Peter thiel cs183 - Four big secrets of business Capitalism and Competition are Antonyms

This is a post about secret #1 about startups by Peter Thiel. To see all 4 of the secrets start here. TLDR: Capitalism and competition are antonyms (opposites of each other). Tweet this. This is the first secret and most people would disagree with it. People generally believe that the differences between firms are pretty small. They miss the big monopoly secret because they dont see through the human secrets behind it. Monopolists pretend that theyre not monopolists (Dont regulate us!) and non-monopolists pretend that they are (We are so big and important!). Things only tend to look similar on the surface. Usual Story The usual story is capitalism and perfect competition are synonyms. No one is a monopoly and firms compete and profits are competed away. This however is a strange belief. Capitalism is about the accumulation of capital whereas perfect competition is one where you cant

make profit. From this frame using capitalism and perfect competition as being interchangeable is a strange belief. Why is competition favored? Favoring competition seems justified because its deep-rooted within our culture. Competition is believed to build character, we learn from it, and it prepares us for the future. For example getting into medical school is extremely competitive but once you get in you get to be a well paid doctor afterwards. Competition isnt bad but too often in the race to compete, we learn to confuse what is hard with what is valuable. The intensity of competition becomes a proxy for value. And to the extent value its not there, youre competing just for the sake of competition. One problem with fierce competition is that its demoralizing. Top high school students who arrive at elite universities quickly find out that the competitive bar has been raised. But instead of questioning the existence of the bar, they tend to try to compete their way higher. That is costly. Competition taught unquestioningly is dangerous because it leads to pointless competition. Perfect competition vs. monopolies Under the

economic idea of supply and demand you get two options at the market equilibrium: perfect competition and monopolies. Under perfect competition supply and demand is perfectly met so no firms in industry make profit. If there were profits to be made news firms would enter the market and take profits away. Its just not new entrants but all firms in the industry dont make a profit in perfect competition. Under a monopoly a single firm (or few) own the market and are they are the only ones that produces the product for that market. Most economists spend a great deal of time studying perfect competition but very few look at monopolies seriously. Perfect competition is fine when you dont want to turn a profit but to the extent one wants to make money you should be quite skeptical about perfect competition. Monopolies arent just an exception Monopolies arent just a strange exception and we should consider monopolies as a valid alternative to the perfect market paradigm. Monopolies tend to be viewed as bad because competition is assumed to be good. More competition

= more perfect marketplace = more progress. If more competition equates to more progress then the opposite of that must be true. This is why the view that monopolies are bad are accepted as a given and why this view is worth questioning. The bias towards perfect competition (its implicit in the word perfect) may be because its easiest to model. Economics is all about modeling the world to make it easier to deal with. Perfect competition is one of those variables that doesnt change and is easier to model in a mathematical equation. The two criticisms of perfect competition are people involved in a business might actually want to make a profit & things within the market are constantly changing which doesnt lead to an equilibrium. The good and bad of monopolies Before getting into the good of monopolies lets talk about the bad aspects of Monopolies. 1. Monopolies tend to produce lower output and charge higher process than firms in competitive markets do. 2. Monopolies tend to be price setters not price takers. 3. Monopolies price discriminate since monopolists may capture more value by charing different groups different prices. 4. Monopolies stifles innovation since it earns profits whether it

innovates or not. The innovation argument can also be a good thing too. If the monopoly creates something better than the next best thing it can charge higher than its cost of product giving them reward for creating the new thing. Since monopolies last longer than other firms (within perfect competition) it can conduct a more long term view on value. If monopolies exist why dont we see them? Even if the world isnt a perfect competition and monopolies do exist we wouldnt know about them because: 1. Companies dont want to say they are monopolies for fear of the DOJ 2. Monopolies insist they are in bigger markets than they area (were not the monopoly youre looking for) 3. Lies about market share. Is google in the search engine market or advertising market or a tech company? Depending on what you compare it against its market share is drastically different. How a company can own a market If monopolies do exist a new startup should set out to own an entire market. For a company to do this it has to have some combination of brand, scale cost advantages, network

