Lecture 5 - Competition is for Losers (Peter Thiel)

Introduction

Peter Thiel, founder of PayPal, Palantir and Founders Fund, talks about strategy and competition. He suggests that when starting a company, one should aim for monopoly and avoid competition.

Aim for Monopoly

• When starting a company, aim for monopoly.

• Avoid competition as it is for losers.

Creating Value

To create a valuable company, two things must be true: it creates X dollars of value for the world and captures Y% of X. X and Y are independent variables.

Formula to Create Value

• To create a valuable company:

• It must create X dollars of value for the world.

• It must capture Y% of X.

• X and Y are independent variables.

Example: Airlines vs Google

• Airlines have more revenue than Google but are less valuable because their profit margins are much smaller.

• The combined market capitalization of the airline industry is only a quarter that of Google's.

Perfect Competition vs Monopolies

Perfect competition has pros and cons while monopolies are stable long-term businesses with more capital.

Pros and Cons of Perfect Competition

• Pros:

• Easy to model

• Efficient in static worlds

• Politically desirable

• Cons:

• Not good if you're involved in anything hypercompetitive because you often don't make money off it.

Monopolies Are More Valuable

• Monopolies are more stable long-term businesses with more capital.

• A creative monopoly is symptomatic of having created something really valuable.

Two Kinds of Businesses in This World

• There are exactly two kinds of businesses in this world:

• Businesses that are perfectly competitive

• Monopolies.

The Two Kinds of Businesses

In this section, Peter Thiel discusses the two kinds of businesses and how people lie about their businesses.

Lies People Tell About Their Businesses

• There are two types of companies: perfect competition and monopoly.

• Monopolies pretend not to have a monopoly while non-monopolies pretend to have one.

• Non-monopolies describe their market as super small while monopolies describe it as super big.

• This distortion happens because of the lies people tell about their businesses.

Examples of How Lies Work in Practice

• Restaurants are an example of a terrible business where you have to tell some idiosyncratic narrative to attract investors.

• A fictitiously narrow market is when you say that your restaurant is the only British food restaurant in Palo Alto.

• Hollywood movies always get pitched with an idiosyncratic narrative, but it's incredibly hard to make money in Hollywood doing movies.

• Startups often use buzzwords like sharing, mobile, social, apps to create a narrative that generally does not work.

Intersection vs. Union

In this section, Peter Thiel talks about the intersection and union of markets.

Intersection vs. Union

• Non-monopolies describe their market as the intersection while monopolies describe it as the union.

• The question is whether the intersection makes sense and has value or if it's just another movie or startup idea that doesn't work.

Conclusion

In this section, Peter Thiel concludes his discussion on the two kinds of businesses and how people lie about their businesses.

Final Thoughts

• The real difference between perfect competition and monopoly is actually quite big.

• People need to be aware of the lies that people tell about their businesses.

Google's Monopoly and Market Strategy

In this section, the speaker discusses how Google describes itself as an advertising company or a technology company. He explains that the tech industry is prone to creating monopoly-like businesses, which is reflected by companies accumulating so much cash. The speaker also shares insights on how to build a monopoly.

Building a Monopoly

• To get to a large share of the market, start with a really small market and take over that whole market.

• Going after a giant market on day one is typically evidence that you haven't defined the categories correctly and there will be too much competition.

• Successful companies in Silicon Valley often start with markets that are so small that people don't think they're valuable at all when they get started.

Examples of Starting Small

• Amazon started as just a bookstore before expanding into different forms of e-commerce.

• eBay started with Pez dispensers before expanding into auctions for different goods.

• PayPal started with power sellers on eBay, which was about 20,000 people.

Evidence of Narrow Markets in Tech Industry

• Big tech companies like Apple, Google, Microsoft, and Amazon have been building up cash for years with incredibly high profit margins.

• The reason why the tech industry in the US has been so successful financially is because it's prone to creating all these monopoly-like businesses.

Distorting Nature of Markets

• There are powerful incentives to distort the nature of markets one way or another.

• One has to always be super aware of this fact.

Going After Small Markets

In this section, Peter Thiel discusses the importance of going after small markets and how it can lead to a monopoly business.

The Importance of Small Markets

• Thiel believes that going after small markets is counterintuitive but essential for creating a successful business.

• Starting with massive markets often leads to tons of competition and makes it hard to differentiate your company from others.

• Going after small markets allows you to get a foothold and potentially scale into a big monopoly business.

Characteristics of Monopoly Technology Companies

• All happy companies are different because they're doing something very unique. All unhappy companies are alike because they fail to escape the essential sameness that is competition.

