Weekly Reading #4: Zero to One (Part 3)
Notes on Startups, or How to Build the Future by Peter Thiel
“Every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Segrey Bin 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.”
It’s easier to copy than to create something new. Copying takes the world from 1 to n, adding more of something similar. Creating takes us from 0 to 1. Innovation is what makes American businesses successful. We will fail if we stop searching for new paths.
Zero to One is about how to build companies that create new things.
Read Part 2 (Chapter 4–5) here:
Chapter 6: You Are Not A Lottery Ticket
Does success come from luck or skill?
Malcolm Gladwell wrote that success comes from “a patchwork of lucky breaks and arbitrary advantages.” Warren Buffet considers himself a “member of the luck sperm club”. Jeff Bezos attributes Amazon’s success to an “incredible planetary alignment”. Bill Gates goes so far as to claim he “was lucky to be born with certain skills.”
Those guys are humble, and success seems to be a matter of chance. But hundreds of people have started multiple multimillion-dollar business. A few, like Steve Jobs, Jack Dorsey, or Elon Musk, have created several multibillion-dollar companies. If success was a matter of luck, these kinds of serial entrepreneurs probably wouldn’t exist. Jack Dorsey tweeted, in January 2013, “success is never accidental.”
Even from the past, people believed that luck was something to be mastered, dominated and control. “Ralph Waldo Emerson wrote: “Shallow men believe in luck, believe in circumstances… Strong men believe in cause and effect.” In 1912, Roald Amundsen, the first explorer to reach the South Pole, wrote: “Victory awaits him who has everything in order — luck, people call it.”
Learning about startups is worthless if you’re just reading stories about people who won the lottery. Slot Machines for Dummies can tell you which machines is “hot”, but it can’t tell you how to win.
Can you control the future?
If you treat the future as something definite, it makes sense to understand it in advance and work to shape it. If you expect an indefinite future ruled by randomness, you’ll give up on trying to master it. You can also expect the future to be either better or worse than the present. Optimists welcome the future; pessimists fear it. Combining these possibilities yields four views:
- Indefinite Pessimism (Euro, present) — A indefinite pessimist looks out onto a bleak future, but he has no idea what to do about it. The Eurozone is in slow-motion and nobody is in charge. They just react to events that happen and hope things don’t get worse.
- Definite Pessimism (China, present) — A definite pessimist believes the future can be known, but since it will be bleak, he must prepare for it.
- Definite Optimism (US, 1950s-1960s) — The future will be better than the present if he plans and works to make it better.
- Indefinite Optimism (US, today) — The future will be better, but he doesn’t know how exactly, so he won’t make any specific plans. He expects to profit from the future but sees no reason to design it concretely. Indefinite optimists rearrange already-invented ones instead of inventing.
Malcolm Gladwell says you can’t understand Bill Gates success without understanding his fortunate personal context: he grew up in good family, went to a private school equipped with a computer lab, and befriended Paul Allan. But you can’t understand Gladwell unless you know his context. Gladwell belongs to Baby Boomer, the generation learned from childhood to overrate the power of chance and underrate the importance of planning. Gladwell appears to be a contrarian critique of the myth of the self-made businessman, but actually his own account encapsulates the conventional view of a generation.
The return of design
What would it mean to prioritize design over chance? Today, “good design” is an esthetic imperative. It’s true that every great entrepreneur is first and foremost a designer. However, the greatest thing Steve Jobs designed wasn’t the iDevice, but the Apple’s business. Apple imagined and executed definte multi-year plans to create new products and distribute them effectively. When the first iPod was released in Oct. 2001, industry analyst couldn’t see much more than “a nice feature for Macintosh user”. They didn’t see Jobs’ plan to create a new generation of portable post-PC devices. That secret is invisible to most people.