affects, or proprietary technology. Of those brand is hardest to understand and identify in advance but if you build a brand you build a monopoly. Scale advantages, network effects, and proprietary technology are more easily understood. 1. Scale advantages work best when their are high fixed costs and low marginal costs. Think about Amazon. 2. Network effects locks people into their particular business. Think about the IPod and iTunes. 3. Proprietary technology is technology, for whatever reason, no one can use besides yourself. Think about a new drug. The archetypal monopoly story The best business is one where you can tell a compelling story about the future which leads to a monopoly. All of the great companies have a similar archetypal story that follows something like this: 1. 2. 3. 4. 5. 6. Find a small target market Become the best in the world at it Take over adjacent markets Widen the aperture of what the companies doing Capture more and more of the market. Once the operation is quite large some combination of network effects, technology, scale advantages, and brand should make it very hard

for others to follow. Value of high growth monopolies Valuations for high growth companies are different than valuations of businesses in decline because at first most of them loose money and most of the value exist far into the future. This is counterintuitive because most people, even ones working in startups, think you have to create value right off the bat. The focus is on the next month, quarters, or less frequently years. For startups this is too short of a timeline. Paypal and Linkedin are good examples where much of the value is expected to be gained in 2020 and beyond. This is why valuations driven by multiples and comparables tend to not work as well with high growth companies. They are too heavily based on the standards and conventions that exist at that time and not take into account the future value. In startups so much value is placed on having first mover advantage but the danger is you simply arent going to be around to success. More important is to be durable and last a long time. Business is like chess where you have to study the endgame before anything else.

The biggest secret is there are many

important secrets left

This is a post about secret #4 about startups by Peter Thiel. To see all 4 of the secrets start here. TLDR: The biggest secret is there are many important secrets left. Tweet this. Secrets answer the question, what important truth do very few people agree with you on? Secrets are the unpopular or unconventional answers to this question. In a business context, the key question is: what great company is no one starting? If there are many possible answers, it means that there are many great companies that could be created. If there are no good answers, its probably a very bad idea to start a company. From this perspective, the question of how many secrets exist in our world is roughly equivalent to how many startups people should start. Some secrets are small and incremental. Others are very big. Some secretsgossip, for instanceare just silly. The purpose of Peter Thiels class is to share some secrets about starting a company: Monopolies, Distribution, and Power Laws.

The biggest secret is there are many important secrets left. Everyone used to believe there was many more things to do but now we no longer believe that, its a secret again. Why do people disbelieve in secrets? Four primary things have been driving peoples disbelief in secrets. 4. First is the pervasive incrementalism in our society. People seem to think that the right way to go about doing things is to proceed one very small step at a time. Second is that people are becoming more riskaverse. People today tend to be scared of secrets. They are scared of being wrong. Of course, secrets are supposed to be true. But in practice, whats true of all secrets is that there is good chance theyre wrong. Third is complacency. Theres really no need to believe in secrets today. Law school deans at Harvard and Yale give the same speech to incoming first year students every fall: Youre set. You got into this elite school. Your worries are over. Finally, some pull towards egalitarianism is driving us away from secrets. We find it increasingly hard to believe that some people have important insight into reality that other people do not.

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Twitters secret The story of web 2.0 and the information age has been the story that, on some level, many small secrets can add up and change the world. Its easy to make fun of things like Twitter. Youre limited to 140 characters. No individual tweet is particularly important. Most are probably kind of useless. But in the aggregate, the platform has proven quite powerful. Social media has, the story goes, played a non-trivial role in great political transformation and even governmental overthrow. The secret force behind this web 2.0 empowerment is the fact that there are far more secrets that people think. If things are very different in the increasingly transparent world, it just means that they were covered up before. To the extent that things are not transparent, they are secretive. And all these small secrets add up to something very big indeed. How to find secrets There is no straightforward formula that can be used to find secrets. You cant make a list of them so the only thing you can do is develop a good method for finding important secrets. From this there are two types of secret 4. 5. Natural secrets, involving science and the world around us. Secrets about people (people wont tell you or

cant express). There is something to be said for both approaches. But the importance of human secrets is probably underappreciated. These might be political secrets. Or they might be anthropological or psychological secrets. Here, you just ask the questions and see where they lead. What kinds of things are we allowed to talk about? Are there areas that people cant look into? What is explicitly forbidden? What is implicitly off-limits or taboo? On one hand natural secrets are hard but politically safe but human secrets are different, theres usually much more at stake.

Distributions importance is understand least in startups

This is a post about secret #3 about startups by Peter Thiel. To see all 4 of the secrets start here. TLDR: Distributions importance is understand least in startups. Tweet this. Distribution is how you get a product out to consumers. More generally it can refer to how you spread the message about your company. The distribution secret also has two sides to it.