• Proprietary technology is one characteristic of a monopoly technology company.

• A technology that's an order of magnitude better than the next best thing is another characteristic of a monopoly technology company.

Examples

• Facebook, PayPal, and eBay were all considered to have little value early on due to their small markets, but they were able to grow concentrically and become valuable.

• Amazon had over ten times as many books as its competitors, while PayPal was able to send money more than ten times faster than using checks on eBay. The iPhone was also an example of a product that provided an order of magnitude improvement over existing smartphones.

Why is it valuable to the first person who is doing something?

In this section, Peter Thiel discusses why it's valuable to be the first person doing something and how branding creates real value.

Valuable to the First Person

• There is always a tricky question of why something is valuable to the first person who is doing it.

• Economies of scale and branding are two reasons why something can be valuable to the first person who does it.

• Software businesses are often good at economies of scale because their marginal cost is zero.

Branding

• Branding creates real value, but Thiel doesn't fully understand how it works.

• Thiel doesn't invest in companies that rely solely on branding.

Characteristics of Monopoly

In this section, Thiel discusses the characteristics of a monopoly and how they relate to lasting over time.

Last Mover Advantage

• The critical thing about monopolies is having one that lasts over time.

• Being the last mover in a category can create real value. Microsoft was the last operating system, Google was the last search engine, and Facebook will be valuable if it turns out to be the last social networking site.

Value in Future Cash Flows

• Most of the value in tech companies exists far in the future.

• Three-quarters or more of a tech company's value comes from cash flows in years 2024 and beyond.

Overvaluing Growth Rates

• Silicon Valley overvalues growth rates and undervalues durability.

• Durability is a qualitative factor that dominates the value equation.

Characteristics of Monopoly

• The characteristics of monopoly include proprietary technology, network effects, and economies of scale.

• Network effects get more robust as the network scales, making it easier for a business to become a bigger and stronger monopoly over time.

Last Mover Advantage

In this section, Peter Thiel discusses the importance of being the last mover in business and technology. He explains that while being a first mover may provide a small advantage, it is more important to be the company that wins in the end.

The Last Mover Advantage

• Being the last mover is critical for success in business and technology.

• A structure of innovation where others come up with new things in your area is great for society but not necessarily good for your business.

• The last mover who wins the game is what you want to be.

• It's important to ask why your company will still be leading 10, 15, or 20 years from now.

Science and Technology Innovation

In this section, Peter Thiel talks about how much value scientists and inventors capture from their innovations. He explains that while some innovations can be extremely valuable, those who invent them often do not get rewarded for their work.

Value Capture in Science and Technology

• There is a whole history of science and technology that can be told from the perspective of how much value was actually captured.

• Scientists never make any money; they are deluded into thinking they live in a just universe that will reward them for their work.

• Most of the time, Y (the percentage of X created by an inventor or scientist) is 0% across the board.

• There are entire sectors where people didn't capture anything despite creating tremendous value for society.

Success Cases in Innovation

In this section, Peter Thiel discusses the rarity of success cases in innovation. He explains that while there have been many technological innovations over the past 250 years, it is unusual for people to make money from them.

The Rarity of Success Cases

• Y is almost always 0% in science and almost always low in technology.

• It's very rare where people made money from their innovations.

• Most of the time, Y is 0% across the board.

• Relentless improvements were made during the first industrial revolution, but most textile mills and railroads went bankrupt despite creating tremendous value for society.

The Value of Vertically Integrated Complex Monopolies and Software

In this section, Peter Thiel discusses the value of vertically integrated complex monopolies and software in creating new things and making money. He explains that these business forms are valuable but often underexplored modalities of technological progress.

Vertically Integrated Complex Monopolies

• Vertically integrated complex monopolies are a valuable business form that is often fairly capital intensive.

• These monopolies require very complex coordination, but when assembled correctly, they provide a tremendous advantage.

• Tesla and SpaceX are examples of companies that have successfully used this business form to integrate all the pieces together more vertically than most competitors.

The Power of Software

• Software has incredible economies of scale and low marginal costs, making it a powerful industry.

• Fast adoption is critical to capturing and taking over markets in the world of bits as opposed to the world of atoms.

• We should be more critical of rationalizations that obscure the fact that Y equals zero percent for scientists operating in a world where all innovation is effectively competed away.

Competition vs. Monopoly

In this section, Peter Thiel discusses competition versus monopoly and argues that competition prevents people from making any money.

Competition Preventing People from Making Money

• The structure of competition prevents people from making any money because it drives down prices and profits.

