Lecture 5 - Competition is for Losers (Peter Thiel)

Introduction (00:00:00)

• Peter Thiel, founder of PayPal, Palantir, and Founders Fund, discusses strategy and competition.
• Thiel believes that entrepreneurs should aim for monopoly and avoid competition.

CAPTURING VALUE (00:01:00)

• A valuable company creates X dollars of value for the world and captures Y% of X.
• X and Y are independent variables, so X can be big and Y can be small, or vice versa.
• To create a valuable company, entrepreneurs must create something of value and capture a fraction of that value.

BIG PIECE OF A SMALL PIE (00:02:01)

• Comparing the US airline industry with Google illustrates the difference between X and Y.
• Airlines are more important than search in terms of revenue, but Google is more valuable.
• The airline industry has low profit margins and has been marginally profitable over its history.
• Google, despite being smaller than the airline industry, is much more valuable due to its high Y%.

PERFECT COMPETITION (00:03:40)

• Perfect competition is easy to model and efficient in static environments.
• It is politically seen as good to have competition.
• However, it is not always good for businesses involved as they often don't make money.

DIFFERENCES UNDERESTIMATED (00:05:39)

• The apparent differences between perfect competition and monopolies are quite small.
• Monopolists pretend not to have monopolies to avoid government regulation.
• Non-monopolists pretend to have monopolies to differentiate themselves and attract capital.

NARRATIVES (00:07:02)

• Non-monopolists lie that they are in a very small market.
• Monopolists lie that the market they are in is much bigger than it looks.
• Non-monopolists describe their market as the intersection of vastly different markets.
• Monopolists describe their market as the union of these vastly different markets.

BRITISH FOOD IN PALO ALTO (00:07:57)

• Capitalism and competition are often seen as antonyms.
• Opening a restaurant business is a terrible business because there is too much competition and no one wants to invest.
• To attract investors, a restaurant owner might create a fictitiously narrow market by claiming to be the only British food restaurant in Palo Alto.
• However, this market is too small and not viable.

BLOCKBUSTER MOVIE (00:08:49)

• Movies are often pitched as being unique and different, but in reality, they are often just another movie in a crowded market.
• This makes it very difficult to make money in Hollywood.

IS THE INTERSECTION VALUABLE? (00:09:32)

• When evaluating a business idea, it is important to ask whether the intersection of different elements creates real value.
• Simply combining buzzwords like "sharing," "mobile," "social," and "apps" does not guarantee success.

STARTUP VERSION (00:09:39)

• Many startups use a formulaic approach by combining buzzwords without creating a real business.
• This pattern recognition often leads to failure.
• Google, with its dominant 66% market share in the search market, does not describe itself as a search engine.
• Instead, it describes itself in various ways, such as an advertising company.

THE ADVERTISING MARKET (00:11:04)

• The search advertising market is a small part of the larger online advertising market, which is in turn a part of the even larger US advertising market.
• Global advertising is worth close to $500 billion, making search advertising a tiny fraction of a much larger market.

THE TECHNOLOGY MARKET (00:11:31)

• Google presents itself as a technology company competing in various sectors like self-driving cars, TVs, iPhones, office products, and cloud services.
• This narrative helps Google avoid being seen as a monopoly and evades regulations.

EVIDENCE OF NARROW MARKETS (00:12:39)

• Big tech companies like Apple, Google, Microsoft, and Amazon have been accumulating cash and have high-profit margins.
• The tech industry's financial success in the US is attributed to its tendency to create monopoly-like businesses.
• These companies accumulate so much cash that they struggle to find ways to use it effectively.

THE RIGHT SIZE (00:13:42)

• To build a monopoly, startups should target small markets and gradually expand.
• Starting with a large market on day one is usually a mistake as it indicates poorly defined categories and intense competition.
• Successful companies in Silicon Valley often start with small markets and expand over time.
• Examples:
  • Amazon started as an online bookstore and gradually expanded into various forms of e-commerce.
  • eBay began by selling Pez dispensers.

START SMALL AND EXPAND (00:15:04)

• Start with small markets that people often overlook.
• PayPal started with power sellers on eBay, a small market of about 20,000 people.
• Achieved 25-30% market penetration in 2-3 months.
• Facebook started with 10,000 people at Harvard and reached 60% market share in ten days.
• Small markets can be valuable if they have the potential for concentric growth.