Distribution is much more important than people think. That makes it a business secret. But its a human secret too, since the people involved in distribution work very hard to hide whats going on. Salespeople do best when people do not know theyre dealing with salespeople. Distribution is the single topic whos importance people understand least. Even if you have an awesome product you still have to get it out to people. Distribution isnt the same for every business One helpful way to think about distribution is to realize that different kinds of customers have very different acquisition costs. You build and scale your operation based on what kinds of things youre selling. On one extreme you have inexpensive products such as steak knives where sales are a couple of dollars each. The other extreme your selling to governments or huge companies and sales are $1M-$50M each. As the unit value of each sale goes up, there is necessarily a shift towards more people-intensive processes. Your approach to these kinds of sales must be to utilize salespeople and business development people, who are basically just fancy salespeople who do three martini lunches and work on complex deals.

The truth is that selling thingswhether were talking about advertising, mass marketing, cookiecutter sales, or complex salesis not a purely rational enterprise. It is not just about perfect information sharing, where you simply provide prospective customers with all the relevant information that they then use to make dispassionate, rational decisions. There is much stranger stuff at work here. To succeed, every business has to have a powerful, effective way to distribute its product. Great distribution can give you a terminal monopoly, even if your product is undifferentiated. The converse is that product differentiation itself doesnt get you anywhere. Understanding the critical importance of distribution is only half the battle; a companys ideal distribution effort depends on many specific things that are unique to its business. Just like every great tech company has a good, unique product, theyve all found unique and extremely effective distribution angles too. Different distribution models 8. Complex Sales Deal sizes of $1M-$500M+ per deal Examples are SpaceX and Palantir. At this scale is relationship intensive and its important

the CEO is upper management is involved in all of the sales. 9. Large sales Deal Sizes of $10K-$100K per deal Examples are Yammer and ZocDoc. Need to have a more cookie cutter sales process that scales and build out a sales team. 10. Missing middle sales There is a large zone in the middle where theres no good distribution channel to reach customers. If you get the distribution right in this category you may have a terminal monopoly business. Example is inuit which sells tax software. Now they they are the standard, its probably impossible to displace. 11. Marketing/Advertising Low cost consumer items Examples Coke, Downey, Zynga, etc Find a differentiated way to target your customer demographic online. Examples would be Zynga who built their distribution off of Facebook and Googles ad networks. 12. Viral Marketing Create strong network effects that get every 1 customer to pull in more than 1 additional customer. PayPal got their first 100,000s of customers through referral programs and viral growth. Note: The hard part of viral marketing is marketing people cant do viral marketing. You dont just build a product and then choose viral marketing. There is no viral marketing add-on. But viral marketing requires

that the products core use case must be inherently viral. Usually only one distribution model wins Power law strikes again you probably wont have a bunch of equally good distribution strategies. Most businesses actually get zero distribution channels to work. Poor distributionnot productis the number one cause of failure. If you can get even a single distribution channel to work, you have great business.

Massive inequality exists

This is a post about secret #2 about startups by Peter Thiel. To see all 4 of the secrets start here. TLDR: Massive inequality exists. Tweet this. This is the second secret. A power law distribution curve (or more generally called a power law) is one where a small sample produces the majority of the effect or put in easier way to grasp one in where 20% of the actions produce 80% of the results (Paretos principle). In one sense its a secret about finance, Startup outcomes are not evenly distributed; they follow a power law distribution. But in another sense its a

very human secret. People are uncomfortable talking about inequality, so they either ignore it or rationalize it away. It is psychologically difficult for investors to admit that their best investment is worth more than the rest of their portfolio companies combined. So they ignore or hide that fact, and it becomes a secret. Here is how this secret manifests itself in venture capital investing. How VCs think The most important concept to understand for technology investors is exponential power. As Einstein says the most powerful force in the universe is compound interest. Because of the power law distribution, Venture Capital investor returns are incredibly skewed. In practice VCs only make money if your best company investment ends up being worth more than your whole fund. The two conclusions this brings up for investors are: 13. Every investment has to have the potential of being worth more than the whole fund. 14. Its better to be very concentrated in a few investments as opposed to being diversified. Real example of power law The 100th employee

at Google did much better than the average venturebacked CEO did in the last decade. The distribution is worth thinking hard about. The power law distribution simply means you have to think hard about a given company is going to fall on the curve. Power law applies to everything Understanding exponents and power law distributions isnt just about understanding VC. There are important personal applications too. Many things, such as key life decisions or starting businesses, also result in similar distributions. This secret plays a very important part for all of Peter Thiels other secrets and views as a whole.