Notes on Zero to One

Peter Thiel begins the book with an anecdote. Whenever he interviews someone for a job, he likes to ask “What important truth do very few people agree with you on?”. Good answers to the question, he says, are as close as we can come to looking into the future.
For the startup and investing world, the parallel that can be drawn from the question is simply- what valuable company is nobody building?
Zero to One is written to be a short and easy read but is packed with insights. Thiel walks us through his view of the world, and what the future holds, by using anecdotes from his personal journey of building PayPal and Palantir, and investing in startups through Founders Fund.
So, what exactly does Zero to One refer to? According to Thiel, there are two models of progress in the world. A 1 to n (horizontal) progress which refers to incremental changes or taking something and building more of it. On the other hand, 0 to 1 refers (vertical) progress involves building something new, something that no one has ever done before.
“If you take one typewriter and build 100, you have made horizontal progress. If you have a typewriter and build a word processor, you have made vertical progress.”
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Thiel advises people to eschew competition and instead aim to build creative monopolies. Competition and rivalry leads us to overemphasize old opportunities and simply copy what has worked in the past.  Further, businesses that are in highly competitive markets often get derailed of their main focus and start doing petty things.
Monopoly is the condition of every successful business, he writes:
Tolstoy opens Anna Karenina by observing: “All happy families are alike; each unhappy family is unhappy in its own way.” Business is the opposite. 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.”
It is important to note that here, Thiel refers to the monopoly of the creative kind- one which is built on innovation and value creation for society and not one which is built on government regulation or licensing.
A monopoly business will typically involve building something completely new, for example, a drug that can safely eliminate the need to sleep or a drug to cure baldness. Otherwise, the product has to radically improve over the current solutions by at least an order of magnitude. PayPal, for example, made buying and selling on eBay at least 10 times better. Instead of mailing a check that would take 7 to 10 days to arrive, PayPal let buyers pay as soon as an auction ended. Similarly, Amazon could claim to be “Earth’s largest bookstore” because, unlike a retail bookstore that might stock 100,000 books, Amazon didn’t need to physically store any inventory—it simply requested the title from its supplier whenever a customer made an order.
Thiel offers clear advice on how to build a monopoly. First, every startup should start with a small, concentrated market, and capture a significant share in it before expanding to other segments, ala Amazon which started with books first and then captured CDs and videos, before becoming the “everything store”. In the process of scaling, disruption of competitors is overrated. Competitive markets are to be avoided like the plague.
For VCs and investors, the most important lesson in the book is that investment returns follow the power law distribution and not a normal distribution. In other words, since most startups fail, 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, Thiel writes.
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.
Consider what happens when you break the first rule. Andreessen Horowitz invested $250,000 in Instagram in 2010. When Facebook bought Instagram just two years later for $1 billion, Andreessen netted $78 million—a 312x return in less than two years. That’s a phenomenal return, befitting the firm’s reputation as one of the Valley’s best. But in a weird way it’s not nearly enough, because Andreessen Horowitz has a $1.5 billion fund: if they only wrote $250,000 checks, they would need to find 19 Instagrams just to break even.
Here are some more assorted practical advice for entrepreneurs:
  • The beginnings of a startup are supremely important. Set a strong  foundation by choosing the right co-founders and employees. It’s hard to go from 0 to 1 without a strong team.
  • Hire co-conspirators who are passionate about your mission and who also enjoy working and hanging out with each other. ” At PayPal, if you were excited by the idea of creating a new digital currency to replace the U.S. dollar, we wanted to talk to you; if not, you weren’t the right fit.”
  • Have a small but exceptional board. Not more than 5 people (ideally 3) who you trust to exercise effective oversight.
  • Equity for employees can help shape incentives to maximize future value creation. It’s okay to discriminate on the amount of equity distributed to the team based on talent and responsibility but keep the information private.
  • CEO pay is an effective tool to set the standard for everyone else:  “Aaron Levie, the CEO of Box, was always careful to pay himself less than everyone else in the company—four years after he started Box, he was still living two blocks away from HQ in a one-bedroom apartment with no furniture except a mattress. Every employee noticed his obvious commitment to the company’s mission and emulated it.”
  • On assigning roles to employees: “The best thing I did as a manager at PayPal was to make every person in the company responsible for doing just one thing. Every employee’s one thing was unique, and everyone knew I would evaluate him only on that one thing. I had started doing this just to simplify the task of managing people. But then I noticed a deeper result: defining roles reduced conflict.”
  • Distribution is as important as the product. There are two important metrics to look at for distribution. The total net profit that you earn on average over the course of your relationship with a customer (Customer Lifetime Value, or CLV) must exceed the amount you spend on average to acquire a new customer (Customer Acquisition Cost, or CAC).
Thiel’s own answer to the contrarian view question mentioned in the beginning, is that while people think that globalization is what will change the world, it is actually technology that is more powerful.
He is optimistic about the future of technology and strongly believes that technology will be complementary to human talents. Thiel shows that building 0 to 1 companies requires eccentric founders. It is these unusual individuals who can set aside traditional wisdom, think from first principles, and build monopolistic companies based on radical innovation.

 

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