Notes on: Zero to One — by Peter Thiel
Peter Thiel is one of the more successful entrepreneurs and investors in Silicon Valley. Co-Founder of Paypal, leader of the Paypal Mafia, investor in Facebook and SpaceX, Thiel has had a big influence in many of the Valley's success stories. One of the things that separate Thiel from other investors is his unique view of the world and how he understands companies. In his book Zero to One, Thiel outlines the principles to build companies that “create new things” and by doing so they create a durable, high-margin monopoly. To build such a company is the ultimate goal of every CEO. This is a must read for CEOs and entrepreneurs alike.
As I become more familiar with the wisdom of Charlie Munger and other business luminaries I am convinced that one of the most important skills for a CEO to develop is second-level thinking as outlined by Howard Marks. Thiel is such a thinker. The more valuable principles from his book are the following:
- Capitalism and competition are opposites. Competition destroys wealth creation and erodes margins. A capitalists looks to build wealth and have high margins.
- Monopolies are not evil. Many of us have been thought that monopolies are the root of many of the markets’ defects. For Thiel, monopolies that act as rent seekers are negative to society but monopolies that must constantly reinvent themselves to keep their market share are beneficial to society as they allow companies to use the excess profits they generate to invest in new innovations. This latter type of monopolies are more common in the dynamic world that we inhabit.
What valuable company is nobody building?
- The goal of a company is to create long term value. To do this one must create value for customers but also capture some of that value. That is the difference between the market value of airlines and the market value of Google.
- All companies that enjoy a durable monopoly type dominance of a market are different. They all solve a unique problem. All failed companies are the same. They failed to escape competition.
- The four keys to building a monopoly are: proprietary technology, network effects, economies of scale and branding.
- Profit distribution in a market follows a Power-law distribution and not a Normal distribution. It behooves you to dominate a market.
- The best companies always solve a secret. A secret is an understanding that the current reality is not optimized, given the available technology or resources. The answer to the question: what valuable company is nobody building is necessarily a secret. Something that is important but unknown, something hard but doable.
- The best culture inside a company is that of a team of people on a mission, who share a set of ideals and beliefs about life in general.
- Advertising and sales are extremely important to a company. They matter because they work. They create impressions of a product or service in our minds that drive sales in the future. The best salesmen are those you don’t realize are selling you something.
- In the future, the best companies won’t try to replace humans to solve problems but will rather help humans solve harder problems.
- To become relevant all businesses must answer seven questions: Can you create breakthrough technology instead of incremental improvements? Is now the right time to start your particular business? Are you starting with a big share of a small market? Do you have the right team? Do you have a way to not just create but deliver your product? Will your market be defensible 10 and 20 years in the future?
For entrepreneurs, Zero to One is a manifesto. A book full of insight that should be reviewed over and over while brainstorming and prototyping different products and services in the hope of creating a company. For a CEO, Zero to One offers a fresh perspective on the goal of building a business; a durable, high-margin monopoly that will rid itself of endless ruinous competition.
Highlights of the book
Zero to One is about how to build companies that create new things. It draws on everything I’ve learned directly as a co-founder of PayPal and Palantir and then an investor in hundreds of startups, including Facebook and SpaceX. But while I have noticed many patterns, and I relate them here, this book offers no formula for success. The paradox of teaching entrepreneurship is that such a formula necessarily cannot exist; because every innovation is new and unique, no authority can prescribe in concrete terms how to be innovative. Indeed, the single most powerful pattern I have noticed is that successful people find value in unexpected places, and they do this by thinking about business from first principles instead of formulas.
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THE BUSINESS VERSION of our contrarian question is: what valuable company is nobody building? This question is harder than it looks, because your company could create a lot of value without becoming very valuable itself. Creating value is not enough — you also need to capture some of the value you create.
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Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away. The lesson for entrepreneurs is clear: if you want to create and capture lasting value, don’t build an undifferentiated commodity business.
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Monopolists, by contrast, disguise their monopoly by framing their market as the union of several large markets:
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In business, money is either an important thing or it is everything. Monopolists can afford to think about things other than making money; non-monopolists can’t. In perfect competition, a business is so focused on today’s margins that it can’t possibly plan for a long-term future.
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Monopoly is therefore not a pathology or an exception. Monopoly is the condition of every successful business.
