What does competition actually look like in the startup world? How can young businesses be competitive? And is our society’s relationship with competition healthy?

Peter Thiel — co-founder of PayPal, early investor in Facebook, and co-founder of Founders Fund — answered these questions and more during his Stanford University lecture.

Creating Value

Comparing the size of the airline industry to the size of the search industry, you would come to the conclusion that airlines are more important than search. But Thiel points out that the airline industry’s profit margins are significantly less than those of the search industry.

In the airline industry, the companies make money, go bankrupt, get recapitalized, and then that cycle repeats itself. This is reflected in the combined market capitalization of the airline industry, which is close to just a quarter of Google‘s. So even though the search industry is much smaller than air travel, it’s actually more valuable.

So how do you go about creating value when you first start a business, and what makes a company valuable? Thiel said you have to create something of value and capture some fraction of the value you’ve created.

Monopolies vs Perfect Competition

Thiel sees the business world as a binary. On one end of the spectrum, you have industries that are perfectly competitive, and at the other end of the spectrum are monopolies. Thiel said, “There is shockingly little that is in between.”

Monopolies

Monopolies are more stable, long-term businesses, and they have more capital. And if you get a creative monopoly for inventing something new, it often means you’ve created something really valuable.

The other side of things is perfect competition.

Perfect Competition

According to Investopedia, perfect competition is “a market structure in which the following five criteria are met:

All firms sell an identical product.
All firms are penetration price takers they cannot control the market price of their product.
All firms have a relatively small market share.
Buyers have complete information about the product being sold and the prices charged by each firm.
The industry is characterized by freedom of entry and exit.”
Pro

Perfect competition is always easy to model and it’s efficient, especially in a world where things are static.

Con

Perfect competition doesn’t make money when a lot of competition is involved.

The Lies We Tell

Monopolies Pretend to Have Lots of Competition

According to Thiel, monopolies tend to lie. They don’t want the government to regulate them, so they won’t call themselves a monopoly. What do they do to escape scrutiny? They pretend to have a lot of competition.

For example, Google has a 66% market share of the search industry. But you’ll never hear them describe themselves as a search engine anymore. Sometimes they call themselves an advertising company and sometimes they refer to themselves as a technology company.

There’s a good reason for this renaming. The technology market is valued at close to $1 trillion. So Google’s narrative is that they’re competing with all the car companies with their self-driving cars, they’re competing with Apple on TVs and smartphones, they’re competing with Microsoft on office products, and they’re competing with Amazon on cloud services.

They’ve positioned themselves in the expansive technology market where there’s competition everywhere. That’s how they escape the threat of regulating their monopoly.

Non-Monopolies Pretend to Have No Competition

The companies on the other end of the spectrum, which exist in a highly competitive industry, are also tempted to lie because they may not make any money otherwise.

They’ll say they’re doing something unique that is less competitive than it looks. They want to separate themselves from the rest of the herd and attract capital. Thiel said that they do this to increase their perceived value.

For example, a new restaurant that no one wants to invest in (because restaurants are notoriously bad investments) will be tempted to rebrand themselves. They’ll claim that they’re the only British food restaurant in Palo Alto. That’s too small of a market. But because of the way they talk about their place in the market, it seems like they have a monopoly on British food in Palo Alto.

The Result?

“In a world where monopolists pretend not to have monopolies and non-monopolies pretend to have monopolies, it seems like the difference between the two is very small. But in reality, the real difference is vast. These lies produce a distortion of the business world.”
Look at the big tech companies: Apple, Google, Microsoft, and Amazon. They have built up cash for years, producing incredibly high profit margins.

Thiel said that the U.S. tech industry has been so financially successful because it’s prone to creating monopoly-like businesses. These companies accumulate so much cash that they don’t even know what to do with it beyond a certain point.

Go After Small Markets

If you’re a startup, you want to have a monopoly because monopolies possess a large share of the market. But how do you get there?

Thiel advised beginning with a really small market, taking over said market, and then expanding that market in concentric circles.

The biggest mistake you can make as a young startup is going after a giant market from the get-go. That signifies that you haven’t defined categories correctly. And you’re going to be dealing with too much competition in one way or another.

