Peter Thiel’s 4 Essential Rules for Creating a Dominant Company
Creating a dominant company in your industry is hard work, says Peter Thiel in his new book Zero to One. But when done correctly, the rewards are huge profits and a durable business for years to come.
The advice he gives goes against most conventional thinking, or what you’d normally find in other business books or magazines. This contrarian philosophy has led him to co-found Paypal, invest early in Facebook, and later co-found Palantir. All three are multi-billion dollar companies.
This week he talked about his book and the lessons he’s learned building these companies in an interview on The James Altucher Show. His first contrarian idea was that a great company is a monopoly:
“Great companies do something unique, and because of this unique thing that they do, have monopoly like pricing power. So there’s a question of how can one go about creating a new business that creates a valuable monopoly for oneself and for the rest of society. Because if you’ve done something new, it also creates value for all the consumers.”
Thiel answered this question in the podcast with four rules for creating a dominant company and reaping monopoly profits. However, you don’t need all four of these to succeed. Even with just one, you can build a great business.
1. Create a 10X Technology or Innovation
“A company should start when they have a technology that’s 10X better than their closest competitor.”
The first rule is to create a technology or innovation that is 10X better than what is in the market. One simple way to know if you have a 10X business is to ask yourself two questions:
- Is this 10X better than what is out there?
- Is it different or new enough that people will notice and buy?
Another way is to look at the 10X rule in a context where you can measure things like units of product, customers, or users. Some examples are Amazon, Google, and Uber:
- Amazon was as an online bookstore with 10X more books than the average local bookstore.
- Google’s search engine gave users 10X better results than other search engines.
- Uber made it 10X easier to hail a taxicab and get around a big city.
2. Go Where There Are Network Effects
“Network effects and virality are different. Virality is a growth mechanism where customers bring in more customers. Network effects are where the value is driven by the fact that you have a number of other people inside the network [using your product or service] at a given time. Network effect businesses are extremely valuable.”
The paradox of network effects is the question of why is it valuable to the first person who uses it. If it’s only extremely valuable once you have one million people, how would you get the first ten or the first hundred to buy in before you get one million?
The answer is to start a new service that is valuable to it’s first users. Facebook is a textbook example. It started with a small market (more on this below) of only Harvard students. It started with those 10,000 students and went from 0 to 60% of this small market in ten days. Then they replicated it at other colleges and expanded from there.
3. Design with Economies of Scale in Mind
Economies of scale allow a company to grow exponentially without growth in their fixed costs or overhead.
Software startups are huge beneficiaries of this rule. Companies like Google, Facebook, and Twitter can add customers or users without adding any fixed costs. Service businesses are more difficult to scale. If you own a yoga studio, your fixed costs grow with the expansion of another studio or adding more instructors.
A great business should have the potential for scale built into it’s design.
4. Start with a Small Market
“You can define a monopoly as having a large market share. So how do you get a large market share as a startup? Because every startup necessarily starts very small. The answer is that you have to start with a small market.”
Facebook started with Harvard students. PayPal began with transactions for a small percentage of eBay power-sellers. Amazon sold books before becoming the Everything Store. In each case, their initial strategy was to dominate a small market and expand into related markets.
If a company starts with a market that’s measured in hundreds of billions or trillions of dollars, you will be a tiny fish in a vast ocean. You will enormous unpredictable competition that will wipe you out.
James Altucher named this rule The Chinese Refrigerator Rule.
At minute 46:10 of their conversation on the podcast, Altucher says, “I always call this The Chinese Refrigerator Rule. If somebody comes in to pitch and says, ‘Look, we’ve got this brand new kind of refrigerator. If just 1% of China buys it, we’re going to be billionaires.’ I’ve never seen anyone succeed with that kind of argument.”
Thiel agreed replying, “Yes because if 1% of china buys it, there will be 99 other Chinese companies for the other 99% of China, and they will drive the marginal profit to zero.”
Bonus Rule: Build a Strong Brand
“Branding alone is always a difficult one. It’s a real thing. It’s something I don’t claim to understand, so I don’t like investing in companies that are nothing but a brand, even though sometimes those things do work.”
While Thiel prefers the other rules, he admits that branding is one route to dominance. The beverage industry with companies like Coca-Cola, Red Bull, and Absolut Vodka are power users of this rule. Strong branding can create success for an undifferentiated, non-10X product like energy drinks in Red Bull’s case.
This rule is difficult to pull off in tech because they need great fundamentals (see other rules) to dominate. Yahoo has focused more on branding in the last few years, but still does not have a 10X technology like Google’s search engine or Apple’s iPhone. As a result these two companies each have a market cap that is more than 10X of Yahoo’s.
Creating a dominant company is obviously not easy, but there is a systematic way to go about it. You want to create a business with a 10X innovation, network effects, ability to scale, and a cool brand all in a small market (at first). But remember that even having just one of these can make a great business.
The whole interview is worth a listen. Thiel talks more about startups, the economy, and the future with Altucher here on his show.