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All happy companies are different: each one earns a monopoly by solving a unique problem. All failed companies are the same: they failed to escape competition.
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Sometimes you do have to fight. Where that’s true, you should fight and win. There is no middle ground: either don’t throw any punches, or strike hard and end it quickly.
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The overwhelming importance of future profits is counterintuitive even in Silicon Valley. For a company to be valuable it must grow and endure, but many entrepreneurs focus only on short-term growth.
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If you focus on near-term growth above all else, you miss the most important question you should be asking: will this business still be around a decade from now? Numbers alone won’t tell you the answer; instead you must think critically about the qualitative characteristics of your business.
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What does a company with large cash flows far into the future look like? Every monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding. This isn’t a list of boxes to check as you build your business — there’s no shortcut to monopoly. However, analyzing your business according to these characteristics can help you think about how to make it durable.
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As a good rule of thumb, proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage.
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Network effects make a product more useful as more people use it.
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A monopoly business gets stronger as it gets bigger: the fixed costs of creating a product (engineering, management, office space) can be spread out over ever greater quantities of sales. Software startups can enjoy especially dramatic economies of scale because the marginal cost of producing another copy of the product is close to zero.
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The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors.
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And even if you do succeed in gaining a small foothold, you’ll have to be satisfied with keeping the lights on: cutthroat competition means your profits will be zero.
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As you craft a plan to expand to adjacent markets, don’t disrupt: avoid competition as much as possible.
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well: to succeed, “you must study the endgame before everything else.”
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A startup is the largest endeavor over which you can have definite mastery. You can have agency not just over your own life, but over a small and important part of the world. It begins by rejecting the unjust tyranny of Chance. You are not a lottery ticket.
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how the power law becomes visible when you follow the money: in venture capital, where investors try to profit from exponential growth in early-stage companies, a few companies attain exponentially greater value than all others. Most businesses never need to deal with venture capital, but everyone needs to know exactly one thing that even venture capitalists struggle to understand: we don’t live in a normal world; we live under a power law.
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they follow a power law: a small handful of companies radically outperform all others. If you focus on diversification instead of single-minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place.
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The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.
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This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments. (Even quite successful companies usually succeed on a more humble scale.) This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.
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VCs must find the handful of companies that will successfully go from 0 to 1 and then back them with every resource.
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However, every single company in a good venture portfolio must have the potential to succeed at vast scale. At Founders Fund, we focus on five to seven companies in a fund, each of which we think could become a multibillion-dollar business based on its unique fundamentals. Whenever you shift from the substance of a business to the financial question of whether or not it fits into a diversified hedging strategy, venture investing starts to look a lot like buying lottery tickets. And once you think that you’re playing the lottery, you’ve already psychologically prepared yourself to lose.
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Recall the business version of our contrarian question: what valuable company is nobody building? Every correct answer is necessarily a secret: something important and unknown, something hard to do but doable. If there are many secrets left in the world, there are probably many world-changing companies yet to be started.
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All fundamentalists think this way, not just terrorists and hipsters. Religious fundamentalism, for example, allows no middle ground for hard questions: there are easy truths that children are expected to rattle off, and then there are the mysteries of God, which can’t be explained.
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What secrets is nature not telling you? What secrets are people not telling you?
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Secrets about people are relatively underappreciated. Maybe that’s because you don’t need a dozen years of higher education to ask the questions that uncover them: What are people not allowed to talk about? What is forbidden or taboo?
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So who do you tell? Whoever you need to, and no more. In practice, there’s always a golden mean between telling nobody and telling everybody — and that’s a company. The best entrepreneurs know this: every great business is built around a secret that’s hidden from the outside. A great company is a conspiracy to change the world; when you share your secret, the recipient becomes a fellow conspirator.
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“Thiel’s law”: a startup messed up at its foundation cannot be fixed.
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Companies are like countries in this way. Bad decisions made early on — if you choose the wrong partners or hire the wrong people, for example — are very hard to correct after they are made. It may take a crisis on the order of bankruptcy before anybody will even try to correct them. As a founder, your first job is to get the first things right, because you cannot build a great company on a flawed foundation.
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Technical abilities and complementary skill sets matter, but how well the founders know each other and how well they work together matter just as much. Founders should share a prehistory before they start a company together — otherwise they’re just rolling dice.
