Weekly Reading #4: Zero to One (Part 1)

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.

Chapter 1: The Challenge of the Future

Thiel’s view of the future, which has two parts. First, the future is when the world looks different from today. (Even if everything looks the same 100 years later, it’s not the future yet). Second, the future must be rooted from today.

He likes to ask this question during interviews: “What important truth that very few people agree with you on?” Most answers to the question are different ways to look at the present. (“There is no God”, “American is exceptional”). Good answers come as close as we can come to looking into the future. A good answer takes the following form: “Most people believe in x, but the truth is the opposite of x.

Thiel’s answer: “Most people think the future of the world will be defined by globalization, but the truth is that technology matters more.”

Globalization is the process of copying things that work (1 to n). Technology is doing new things (0 to 1), which is harder. Since 1971, we have seen rapid globalization but limited technology development, mostly confined to IT. In a world of scarce resources, globalization without new technology is unsustainable.

Our challenge is to both imagine and create the new technologies that can make the 21st century more peaceful and prosperous than the 20th. It’s hard to create new things in big organizations or by individuals. New technology tend to come from startups — small groups of people bound together by a sense of mission. Notable examples include the Founding Fathers in politics, the Royal Society in science, or the Fairchild Semiconductors’s “traitorous eight” in business.

Startups operate on a principle that you need to work with other people to get stuff done, but you also need to stay small enough so that you can actually can. A new company’s most important strength is new thinking, even more important than nimbleness, small size affords space to think.

This book is an exercise of thinking. Because that is what a startup has to do: question received ideas and rethink business from scratch.

Chapter 2: Party Like It’s 1999

“Madness is rare in individuals — but in groups, parties, nations and ages it is the rule,” Nietzscehe wrote (before he went mad). If you can identify a delusional popular belief, you can find what lies hidden behind it: the contrarian truth.

The internet craze of the ’90s was the biggest buble since the crash of 1929, and the lessons learned afterward define and distort almost all thinking about technology today. The first step to thinking clearly is to question what we think we know about it.

A quick history of the ‘90s

The ’90s started with euphoria: the fall of the Berlin Wall. In 91 and 92, the US economy was in recession. From 92 to 94, the general public were concerned about U.S. global competitiveness as jobs flowed to Mexico. In technology, Japan seemed to be winning the semiconductor war.

The Internet changed all this. Mosaic (the first browser) was realsed in Nov. ’93, became Netscape and controlled 80% of the browser market in late ’95. Following IPO in Aug. ’95, Netscape stock rose from $28 to $174 in five months. Other tech companies went public, including Yahoo! ($848 million valuation) or Amazon ($428 million valuation). Tech stocks grew so fast that skeptics questioned earnings and revenue multiples higher than any non-internet company. Tech investors were exuberant. (In Dec. ’96, Fed chairman Alan Greenspan warned that “irrational exuberant” might have “unduly escalated asset values”.

At the same time, the rest of the world wasn’t doing well. The East Asian financial crises hit in Jul. ’97. In Aug. ’98, Russian suffered a ruble crisis. American investors grew nervous about a nation with 10,000 nukes and no money. This crisis brought down Long-Term Capital Management, a highly leverage U.S. hedge fund. Meanwhile, Europe wasn’t doing much better. The newly-created euro had to be rescued by the G7 central banks.

It seemed like the Old Economy couldn’t handle the challenges of globalization. The New Economy of the internet was the only way forward. From Sep. 1998 to Mar. 2000, the dot-com mania occurred. The most “successful” companies seemed to embrace a sort of anti-business model where they lost money as they grew. But, investing money was everywhere in the Valley.

The NASDAQ collapsed from 5,048 to 1,114 in about 30 months. For entrepreneurs in Silicon Valley, there were four lessons from the dot-com crash that still guide business thinking today:

  1. Make incremental advances. Anyone who wants to change the world should be more humble. Small, incremental steps are the only safe path forward.
  2. Stay lean and flexible. You should not plan but try things out, “iterate” and treat entrepreneurship as agnostic experimentation.
  3. Improve on the competition. Don’t try to create new market prematurely. Start with an already existing customer, and improve on recognizable products already offered by successful competitors.
  4. Focus on product, not sales. If your product requires advertising or sales pepole to sell it, it’s not good enough: technology is primarily about product development, not distribution.

