In Peter Thiel’s hot book, Zero to One: Notes on Startups, or How to Build the Future, he makes many interesting observations (some I agree with, some I do not) but one in particular is particularly valuable. Thiel asserts that great companies are not great because they beat their competition, they are great because they do not have competition. Although he does not quote Blue Ocean Strategy, it is very consistent with their thesis and data that shows that companies that create new markets have much higher economic returns than those who come up with new strategies to defeat their competition.
Thiel’s point about the benefits of creating what he refers to as a monopoly, what I call a blue ocean opportunity, resonated with me as he use basic economics to prove the point. At its core, classical economics shows competition will drive out excess profits. That is why although Exxon makes a lot of money, they do not make a higher return on investment than another oil company. Whatever you are doing, somebody else will copy.
Thiel points out that, “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.“ Instead he advocates building a virtual monopoly, a company so good at what it does that no other firm can offer a close substitute.
Copying does not create great companies
Given that copying a successful company will not generate excess profits since competition will drive down profits, the only way to create a great (great as in incredibly profitable) company is by building something nobody else is building. Thiel writes, “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. And the next Mark Zuckerberg won’t create a social network. If you are copying these guys, you aren’t learning from them.“
If competing in an existing market will not lead to a great company, then a strategy of disruption will not lead to a great company. Thiel writes, “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.” Disruption means you will be competing with existing players in a different way. That will not create a monopoly as you must avoid competition as much as possible.
Thiel, one of the most successful venture capitalists of all time, also points out why it is a red flag when a founder comes to him and talks about getting 1perent of a $ 100 billion market. What they are saying is that they either lack a good starting point or for entering the market or it will be open to competition, so it’s hard to ever reach that 1 percent. And even if they do gain that 1 percent, you will have to focus on keeping the lights on: cutthroat competition means their profits will be zero.
It’s not about winning
While it may be good if you are a football player from South America or a general in the middle east, success in business is not about winning. One of the things I find most executives is when executives stress how they are going to “win.” What it really means is they are going to compete like crazy in an existing, difficult market and even if they come out with the most market share will not have excess profits, the competition will drive the profit level down. I see this mistakes day after day in the video game industry, where companies think they are cleverer than their competitors and thus try to do the same thing better. Except for the game companies who have created a new space (think Mojang with Minecraft), most end up being the subject of sob stories on Gamasutra.
Rivalry causes companies to overemphasize old opportunities and slavishly copy what has worked in the past.
Competition also can make people hallucinate opportunities where none exist. Thiel points to the dot com craze, where miliions and millions were invested in Pets.com, Petscore.com, and Petopia.com with the hope one would win the space. Each company was obsessed with defeating its rivals, precisely because there were no substantive differences to focus on. In the end, it did not matter who won because there was no opportunity.
Building a great company
Since creating a business that is better than the competition or likely to win will not lead to a great business, you must identify what valuable company nobody is 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.
A new company’s most important strength is new thinking: even more important than nimbleness , small size affords space to think.
Thiel points to several areas that can help you build a great business:
- Proprietary technology can make your product hard or impossible to copy.
- Network effects, where the more users you have the more value you create for existing users, helps create a monopoly. Facebook is the trite but accurate example, nobody can create a social network because people already have all their friends on Facebook.
- A business that benefits from economies of scale, where as it gets bigger the fixed costs (engineering, management, etc) get amortized over a great quantity of sales. With software this is powerful because the marginal costs is often zero (or slightly higher for cloud companies but still lower), so those fixed costs start to approach zero per unit.
- Building a strong brand, as a company effectively has a monopoly on its brand (nobody else can use the name Coke). Creating a strong brand is a powerful way to claim a monopoly.
Finally, make sure you are creating a real monopoly and not what I call a faux monopoly. Exaggerating your own uniqueness is an easy way to botch the monopoly question.
The impact on investors
I also wanted to touch on what I considered the most entertaining part of the book, how this understanding regarding competition impacts investment strategy by venture capital. Thiel points out, “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. This implies two very strange rules for VCs. First, 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. (Even quite successful companies usually succeed on a more humble scale.) This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.“ Given this principle, although even the best investors have a portfolio, investors who understand the power law make as few investments as possible.
Thiel also pokes fun at fellow billionaire investor John Doerr. Thiel recalls the story of when Doerr announced in 2006, “green is the new red, white and blue. He could have stopped at ‘red.’ As Doerr himself said, ‘Internet-sized markets are in the billions of dollars; the energy markets are in the trillions.’ What he didn’t say is that huge, trillion-dollar markets mean ruthless, bloody competition.“ Thiel then points out how these cleantech investments proved to be one of the biggest failures in the history of venture capital.
- Basic economics shows that competition drives profits to zero. Thus, if you want to create a great, highly profitable completion, you must seek a virtual monopoly.
- Winning is great in sports but in business it is a false goal, winning means competition, while avoiding the competition creates excess profits.
- To create a business that enjoys monopoly profits, leverage proprietary technology, network effects, economies of scale and a strong brand.