The Reading Room
Zero to One: Notes on Startups, or How to Build the Future
“People also ask: How much money did Peter Thiel make from Facebook? Is Peter Thiel a genius? What is Peter Thiel known for? How can I get in touch with Peter Thiel?”
Such peculiar popular Google searches for the co-founder of Paypal, the first outside investor in Facebook, and founder of big data analytics company Palantir corroborates why Zero to One is an interesting read. The book is a compilation of notes from a class Peter Thiel taught on start-ups for Computer Science students at Stanford University in 2012.
Whilst only two hundred pages long it is much more than a business or investing book. It covers Thiel’s world view grounded in his knowledge of history, philosophy, economics, science, and technology.
He criticises the consensus amongst many in the investment, legal, and accounting world that luck plays the major part in business success and laments that it is popular to relegate grand vision to a supporting role today. Such a mindset discourages boldness and favours diversification – entrepreneurs wouldn’t get out of bed if they thought this way. Thiel starts with defining a start-up as the “largest group of people you can convince of a plan to build a different future”. He also negatively defines it in the sense that it’s hard to develop new things in big organisations, and it’s even harder to do it by yourself – hence why a start-up comes into existence.
From the seventeenth century to the 1960’s a definite optimism about the future encouraged innovation – moving us from Zero to One. There was little globalisation but positivity about limitless possibilities from technology – from the spinning jenny to underwater cities and fusion energy.
His favourite interview question is “what’s something that you think is true that next to no one agrees with you on?”. An intellectual obsession with stasis and therefore luck has prevailed since the 1980’s. As such, globalisation has prevailed over innovation. This means doing the same thing cheaper somewhere else (1 to n) for example producing 100 typewriters more efficiently. He cites China as an exemplar of this – relentless copying of Western technology at a cheaper rate. In this environment, most of us are pessimistic about the future and so pursue “well-roundedness”. Vertical progress (zero to 1) such as replacing the typewriter with a word processor is hard because it’s doing something no one else has ever done. From a behavioural perspective it can be agonising: “the prospect of being lonely and right – dedicating your life to something that no one else believes in – is already hard. The prospect of being lonely and wrong can be unbearable.” This makes grand thinking from people like his former business partner Elon Musk exist in short supply. We are inclined to fear technology and hence conclude that Space X or Jeff Bezos’s Blue Origin LLC are simply the product of billionaire boys’ are ego trips. Instead Thiel argues that “Without new technology to relieve competitive pressures, stagnation is likely to erupt into conflict”. Musk’s desire to enable us to become a multi-planetary species takes on a new meaning in such context.
The book provides a fresh perspective on monopolies. In economics we are taught that they are price gougers and that there is a spectrum from total monopoly to perfect competition. Instead the reality is much more binary. A company is either in perfect competition or a monopoly with constituents claiming to belong to the other camp and not their own. Palo Alto’s “only British restaurant” will claim to be unique and differentiated when in reality it is in cutthroat combat with other eateries depressing profits. On the flipside, Google will claim it is not a monopoly but a small part of a global advertising industry.
Monopolies get a bad reputation as they are seen through the lens of the board game where there is no change in the world and no technological change to disrupt the status quo. The relative value of properties are fixed for all of time so all we can do is buy them up and rent-seek. What many economists fail to recognise is that we live in a world that is dynamic. Where it’s still possible to invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world.
The dynamism of new monopolies explains why old monopolies don’t strangle innovation. Apple’s iOS reduced Microsoft’s decades-long operating system dominance. IBM’s hardware monopolies of the ‘60s and ‘70s was overtaken by Microsoft’s software monopoly. AT&T had a monopoly on telephony for most of the twentieth century.
“Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate…”
As such successful companies try to monopolise small niches and then adjacent to adjacent markets. Amazon started with books –low storage costs, easy to pack, ship and post. Facebook monopolised the Harvard undergraduate social scene then moved onto dominating students before expanding beyond there. VC investors should be looking for creative monopolies:
“Creative monopoly means new products that benefit everybody and sustainable profits for the creator. Competition means no profits for anybody, no meaningful differentiation, and a struggle for survival.”
The book elaborates on how to approach venture from a portfolio perspective. Returns follow a power law distribution and so spray-and-pray doesn’t work. A small handful of companies will radically outperform all others:
“Only invest in companies that have the potential to return the value of the entire fund. This is a scary rule because it eliminates the vast majority of possible investments…VCs must find the handful of companies that will successfully go from 0 to 1 and then back them with every resource.”
Identifying a potential monopoly is a challenge but there are four aspects to consider. Proprietary technology that is 10x better than its closest substitution. Network effects, whereby the company becomes more useful as customer numbers grow (however the product has to be valuable to its first users when the network is small). Economies of scale where fixed costs can be spread over an ever-greater quantity of sales. A software start-up can enjoy this dramatically as the marginal cost of producing another copy of the product is next to zero. All good start-ups should have the potential for great scale built into their first design. Finally branding is important – on the assumption that there is strong underlying substance. For instance Apple’s sleek designs and in-store experiences had to be built on superior technology.
Drilling down into the portfolio, successful start-ups can be identified from their foundations and some examples he highlights are as follows:
- Founders should have a shared history
- A board of three is ideal to prevent conflicts
- Anyone who doesn’t own stock options or draw a regular salary from your company is fundamentally misaligned. At the margin, they’ll be biased to claim value in the near term, not help you create more value in the future. That’s why hiring consultants or part time employees don’t work
- In no case should a CEO of an early-stage, venture-backed startup receive more than $150k per year in salary
- Equity is a powerful tool to keep necessary secrets inside the business and everyone aligned.
Thiel argues that the importance of sales is underrated and explores different approaches drawing on his experiences at Paypal and Palantir. The book also delves into the failures of bio-tech and green energy companies before issuing a clarion call to investors and entrepreneurs:
“We cannot take for granted that the future will be better, and that means we need to work to create it today….Only by seeing our world anew, as fresh and strange as it was to the ancients who saw it first, can we both re-create it and preserve it for the future.”
That is his answer to his favourite question – possibilities for humanity are still endless. The book is short, thought provoking and very readable. Whilst learning valuable lessons from his considerable business experience, one also gets a fresh perspective on the current malaise affecting large parts of the world and different approaches to tackle it.
The information contained above and in other entries in the Ocean Dial Book Review Series is intended for general information and entertainment purposes only, and should not be relied upon in making, or refraining from making, any investment decisions. No information provided herein should or can be taken to constitute any form of advice or recommendation as to the merits of any investment decision. You should take independent advice from a suitably qualified investment adviser before making any investment decisions.
Published: 1933, Philip Allan & Co. Ltd
On August 1, 1914, on the eve of World War I, Sir Ernest Shackleton and his hand-picked crew embarked in HMS Endurance from London’s West India Dock, for an expedition to the Antarctic. It was to turn into one of the most breathtaking survival stories of all time.
Published: 2011, Columbia University Press
Informed by a lifetime of experience and study, The Most Important Thing explains the keys to successful investment and the pitfalls that can destroy capital or ruin a career.