EVERY MOMENT IN BUSINESS happens only once. The next Bill Gates will not build 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. 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. The act of creation is singular, as is the moment of creation, and the result is something fresh and strange. Unless they invest in the difficult task of creating new things, American companies will fail in the future no matter how big their profits remain today. What happens when we’ve gained everything to be had from fine-tuning the old lines of business that we’ve inherited? Unlikely as it sounds, the answer threatens to be far worse than the crisis of 2008. Today’s “best practices” lead to dead ends; the best paths are new and untried.
WHENEVER I INTERVIEW someone for a job, I like to ask this question: “What important truth do very few people agree with you on?” This question sounds easy because it’s straightforward. Actually, it’s very hard to answer. It’s intellectually difficult because the knowledge that everyone is taught in school is by definition agreed upon. And it’s psychologically difficult because anyone trying to answer must say something she knows to be unpopular. Brilliant thinking is rare, but courage is in even shorter supply than genius. Most commonly, I hear answers like the following: “Our educational system is broken and urgently needs to be fixed.” “America is exceptional.” “There is no God.” Those are bad answers. The first and the second statements might be true, but many people already agree with them. The third statement simply takes one side in a familiar debate. A good answer takes the following form: “Most people believe in x, but the truth is the opposite of x.” I’ll give my own answer later in this chapter.
ZERO TO ONE: THE FUTURE OF PROGRESSWhen 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. Horizontal progress is easy to imagine because we already know what it looks like. 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. 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.
The single word for vertical, 0 to 1 progress is technology. The rapid progress of information technology in recent decades has made Silicon Valley the capital of “technology” in general. But there is no reason why technology should be limited to computers. Properly understood, any new and better way of doing things is technology.
STARTUP THINKING
A startup is the largest group of people you can convince of a plan to build a different future. A new company’s most important strength is new thinking: even more important than nimbleness, small size affords space to think. This book is about the questions you must ask and answer to succeed in the business of doing new things: what follows is not a manual or a record of knowledge but an exercise in thinking. Because that is what a startup has to do: question received ideas and rethink business from scratch.
LESSONS LEARNED
’Cause they say 2,000 zero zero party over, oops! Out of time!
So tonight I’m gonna party like it’s 1999!
—PRINCE
The NASDAQ reached 5,048 at its peak in the middle of March 2000 and then crashed to 3,321 in the middle of April. By the time it bottomed out at 1,114 in October 2002, the country had long since interpreted the market’s collapse as a kind of divine judgment against the technological optimism of the ’90s. The era of cornucopian hope was relabeled as an era of crazed greed and declared to be definitely over.
Everyone learned to treat the future as fundamentally indefinite, and to dismiss as an extremist anyone with plans big enough to be measured in years instead of quarters. Globalization replaced technology as the hope for the future. Since the ’90s migration “from bricks to clicks” didn’t work as hoped, investors went back to bricks (housing) and BRICs (globalization). The result was another bubble, this time in real estate.
THE DOT-COM CRASH
The entrepreneurs who stuck with Silicon Valley learned four big lessons from the dot-com crash that still guide business thinking today:
1. Make incremental advances
Grand visions inflated the bubble, so they should not be indulged. Anyone who claims to be able to do something great is suspect, and anyone who wants to change the world should be more humble. Small, incremental steps are the only safe path forward.
2. Stay lean and flexible
All companies must be “lean,” which is code for “unplanned.” You should not know what your business will do; planning is arrogant and inflexible. Instead you should try things out, “iterate,” and treat entrepreneurship as agnostic experimentation.
3. Improve on the competition
Don’t try to create a new market prematurely. The only way to know you have a real business is to start with an already existing customer, so you should build your company by improving on recognizable products already offered by successful competitors.
4. Focus on product, not sales
If your product requires advertising or salespeople to sell it, it’s not good enough: technology is primarily about product development, not distribution. Bubble-era advertising was obviously wasteful, so the only sustainable growth is viral growth.
These lessons have become dogma in the startup world; those who would ignore them are presumed to invite the justified doom visited upon technology in the great crash of 2000. And yet the opposite principles are probably more correct:
1. It is better to risk boldness than triviality.
2. A bad plan is better than no plan.
3. Competitive markets destroy profits.
4. Sales matters just as much as product.
It’s true that there was a bubble in technology. The late ’90s was a time of hubris: people believed in going from 0 to 1. Too few startups were actually getting there, and many never went beyond talking about it. But people understood that we had no choice but to find ways to do more with less. The market high of March 2000 was obviously a peak of insanity; less obvious but more important, it was also a peak of clarity. People looked far into the future, saw how much valuable new technology we would need to get there safely, and judged themselves capable of creating it.
We still need new technology, and we may even need some 1999-style hubris and exuberance to get it. To build the next generation of companies, we must abandon the dogmas created after the crash. That doesn’t mean the opposite ideas are automatically true: you can’t escape the madness of crowds by dogmatically rejecting them. Instead ask yourself: how much of what you know about business is shaped by mistaken reactions to past mistakes? The most contrarian thing of all is not to oppose the crowd but to think for yourself.