Yet, to Thiel, the opposite principles are probably more correct:

  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.

We still need new technology and even some 1999-style hubris and exuberance to get it. To build the next generation of companies, we must abandon the dogma created after the crash. That doesn’t mean the opposite ideas are automatically true. Instead ask yourself: how much of what you know about business is shaped by mistaken reaction of past mistakes?

The most contrarian thing of all is not to oppose the crowd but to think for yourself.

Chapter 3: All Happy Companies Are Different

The business version of our contrarian question is: what valuable company is nobody building? The tricky part is a company can create a lot of values without being valuable itself. Creating value is not enough — you also need to capture some of the value you create. An example can be the airline industry vs. Google. In 2012, the airline industry made $160 billion, but only had an average profit margin of 0.2%. Google made $50 billion, but with 21% profit margin.

The airlines compete with each other, but Google stands alone. This is perfect competition vs. monopoly. In perfect competition, which is considered the ideal and default state in economics 101, no company makes an economic profit. Meanwhile, a monopoly owns its market, can set its own price and can produce the quantity and price combination that maximizes its profit.

This book isn’t interested in illegal bullies or government favorites. In this case, “monopoly” means the kind of company that’s so good at what it does that no other firm can offer a close business. An example is Google in search, which hasn’t compete since the early 2000s, and definitely distances itself from Yahoo and Microsoft.

A lesson for entrepreneurs: if you want to create and capture lasting value, don’t build an undifferentiated commodity business.

Lies people tell

Monopoly lies to protect themselves. They don’t want to be classified as monopoly, which might bring in troubles. To maintain their monopoly profits, they tend to conceal their monopoly, usually by exaggerating the power of their (nonexistent) competition. The case:

Google owns 68% of the search market (versus 19% Yahoo, and 10% Microsoft) and makes $17 billion annually. Online advertising is $37 billion, the entire U.S. advertising market is $150 billion and global advertising is $495 billion. If Google completely dominated U.S. search engine marketing market, it’s still only have 3.4% of global advertising market. But if we frame Google as a multifaceted tech company, it only owns less than 0.24% of the global consumer tech market (Google’s 2.35 billion non-search revenue vs. $964 billion consumer tech)

On the other hand, non-monopolies like to exaggerate their distinction. “We’re in a league of our own”, “ “no one else is doing this”, “we’ll own the entire market”. Entrepreneurs tend to have a mistake to understate the market. They like to define their market as the intersection of various smaller markets.

The problem with a competitive business goes beyond lack of profits. Because you’re not different from your competitors, you have to fight hard to survive. You have to squeeze out every piece of efficiency, either by paying minimum wage or employ your kids. The competitive ecosystem pushes people toward ruthlessness or death.

A monopoly can care more for works, products and impact on the wider world because it doesn’t have to worry about the competition. In business, money is either an important thing or it is everything. Monopolists can think about other things other than money, non-monopolists can’t think about anything else but daily’s margin.

Monopolies are bad if the world is static (where nothing change). However, today’s world is dynamic. It’s possible to invent new and better things. Creative monopolists give the customers more choice by adding new categories. They are a powerful force to make our society better. Examples: Apple’s new iPhone & iOS monopoly reduced Microsoft’s decade-long Window dominance. Before that, IBM’s hardware monopoly is the ’60s is taken by Microsoft’s software monopoly in the ’70s. Monopoly doesn’t strangle growth. In fact, promise of years or even decades of monopoly profits incentives innovation.

In business, perfect equilibrium means stasis, and stasis mean death. In a competitive equilibrium, the death of your company doesn’t matter to the world; there is always an undifferentiated competitor to replace you. In the real world outside the theory, every successful business is successful exactly to the extent that it does something that others cannot. Monopoly is the condition of every successful business. 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.

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.

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