Even Amazon started with just a bookstore. Their selling point was that they had all the books in the world for sale online. After they established themselves as a bookstore, they expanded into different types of e-commerce.

In the tech world, there’s this feeling that, in technology’s history, every moment happens only once, so your company needs to be unique.

In Thiel’s words: “You don’t want to be the fourth online pet food company. You don’t want to be the tenth solar panel company … All unhappy companies are alike because they failed to escape the essential sameness in competition.”

“The next Mark Zuckerberg won’t build a social network and the next Larry Page won’t be building a search engine, and the next Bill Gates won’t be building an operating system. If you are copying these people, you are not learning from them,” Thiel said.

Last Mover Advantage

You want technology with a magnitude that is 10x better than the next best thing, and you want it to last.

He disagreed with the notion espoused by Silicon Valley that you need to be the first mover to be successful in business. Instead, you need to be the best.

Thiel pointed out some tech companies whose iconic fame comes from being last instead of being first: “Microsoft was the last operating system, at least for many decades. Google was the last search engine. Facebook will be valuable if it turns out to be the last of social networking sites.”

The reason these last movers succeed is because “most of the value in these companies exists far in the future.”

Thiel added, “If you do a discounted cash flow analysis of the business, you’ll look at all these profit streams. You have a growth rate. The growth rate’s much higher that the discount rate, and so most of the value exists far in the future.”

When Thiel was at PayPal in 2001, their growth rate was about 100% per year. And they had been in business for a little over two years. They were discounting future cash flows by 30%, but in actuality, about three quarters of the value of the business as of 2001 came from cash flows in the years 2011 and beyond.

According to Thiel, you get similar results if you analyze Silicon Valley tech companies like Airbnb, Twitter, Facebook, and any emerging Internet companies. The math will tell you that 85% of the value is coming from cash flows in years 2024 and beyond. So, he said, we need to stop overvaluing growth and undervaluing durability.

Everybody wants to have a huge breakthrough in technology — a eureka moment. But unless your breakthrough is the final breakthrough, you won’t last.

Thiel explained that your only other option is to make a breakthrough and constantly improve on it at a pace that no one can keep up with. You need to think about who will be the leading company 10 to 20 years from now.

Competition Is for “Losers”

Not every successful invention or innovation makes the inventor rich. In fact, scientists are seldom adequately rewarded for their advances to how we live. Thiel noted that the smartest physicist of the 20th century, Albert Einstein, wasn’t a billionaire.

For science, the rationale is that scientists aren’t interested in making money; instead they’re supposed to be doing the work for charitable reasons.

Thiel did not say that people should always be motivated by money but thinks we should be more critical of these rationalizations. He questions the obscure explanations for why certain innovations get rewarded and others don’t.

Software is seen as the most valuable thing in the world because so many people have made buckets of money in the industry. The logic is that, if people at Twitter make billions of dollars, then Twitter must be worth more than anything Einstein did. This type of rationalization is dangerous, according to Thiel.

“We think of losers as the people who are slow on the track team in high school or do a little less well on standardized tests and don’t get into the right schools,” Thiel said. Losers are seen as people who can’t compete.

Thiel wants us to rethink and revalue this concept and consider the possibility that the competition itself is off. It’s no longer a form of validation.

“I think it’s more than just an intellectual blind spot, but also a psychological blind spot, where we find ourselves very attracted to competition, and in one form or another we find it reassuring if other people do things. And this is a very problematic thing that we need to always think through and try to overcome,” Thiel said.

When Thiel was in eighth grade, one of his friends wrote “I know you’re going to get into Stanford” in his yearbook.

He did, in fact, attend Stanford Law School years later. Then he ended up at a big New York law firm where, as he put it, “from the outside everybody wanted to get in and on the inside everybody wanted to leave.”

He didn’t like the dynamic and left the firm after seven months. He said that it’s important to pause in the midst of things and ask yourself if the tournament continues to make sense as you keep going.

His colleagues applauded him for leaving, even though for him it was a simple choice. “So much of people’s identities got wrapped up in winning these competitions that they somehow lost sight of what was important, what was valuable,” he said.

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