The power of planning explains the difficulty of valuing private companies. When a big company makes an offer to acquire a successful startup, it almost always offer too much or too little: founders only sell when they have no more concrete visions for the company, in which case the acquirer overpaid; definite founders with robust plans don’t sell, which means the price wasn’t high enough. When Yahoo! offered to buy Facebook for $1 billion in July 2006, I thought we should at least consider it. But Mark Zuckerberg walked into the board meeting and said he wouldn’t sell it. Mark saw where he could take the company, and Yahoo! didn’t.
Chapter 7: Follow the Money
Money makes money. Compound interest can be compared to “the eight wonder of the world.” The message is clear: never underestimate exponential growth. This chapter shows 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.
The power law of venture capital
Venture capitalist aim to identify, fund and profit from promising early-stage companies when they become more value and either go public or get bought by a larger company. A venture fund usually has a 10-year lifespan since it takes time for successful companies to grow and “exit”.
Most startup fails, and most funds fail with them. Every VC knows that his task is to find the companies that will succeed. They know companies are different, but they underestimate the degree of difference. The error lies in expecting that venture returns will be normally distributed: that is, bad companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x.
However, venture returns don’t follow a normal distribution overall. Rather, 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.
Facebook, the best investment in Founders Fund 2005 fund, returned more than all the others combined. Palatir, the second-best investment, is set to return more than the sum of every other investment aside from Facebook. 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.
No one can know with certainty ex ante which companies will succeed, so even the best VC firms have a “portfolio”. However, every single company in a good venture portfolio must have the potential to succeed at vast scale.
Why people don’t see the power law
Imagine a firm invests in 10 companies with the potential to become monopolies. They will look very similar in the early stage before exponential growth. Over the next few years, some companies will fail while others begin to succeed. The difference in valuation is still unclear. After 10 years, the portfolio won’t be divided between winners and losers; it will be split between one dominant investment and everything else
VCs usually spend more time on the most problematic companies than they do on obviously successful, since nobody wants to give up on an investment.
Less than 1% of new businesses started each year in the U.S. receive venture funding, and total VC investment accounts for less than 0.2% of GDP. But the results of those investments disproportionately propel the entire economy. Venture-backed companies create 11% of all private sector jobs. They generate annual revenues equivalent to an astounding 21% of GDP. Indeed, the dozen largest tech companies were all venture-backed. Together those 12 companies are worth more than $2 trillion, more than all other tech companies combined.
What to do with the power law?
The power law is important to everybody because everybody is an investor. When you choose a career, you act on your belief that the kind of work you do will be valuable decades from now.
“Don’t put all your eggs in one basket,” everyone has been told. But life is not a portfolio. Our school teach us not to think in power laws term. Everything is homogenized. They tell us “it doesn’t matter what you do, as long as you do it well.” That is completely false. It does matter what you do. You should focus relentlessly on something you’re good at doing, but before that you must think hard about whether it will be valuable in the future.
For the startup world, this means you should not necessarily start your own company. You can become tremendously successful by joining the the best company while it’s growing fast. The power law means that differences between companies will dwarf the differences in roles inside companies. You could have 100% of the equity if you fully fund your own venture, but if it fails you’ll have 100% of nothing. Owning just 0.01% of Google, by contrast, is incredibly valuable (more than $35 million as of this writing).
If you do start your own company, you must remember the power law to operate it well. One market will probably be better than all others. One distribution strategy usually dominates all others. Some moments matter far more than others. However, you can’t trust a world that denies the power law to accurately frame your decisions for you, so what’s most important is rarely obvious. It might even be secret. But in a power law world, you can’t afford not to think hard about where your actions will fall on the curve.
About Weekly Reading
Weekly Reading is a personal project to expand my knowledge by exposing myself to new ideas. Every Saturday, I lock myself in the neighborhood Barnes & Nobles and consume a book in one reading. Then, I share my note with the world.
If you find this post helpful. Please recommend it and share it with your friends. Feel free to leave me a note anytime.