START BIG AND SHRINK (00:17:08)

• Avoid starting with massive markets.
• Clean tech companies in the 2005-2008 bubble often started with vast markets, leading to intense competition.
• Being a "minnow in a vast ocean" is not a good position.
• Aim to be a one-of-a-kind company in a small ecosystem.
• Large existing markets typically mean lots of competition and difficulty in differentiation.
• Small markets provide a foothold for growth and potential expansion into a big monopoly business.

CHARACTERISITICS OF MONOPOLY (00:18:48)

• Monopoly technology companies often possess proprietary technology that significantly surpasses alternatives, leading to market dominance.
• Network effects can foster monopolies over time but are challenging to establish initially.
• Economies of scale, characterized by high fixed costs and low marginal costs, are common in monopoly-like businesses.
• Branding creates value by lodging ideas in consumers' minds, although its mechanism is not fully understood.
• Software businesses excel at achieving economies of scale due to the zero marginal cost of software.
• The essence of a monopoly lies not only in its momentary existence but in its ability to endure over time.
• The true value of tech companies resides in their distant future cash flows, with a substantial portion originating years ahead.
• Silicon Valley's analysis of tech companies overemphasizes growth rates while undervaluing durability.
• Evaluating monopoly characteristics, such as proprietary technology, network effects, and economies of scale, should consider their long-term sustainability rather than just their current state.
• Network effects strengthen as the network expands, reinforcing the monopoly power of network effect businesses over time.
• Proprietary technology must be significantly superior to the current standard to gain initial attention and break through, but it must also be sustainable to avoid being surpassed by competitors.
• Technological breakthroughs should be accompanied by an explanation of their potential longevity or the feasibility of rapid improvements to prevent competitors from catching up.
• While a continuous innovation structure may benefit society, it can hinder a business's success.

VALUE OF THE FUTURE (00:27:14)

• The first mover in chess has a slight advantage, but the last mover wins the game.
• Capablanca, a world chess champion, began by studying the endgame.
• It is important to ask why a company will still be leading in 10, 15, or 20 years.

TECHNOLOGICAL INNOVATION (00:28:27)

• Most scientific discoveries and technological innovations do not result in financial rewards for their inventors.
• Even in industries with significant technological advancements, such as the textile industry during the first industrial revolution, competition often prevented individuals from capturing the full value of their innovations.
• Complex vertically integrated monopoly structures, such as Ford and Standard Oil, were one of the few exceptions where people were able to create wealth through innovation during the second industrial revolution.
• Tesla and SpaceX innovated on many dimensions but didn't have a single massive breakthrough.
• Integrating all the pieces together and being more vertically integrated than competitors is impressive.
• Vertical integration is an under-explored modality of technological progress.
• Software has incredible economies of scale and low marginal costs.
• Fast adoption is critical to capturing and taking over markets.
• Silicon Valley's success and software's phenomenal growth can be attributed to these factors.
• People often give rationalizations for why certain things work or don't work, obscuring the question of creating X dollars in value and capturing Y percent of X.
• The science rationalization suggests scientists are not motivated by money, but this may be a way to obscure the fact that they can't capture any of the value they create due to competition.
• The software distortion occurs when people assume that because software companies make vast fortunes, software is the most valuable thing in the world, ignoring that X and Y are independent variables.
• The history of innovation shows that the microeconomics and structure of industries matter a lot.
• Some people have made vast fortunes in industries with the right structure, while others have made nothing in competitive industries.
• It's important to understand these differences and not just rationalize them away.

OUTLINE (00:37:06)

• The talk challenges the conventional view of competition and suggests that it may be overrated.
• Competition is often associated with losers, such as those who perform poorly in sports or academics.
• The speaker proposes that we reconsider the value of competition and explore the possibility that it may be flawed.
• The dichotomy between monopoly and competition is distorted and people tend to lie about it.
• There is a psychological blind spot that makes us attracted to competition and find it reassuring when others do things.

MIMETIC PREFERENCES (00:38:17)

• Humans have a deeply mimetic nature, meaning they imitate others.
• This imitative behavior is problematic and should be overcome.