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• Ownership: who legally owns a company’s equity? • Possession: who actually runs the company on a day-to-day basis? • Control: who formally governs the company’s affairs?
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A typical startup allocates ownership among founders, employees, and investors. The managers and employees who operate the company enjoy possession. And a board of directors, usually comprising founders and investors, exercises control.
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A board of three is ideal. Your board should never exceed five people, unless your company is publicly held. (Government regulations effectively mandate that public companies have larger boards — the average is nine members.) By far the worst you can do is to make your board extra large.
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Actually, a huge board will exercise no effective oversight at all; it merely provides cover for whatever microdictator actually runs the organization. If you want that kind of free rein from your board, blow it up to giant size. If you want an effective board, keep it small.
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As a general rule, everyone you involve with your company should be involved full-time. Sometimes you’ll have to break this rule; it usually makes sense to hire outside lawyers and accountants, for example. However, anyone who doesn’t own stock options or draw a regular salary from your company is fundamentally misaligned. At the margin, they’ll be biased to claim value in the near term, not help you create more in the future. That’s why hiring consultants doesn’t work. Part-time employees don’t work. Even working remotely should be avoided, because misalignment can creep in whenever colleagues aren’t together full-time, in the same place, every day. If you’re deciding whether to bring someone on board, the decision is binary. Ken Kesey was right: you’re either on the bus or off the bus.
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In no case should a CEO of an early-stage, venture-backed startup receive more than $150,000 per year in salary. It doesn’t matter if he got used to making much more than that at Google or if he has a large mortgage and hefty private school tuition bills. If a CEO collects $300,000 per year, he risks becoming more like a politician than a founder. High pay incentivizes him to defend the status quo along with his salary, not to work with everyone else to surface problems and fix them aggressively. A cash-poor executive, by contrast, will focus on increasing the value of the company as a whole.
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If a CEO doesn’t set an example by taking the lowest salary in the company, he can do the same thing by drawing the highest salary. So long as that figure is still modest, it sets an effective ceiling on cash compensation. Cash is attractive. It offers pure optionality: once you get your paycheck, you can do anything you want with it. However, high cash compensation teaches workers to claim value from the company as it already exists instead of investing their time to create new value in the future. A cash bonus is slightly better than a cash salary — at least it’s contingent on a job well done. But even so-called incentive pay encourages short-term thinking and value grabbing. Any kind of cash is more about the present than the future.
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Startups don’t need to pay high salaries because they can offer something better: part ownership of the company itself. Equity is the one form of compensation that can effectively orient people toward creating value in the future.
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The most valuable kind of company maintains an openness to invention that is most characteristic of beginnings. This leads to a second, less obvious understanding of the founding: it lasts as long as a company is creating new things, and it ends when creation stops. If you get the founding moment right, you can do more than create a valuable company: you can steer its distant future toward the creation of new things instead of the stewardship of inherited success. You might even extend its founding indefinitely.
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You can’t accomplish anything meaningful by hiring an interior decorator to beautify your office, a “human resources” consultant to fix your policies, or a branding specialist to hone your buzzwords. “Company culture” doesn’t exist apart from the company itself: no company has a culture; every company is a culture. A startup is a team of people on a mission, and a good culture is just what that looks like on the inside.
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But taking a merely professional view of the workplace, in which free agents check in and out on a transactional basis, is worse than cold: it’s not even rational. Since time is your most valuable asset, it’s odd to spend it working with people who don’t envision any long-term future together. If you can’t count durable relationships among the fruits of your time at work, you haven’t invested your time well — even in purely financial terms.
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Why would someone join your company as its 20th engineer when she could go work at Google for more money and more prestige?
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employees you need if you can explain why your mission is compelling: not why it’s important in general, but why you’re doing something important that no one else is going to get done.
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The kind of recruit who would be most engaged as an employee will also wonder: “Are these the kind of people I want to work with?” You should be able to explain why your company is a unique match for him personally. And if you can’t do that, he’s probably not the right match. Above all, don’t fight the perk war. Anybody who would be more powerfully swayed by free laundry pickup or pet day care would be a bad addition to your team. Just cover the basics like health insurance and then promise what no others can: the opportunity to do irreplaceable work on a unique problem alongside great people. You probably can’t be the Google of 2014 in terms of compensation or perks, but you can be like the Google of 1999 if you already have good answers about your mission and team.
