Zero to One is Peter Thiel guide on how/why business thrive or collapse and what we should consider if we are interested in starting our own venture. Peter has been a co-founder for key start-ups such as Paypal and Palantir.
Zero to One
Every moment in business happens only once. The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. If you are copying these guys, you aren’t learning from them. Of course, it’s easier to copy a model than to make something new. Doing what we already know how to do takes the world from 1 to n, adding more of something familiar. But every time we create something new, we go from 0 to 1.
When we think about the future, we hope for a future of progress. That progress can take one of two forms. Horizontal or extensive progress means copying things that work—going from 1 to n. Vertical or intensive progress means doing new things—going from 0 to 1. Vertical progress is harder to imagine because it requires doing something nobody else has ever done.
At the macro level, the single word for horizontal progress is globalization—taking things that work somewhere and making them work everywhere. The single word for vertical, 0 to 1 progress is technology. But there is no reason why technology should be limited to computers. Properly understood, any new and better way of doing things is technology. In a world of scarce resources, globalization without new technology is unsustainable.
New technology tends to come from new ventures—startups. It’s hard to develop new things in big organizations, and it’s even harder to do it by yourself. In the most dysfunctional organizations, signaling that work is being done becomes a better strategy for career advancement than actually doing work. At the other extreme, a lone genius might create a classic work of art or literature, but he could never create an entire industry. Startups operate on the principle that you need to work with other people to get stuff done, but you also need to stay small enough so that you actually can.
The entrepreneurs who stuck with Silicon Valley learned four big lessons from the dot-com crash that still guide business thinking today:
- Make incremental advances.
- Stay lean and flexible
- Improve on the competition.
- Focus on product, not sales.
And yet the opposite principles are probably more correct:
- It is better to risk boldness than triviality.
- A bad plan is better than no plan.
- Competitive markets destroy profits.
- Sales matters just as much as product.
To build the next generation of companies, we must abandon the dogmas created after the crash. There are seven questions that every business must answer:
- The Engineering Question: Can you create breakthrough technology instead of incremental improvements?
- The Timing Question: Is now the right time to start your particular business?
- The Monopoly Question: Are you starting with a big share of a small market?
- The People Question: Do you have the right team?
- The Distribution Question: Do you have a way to not just create but deliver your product?
- The Durability Question: Will your market position be defensible 10 and 20 years into the future?
- The Secret Question: Have you identified a unique opportunity that others don’t see?
Whenever I interview someone for a job, I like to ask this question: “What important truth do very few people agree with you on?” A good answer takes the following form: “Most people believe in x, but the truth is the opposite of x.” The most contrarian thing of all is not to oppose the crowd but to think for yourself.
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. This means that even very big businesses can be bad businesses.
There are two kinds of secrets: secrets of nature and secrets about people. Natural secrets exist all around us; to find them, one must study some undiscovered aspect of the physical world. Secrets about people are different: they are things that people don’t know about themselves or things they hide because they don’t want others to know. So when thinking about what kind of company to build, there are two distinct questions to ask: What secrets is nature not telling you? What secrets are people not telling you?
Perfect Competition and Monopolies
“Perfect competition” is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand. Every firm in a competitive market is undifferentiated and sells the same homogeneous products. Since no firm has any market power, they must all sell at whatever price the market determines. If there is money to be made, new firms will enter the market, increase supply, drive prices down, and thereby eliminate the profits that attracted them in the first place. If too many firms enter the market, they’ll suffer losses, some will fold, and prices will rise back to sustainable levels. Under perfect competition, in the long run no company makes an economic profit. The opposite of perfect competition is monopoly. Whereas a competitive firm must sell at the market price, a monopoly owns its market, so it can set its own prices. Since it has no competition, it produces at the quantity and price combination that maximizes its profits.
Americans mythologize competition and credit it with saving us from socialist bread lines. Actually, capitalism and competition are opposites. 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.
Both monopolists and competitors are incentivized to bend the truth. Monopolists lie to protect themselves. They know that bragging about their great monopoly invites being audited, scrutinized, and attacked. Since they very much want their monopoly profits to continue unmolested, they tend to do whatever they can to conceal their monopoly—usually by exaggerating the power of their (nonexistent) competition. Non-monopolists tell the opposite lie: “we’re in a league of our own.” The fatal temptation is to describe your market extremely narrowly so that you dominate it by definition.
Non-monopolists exaggerate their distinction by defining their market as the intersection of various smaller markets. Monopolists, by contrast, disguise their monopoly by framing their market as the union of several large markets.
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.
So, a monopoly is good for everyone on the inside, but what about everyone on the outside? Do outsized profits come at the expense of the rest of society? Actually, yes: profits come out of customers’ wallets, and monopolies deserve their bad reputation—but only in a world where nothing changes. In a static world, a monopolist is just a rent collector.
Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Even the government knows this: that’s why one of its departments works hard to create monopolies (by granting patents to new inventions) even though another part hunts them down (by prosecuting antitrust cases).
Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and to finance the ambitious research projects that firms locked in competition can’t dream of.
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.
Rivalry causes us to overemphasize old opportunities and slavishly copy what has worked in the past.
Winning is better than losing, but everybody loses when the war isn’t one worth fighting.