• Competition is seen as good because it leads to innovation, but Thiel argues that innovation can also come from monopoly.

• Monopoly is often seen as bad because it leads to higher prices, but Thiel argues that it can also lead to lower costs and better products.

The Importance of Creating a Monopoly

In this section, Peter Thiel discusses the importance of creating a monopoly and explains that monopolies are good for society when they create new things.

Monopolies Are Good When They Create New Things

• Monopolies are good for society when they create new things because they allow companies to capture the value they create.

• Thiel argues that we need more monopolies in areas like clean energy and biotechnology where there is still much progress to be made.

• He also argues that we should focus on creating new things rather than competing with existing businesses.

The Power Law

In this section, Peter Thiel discusses the power law and how it applies to startups.

The Power Law Applies to Startups

• The power law applies to startups because a small number of companies will generate most of the returns.

• This means that investors should focus on finding the few companies that will be successful rather than investing in many companies.

• Thiel argues that startups should aim for monopoly from the beginning because it is easier to go from zero to one than from one to two.

Understanding Monopoly and Competition

In this section, Peter Thiel discusses the dichotomy between monopoly and competition. He argues that people often misunderstand the relationship between these two concepts and that it is worth exploring further.

Monopoly vs. Competition

• Some industries have a structure that allows for monopolies to form, while others are highly competitive.

• People often think of losers as those who are not good at competing, but Thiel suggests that we should revalue competition itself.

• There is a psychological blind spot when it comes to competition, as humans tend to be deeply mimetic and imitative.

• The fact that lots of people are trying to do something does not necessarily mean it is valuable or wise.

The Logic of Competition

• When it is hard to differentiate oneself from others in a field, people will compete ferociously to maintain even an imaginary difference.

• This can lead to battles over small stakes, such as in academia where the differences between scholars may be small but still fiercely contested.

• Thiel shares his personal experience of being hyper-tracked and ending up at a big law firm in New York where everyone wanted to leave.

Conclusion

In this final section, Thiel concludes his talk by reflecting on his own experiences and offering some parting thoughts on competition.

Parting Thoughts

• Thiel reflects on leaving the law firm after realizing it was not the best idea and how one person told him it was reassuring to see him leave.

• Thiel suggests that sometimes escaping from a situation can be the best thing to do.

The Price of Competition

In this section, Peter Thiel talks about the price of competition and how it can prevent people from asking bigger questions.

Don't Always Follow the Crowd

• When competing, you're comparing yourself with others and figuring out how to beat them. This often comes at a tremendous price.

• Instead of always going through the tiny door that everyone's trying to rush through, go around the corner and take the vast gate that no one's taking.

• By doing so, you'll be able to ask bigger questions about what's truly important and valuable.

Q&A Session

In this section, Peter Thiel takes a few questions from the audience.

Determining Market Value

• To determine if an idea is better than your own idea, focus on what is the actual market instead of what's being narrated about it.

• People have incentives to powerfully distort things in their favor.

Monopolies

• Google has all four aspects of monopolies: network effects with ad networks, proprietary technology (page rank algorithm), economies of scale for storing sites, and brand recognition.

Lean Startups vs. Quantum Improvements

• Peter Thiel is skeptical of lean startup methodology because great companies did something that was somewhat more quantum improvement than iteration.

• Great companies typically did not do massive customer surveys but had a virtual esp link with the public and figured it out themselves.

Risk Mitigation

• It's often tricky to mitigate risk because you don't have enough time to figure out what people want. If you take too much time, you'll miss the boat.

Risk and Competition

In this section, the speaker discusses risk and competition in business. He explains that risk is a complicated concept and that there are different categories of businesses that are bundled together. The speaker also talks about how competition can be seen as validation, which can lead to problems.

Risk in Business

• Risk is a complicated concept.

• There are different categories of businesses that are bundled together.

• Monopoly businesses were big first movers in some sense.

• Companies like Google and Facebook were not the first in their respective fields but were dramatically better than everyone else on one dimension.

Competition in Business

• People often see competition as validation, which can lead to problems.

• Studies have shown that people who go to business school tend to do the wrong thing at the end of it because they try to catch the last wave.

• This tendency for us to see competition as validation is very deep, and there is no easy psychological formula to avoid it.

Overcoming Competition

In this section, the speaker talks about how we can overcome our tendency to see competition as validation.

Overcoming Competition

• We should never underestimate how big a problem our tendency to see competition as validation is.

• Advertising works on all of us to a disturbing extent, and we should all work to overcome it.