other factors have combined to roughly double the life of expectancy of people in developed countries over the past 200 years.

The breakthrough discovery of penicillin in 1928 doesn’t even cause a blip on that chart.

And the teen birth date has dropped by more than 50% in the past 25 years, but there was no one, single breakthrough that produced it.

Thiel’s formula may be useful for that (literally) one in a million breakthrough company. (He says that the dozen largest tech companies are worth more than all other tech companies combined.) Jim Collins’ outstanding Good to Great describes how the rest of us can create leading, profitable companies through sustained, incremental improvements.

Competition never ends

Thiel is smart enough to know that it’s difficult to be first to market. We’re not working on Commodore or Tandy computers. We’re not writing with WordStar or MultiMate or a Wang, or using VisiCalc to do our calculations. And you won’t be discussing this article on CompuServe, perhaps the first commercial social network, or even on AOL, which had its boom/bust about 15 years ago.

No, most first to market products and companies fail. And most startups fail, whether or not they are moonshots. You could look it up.

But in place of wanting to be first to market Thiel proposes a curious “end of history” idea of “the last mover advantage”:

It’s much better to be the last mover — that is, to make the last great development in a specific market and enjoy years or even decades of monopoly profits.

Well, maybe that kind of monopoly is possible for a short time, in a very few cases, but as the cost of developing and prototyping new technologies plummet, and technical education spreads around the world, that kind of permanent competitive advantage is less and less likely.

After all, Apple could have looked at the mobile phone market in 2005 and decided that Nokia and Blackberry had it locked up and decided to not develop a smartphone. But they didn’t. They developed the iPhone.

Yet Apple couldn’t grab a monopoly. Google came in and Android now has about 80% of the global smartphone OS market.

And not only are product lifespans shortening, the lifespans of entire companies are shortening, too.

Competitive advantage is fleeting. Competition never ends. There is no last mover.

Technology won’t solve all of our problems

Thiel is a technologist who thinks that technology is the answer to peace and prosperity with, seemingly, few if any downsides. Pretty much assumed in Zero to One is Thiel’s boundless faith in technology.

If only it were that easy.

Now, I realize that technology has vastly increased the health, longevity and standard of living of billions of people around the world. Today a person with just a $100 smartphone has access to the vast store of knowledge, and cat videos, that are on the Internet. And many problems still need to be addressed through technology. I am especially hopeful that medical researchers will eventually solve such problems as Alzheimer’s and cancer.
Thiel starts out his first chapter by asking a fundamental question, “What important truth do very few people agree with you on?” The important truth that few in the startup/innovation world would agree with me on is that many of our most challenging problems, and their solutions, are human, not technological.

For example, without displaying any irony or self-awareness that technology is causing global warming, Thiel thinks that we need new technology to solve global warming. “Without technological change, if China doubles its energy production over the next two decades, it will also double its air pollution. If every one of India’s hundreds of millions of households were to live the way that Americans already do — using only today’s tools — the result would be environmentally catastrophic.”

In fact, renewable energy is already price competitive with carbon-based energy. The Union of Concerned Scientists disagrees with Thiel. It says:

In order to effectively address global warming, we must significantly reduce the amount of heat-trapping emissions we are putting into the atmosphere. The good news is that we have the technology and practical solutions at hand to accomplish it.

The real challenge with global warming is not a lack of technology but that we have a legacy energy infrastructure in which billions have been invested. In the U.S. the craven Congress is full of politicians more interested in their re-election than in saving the world. And we have deep-pocketed energy companies only interested in short term profits. And the Chinese government is no better.

Thiel says, “There simply aren’t enough resources in the world to replicate old approaches or redistribute our way to prosperity.” And today one-seventh of the world is hungry. But one third of the world’s food is wasted. So twice as much food already is being produced as is needed to feed all of the world’s hungry. This is a problem of distribution. This is a problem with our economic and political systems, and the fundamental solution won’t be technological. The flip side of the success of the Green Revolution in agriculture 50 years ago is that one of our biggest problems now is obesity, and as more and more countries adopt the Western diet they, too, start to encounter the problems of abundance.