Building a Monopoly
Simply stated, the value of a business today is the sum of all the money it will make in the future. (To properly value a business, you also have to discount those future cash flows to their present worth, since a given amount of money today is worth more than the same amount in the future.) Comparing discounted cash flows shows the difference between low-growth businesses and high-growth startups at its starkest. Most of the value of low-growth businesses is in the near term. Technology companies follow the opposite trajectory. They often lose money for the first few years: it takes time to build valuable things, and that means delayed revenue. Most of a tech company’s value will come at least 10 to 15 years in the future.
For a company to be valuable it must grow and endure, but many entrepreneurs focus only on short-term growth. They have an excuse: growth is easy to measure, but durability isn’t (will this business still be around a decade from now?).
Every monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding.
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.
Network effects make a product more useful as more people use it. Network effects can be powerful, but you’ll never reap them unless your product is valuable to its very first users when the network is necessarily small.
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.
A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful way to claim a monopoly.
Every startup is small at the start. Every monopoly dominates a large share of its market. Therefore, every startup should start with a very small market. The reason is simple: it’s easier to dominate a small market than a large one. Once you create and dominate a niche market, then you should gradually expand into related and slightly broader markets. As you craft a plan to expand to adjacent markets, don’t disrupt: avoid competition as much as possible. If you truly want to make something new, the act of creation is far more important than the old industries that might not like what you create. Indeed, if your company can be summed up by its opposition to already existing firms, it can’t be completely new and it’s probably not going to become a monopoly.
Image by author, adapted from Zero to One Chapter 6.
- To a definite optimist, the future will be better than the present if he plans and works to make it better.
- To an indefinite optimist, 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. Instead of working for years to build a new product, indefinite optimists rearrange already-invented ones.
- A definite pessimist believes the future can be known, but since it will be bleak, he must prepare for it. Every other country is afraid that China is going to take over the world; China is the only country afraid that it won’t.
- An indefinite pessimist looks out onto a bleak future, but he has no idea what to do about it. The indefinite pessimist can’t know whether the inevitable decline will be fast or slow, catastrophic or gradual. All he can do is wait for it to happen, so he might as well eat, drink, and be merry in the meantime: hence Europe’s famous vacation mania.
While a definitely optimistic future would need engineers to design underwater cities and settlements in space, an indefinitely optimistic future calls for more bankers and lawyers. Finance epitomizes indefinite thinking because it’s the only way to make money when you have no idea how to create wealth.
An an indefinite world, people actually prefer unlimited optionality; money is more valuable than anything you could possibly do with it. Only in a definite future is money a means to an end, not the end itself.
Definite optimism works when you build the future you envision. Definite pessimism works by building what can be copied without expecting anything new. Indefinite pessimism works because it’s self-fulfilling: if you’re a slacker with low expectations, they’ll probably be met. But indefinite optimism seems inherently unsustainable: how can the future get better if no one plans for it? Progress without planning is what we call “Darwinian evolution.”
Making small changes to things that already exist (lean start-up methodology) might lead you to a local maximum, but it won’t help you find the global maximum (iteration without a bold plan won’t take you from 0 to 1).
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 offers too much or too little: founders only sell when they have no more concrete visions for the company, in which case the acquirer probably overpaid; definite founders with robust plans don’t sell, which means the offer wasn’t high enough.
A business with a good definite plan will always be underrated in a world where people see the future as random.
Venture capitalists aim to identify, fund, and profit from promising early-stage companies. They raise money from institutions and wealthy people, pool it into a fund, and invest in technology companies that they believe will become more valuable. If they turn out to be right, they take a cut of the returns—usually 20%. A venture fund makes money when the companies in its portfolio become more valuable and either go public or get bought by larger companies. Venture funds usually have a 10-year lifespan since it takes time for successful companies to grow and “exit.” But most venture-backed companies don’t IPO or get acquired; most fail, usually soon after they start. Due to these early failures, a venture fund typically loses money at first. VCs hope the value of the fund will increase dramatically in a few years’ time, to break-even and beyond, when the successful portfolio companies hit their exponential growth spurts and start to scale.
But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all. This is because 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.
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.
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.
When you start something, the first and most crucial decision you make is whom to start it with. Choosing a co-founder is like getting married, and founder conflict is just as ugly as divorce.
To anticipate likely sources of misalignment in any company, it’s useful to distinguish between three concepts:
- 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? 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.
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.
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. However, for equity to create commitment rather than conflict, you must allocate it very carefully.
Anyone who prefers owning a part of your company to being paid in cash reveals a preference for the long term and a commitment to increasing your company’s value in the future. Equity can’t create perfect incentives, but it’s the best way for a founder to keep everyone in the company broadly aligned.
Talented people don’t need to work for you; they have plenty of options. You should ask yourself a more pointed version of the question: Why would someone join your company as its 20th engineer when she could go work at Google for more money and more prestige? There are two general kinds of good answers: answers about your mission and answers about your team.
In the most intense kind of organization, members hang out only with other members. We have a word for such organizations: cults. The extreme opposite of a cult is a consulting firm like Accenture: not only does it lack a distinctive mission of its own, but individual consultants are regularly dropping in and out of companies to which they have no long-term connection whatsoever.
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.
Even though sales is everywhere, most people underrate its importance. Silicon Valley underrates it more than most.
Superior sales and distribution by itself can create a monopoly, even with no product differentiation. The converse is not true.
“Madness is rare in individuals—but in groups, parties, nations, and ages it is the rule,” - Nietzsche
“Shallow men believe in luck, believe in circumstances…. Strong men believe in cause and effect.” - Ralph Waldo Emerson
Book Authors: Blake Masters and Peter Thiel