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Internal conflict is like an autoimmune disease: the technical cause of death may be pneumonia, but the real cause remains hidden from plain view.
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The best startups might be considered slightly less extreme kinds of cults. The biggest difference is that cults tend to be fanatically wrong about something important. People at a successful startup are fanatically right about something those outside it have missed. You’re not going to learn those kinds of secrets from consultants, and you don’t need to worry if your company doesn’t make sense to conventional professionals. Better to be called a cult — or even a mafia.
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But advertising matters because it works. It works on nerds, and it works on you. You may think that you’re an exception; that your preferences are authentic, and advertising only works on other people. It’s easy to resist the most obvious sales pitches, so we entertain a false confidence in our own independence of mind. But advertising doesn’t exist to make you buy a product right away; it exists to embed subtle impressions that will drive sales later. Anyone who can’t acknowledge its likely effect on himself is doubly deceived.
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All salesmen are actors: their priority is persuasion, not sincerity. That’s why the word “salesman” can be a slur and the used car dealer is our archetype of shadiness. But we only react negatively to awkward, obvious salesmen — that is, the bad ones. There’s a wide range of sales ability: there are many gradations between novices, experts, and masters. There are even sales grandmasters. If you don’t know any grandmasters, it’s not because you haven’t encountered them, but rather because their art is hidden in plain sight.
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Two metrics set the limits for effective distribution. The total net profit that you earn on average over the course of your relationship with a customer (Customer Lifetime Value, or CLV) must exceed the amount you spend on average to acquire a new customer (Customer Acquisition Cost, or CAC). In general, the higher the price of your product, the more you have to spend to make a sale — and the more it makes sense to spend it.
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Whoever is first to dominate the most important segment of a market with viral potential will be the last mover in the whole market.
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Most businesses get zero distribution channels to work: poor sales rather than bad product is the most common cause of failure. If you can get just one distribution channel to work, you have a great business. If you try for several but don’t nail one, you’re finished.
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Your company needs to sell more than its product. You must also sell your company to employees and investors. There is a “human resources” version of the lie that great products sell themselves: “This company is so good that people will be clamoring to join it.” And there’s a fundraising version too: “This company is so great that investors will be banging down our door to invest.” Clamor and frenzy are very real, but they rarely happen without calculated recruiting and pitching beneath the surface. Selling your company to the media is a necessary part of selling it to everyone else. Nerds who instinctively mistrust the media often make the mistake of trying to ignore it. But just as you can never expect people to buy a superior product merely on its obvious merits without any distribution strategy, you should never assume that people will admire your company without a public relations strategy.
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1. The Engineering Question Can you create breakthrough technology instead of incremental improvements? 2. The Timing Question Is now the right time to start your particular business? 3. The Monopoly Question Are you starting with a big share of a small market? 4. The People Question Do you have the right team? 5. The Distribution Question Do you have a way to not just create but deliver your product? 6. The Durability Question Will your market position be defensible 10 and 20 years into the future? 7. The Secret Question Have you identified a unique opportunity that others don’t see?
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Doing something different is what’s truly good for society — and it’s also what allows a business to profit by monopolizing a new market. The best projects are likely to be overlooked, not trumpeted by a crowd; the best problems to work on are often the ones nobody else even tries to solve.
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The 1990s had one big idea: the internet is going to be big. But too many internet companies had exactly that same idea and no others. An entrepreneur can’t benefit from macro-scale insight unless his own plans begin at the micro-scale. Cleantech companies faced the same problem: no matter how much the world needs energy, only a firm that offers a superior solution for a specific energy problem can make money. No sector will ever be so important that merely participating in it will be enough to build a great company.
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This chapter is about why it’s more powerful but at the same time more dangerous for a company to be led by a distinctive individual instead of an interchangeable manager.
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Whether we achieve the Singularity on a cosmic scale is perhaps less important than whether we seize the unique opportunities we have to do new things in our own working lives. Everything important to us — the universe, the planet, the country, your company, your life, and this very moment — is singular. Our task today is to find singular ways to create the new things that will make the future not just different, but better — to go from 0 to 1. The essential first step is to think for yourself. Only by seeing our world anew, as fresh and strange as it was to the ancients who saw it first, can we both re-create it and preserve it for the future.
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