We know that just 30 minutes of exercise a day can provide tremendous health benefits to individuals. And this could provide great cost savings in our public health system, too. But 80% of adult Americans do not do even this minimal amount of exercise, and technology won’t change that.

We know that educating girls is one of the best ways to promote development in third world countries. And we know how to educate girls as well as boys. But groups like the Taliban would rather kill girls than educate them.

If the Eric Garner case has proven anything it’s that adding police body cameras will not change the behavior of police, or what prosecutors do about it.

And we know how to treat women, people of color, and older workers with respect. And we know how to create and manage diverse workforces. But Silicon Valley remains behind the rest of U.S. industry when it comes to diversity.

This latter fact doesn’t bother Thiel; he embraces it. He writes, with agreement, “Max Levchin, my co-founder at PayPal, says that startups should make their early staff as personally similar as possible.” Biodiversity may be good; workforce diversity, not so much.

Thiel doesn’t spend much if any time looking at the values of the technology he advocates for, or the reality that it can often be — and is — used for evil as well as good.

E=MC2 was available to Hitler and Roosevelt. Encrypted payments and communication are used by terrorists and drug dealers as well as charities and legitimate businesses. And better drones won’t bring world peace.

Thiel sees no danger of us ever reaching a point where machines will displace too many workers, writing “Better technology in law, medicine, and education won’t replace professionals, it will allow them to do even more.” He’s ignoring that in law, for example, technology is already replacing professionals. I know media planners who are worried that programmatic ad buying will eliminate their jobs. Thiel also doesn’t discuss that technology may displace a certain class of workers while a different class profits from it. Not his problem.

But a “jobless recovery” is a problem for millions of Americans. And even now, when hiring is picking up, wages are lagging behind. The income gap is rising, and so is the wealth gap. The gap between white and black households is rising, too. Tech will not solve this.

Tech companies often don’t generate many jobs relative to their sales. In the most extreme case WhatsApp only had 55 employees when Facebook paid $19 billion for it. Facebook only needs 8,300 employees to generate over $11 billion in revenue — over $1 million in revenue per employee. Google has about 49,000 employees producing over $67 billion in revenue — again, over $1 million per employee.

The 2.2 million Walmart employees, on the other hand, produce about $480 billion in revenue — a bit over $200,000 per employee.

It may seem from this that there’s a choice between having tech companies with a small number of skilled, well-paid employees, and traditional companies with large numbers of poorly paid employees.

But there is a third way: professional services firms. There’s a great need for more data scientists, marketing technologists, software engineers and other professionals — in tech. Finding, training, and managing them for clients is a real business opportunity. But it’s not the kind of 10X roll of the dice that Thiel would be interested in.

As Bernstein says in “Citizen Kane”, “It’s not hard to be rich if all you care about is being rich.”

In the book’s “Conclusion” chapter Thiel lays out charts of four possible scenarios for the future of humanity (I told you he can think big): Recurrent Collapse (grim), Plateau (meh), Extinction (really grim), and Takeoff. Thiel is rooting for “takeoff”, which looks just like — surprise! — the classic startup hockey stick growth projection that few companies achieve.

The most likely future is a continuation of the past 100+ years of steady, incremental progress with occasional plateaus and dips. The trend is your friend. But this possibility doesn’t even enter his thinking.

So those are some of my problems with Thiel’s book. While not a memoir, his experience with PayPal is mentioned dozens of times. And his newer company, Palantir, is mentioned several times, too. Understandably his personal, unique history colors his view of the business world.

It’s a very romantic book actually, and no doubt it’s very seductive for a techie audience. Create a unique, better mousetrap and you’ll gain monopoly profits. You won’t have to bother with messy competition.

It’s rare that it works out quite that way in tech, and even rarer in other industries.

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