ALL HAPPY COMPANIES ARE DIFFERENT!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. For example, U.S. airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google, which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry’s profit margin that year. Google makes so much money that it’s now worth three times more than every U.S. airline combined. The airlines compete with each other, but Google stands alone. Economists use two simplified models to explain the difference: perfect competition and monopoly.
“Perfect competition” is considered both the ideal and the default state in Economics 101. Socalled 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.
To an economist, every monopoly looks the same, whether it deviously eliminates rivals, secures a license from the state, or innovates its way to the top. In this book, we’re not interested in illegal bullies or government favorites: by “monopoly,” we mean the kind of company that’s so good at what it does that no other firm can offer a close substitute. Google is a good example of a company that went from 0 to 1: it hasn’t competed in search since the early 2000s, when it definitively distanced itself from Microsoft and Yahoo!
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.
Monopoly LiesMonopolists 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.
Think about how Google talks about its business. It certainly doesn’t claim to be a monopoly. But is it one? Well, it depends: a monopoly in what? Let’s say that Google is primarily a search engine. As of May 2014, it owns about 68% of the search market. (Its closest competitors, Microsoft and Yahoo!, have about 19% and 10%, respectively.) If that doesn’t seem dominant enough, consider the fact that the word “google” is now an official entry in the Oxford English Dictionary—as a verb. Don’t hold your breath waiting for that to happen to Bing.
But suppose we say that Google is primarily an advertising company. That changes things. The U.S. search engine advertising market is $17 billion annually. Online advertising is $37 billion annually. The entire U.S. advertising market is $150 billion. And global advertising is a $495 billion market. So even if Google completely monopolized U.S. search engine advertising, it would own just 3.4% of the global advertising market. From this angle, Google looks like a small player in a competitive world.
What if we frame Google as a multifaceted technology company instead? This seems reasonable enough; in addition to its search engine, Google makes dozens of other software products, not to mention robotic cars, Android phones, and wearable computers. But 95% of Google’s revenue comes from search advertising; its other products generated just $2.35 billion in 2012, and its consumer tech products a mere fraction of that. Since consumer tech is a $964 billion market globally, Google owns less than 0.24% of it—a far cry from relevance, let alone monopoly. Framing itself as just another tech company allows Google to escape all sorts of unwanted attention.
Competitive LiesNon-monopolists tell the opposite lie: “we’re in a league of our own.” Entrepreneurs are always biased to understate the scale of competition, but that is the biggest mistake a startup can make. The fatal temptation is to describe your market extremely narrowly so that you dominate it by definition. Suppose you want to start a restaurant that serves British food in Palo Alto. “No one else is doing it,” you might reason. “We’ll own the entire market.” But that’s only true if the relevant market is the market for British food specifically. What if the actual market is the Palo Alto restaurant market in general? And what if all the restaurants in nearby towns are part of the relevant market as well? These are hard questions, but the bigger problem is that you have an incentive not to ask them at all. When you hear that most new restaurants fail within one or two years, your instinct will be to come up with a story about how yours is different. You’ll spend time trying to convince people that you are exceptional instead of seriously considering whether that’s true. It would be better to pause and consider whether there are people in Palo Alto who would rather eat British food above all else. It’s very possible they don’t exist.
In 2001, my co-workers at PayPal and I would often get lunch on Castro Street in Mountain View. We had our pick of restaurants, starting with obvious categories like Indian, sushi, and burgers. There were more options once we settled on a type: North Indian or South Indian, cheaper or fancier, and so on. In contrast to the competitive local restaurant market, PayPal was at that time the only emailbased payments company in the world. We employed fewer people than the restaurants on Castro Street did, but our business was much more valuable than all of those restaurants combined. Starting a new South Indian restaurant is a really hard way to make money. If you lose sight of competitive reality and focus on trivial differentiating factors—maybe you think your naan is superior because of your great-grandmother’s recipe—your business is unlikely to survive.
Non-monopolists exaggerate their distinction by defining their market as the intersection of various smaller markets:
British food ∩ restaurant ∩ Palo Alto
Rap star ∩ hackers ∩ sharks
Monopolists, by contrast, disguise their monopoly by framing their market as the union of several large markets:
search engine ∪ mobile phones ∪ wearable computers ∪ self-driving cars
What does a monopolist’s union story look like in practice? Consider a statement from Google chairman Eric Schmidt’s testimony at a 2011 congressional hearing: We face an extremely competitive landscape in which consumers have a multitude of options to access information. Or, translated from PR-speak to plain English: Google is a small fish in a big pond. We could be swallowed whole at any time. We are not the monopoly that the government is looking for.
RUTHLESS PEOPLEThe problem with a competitive business goes beyond lack of profits. Imagine you’re running one of those restaurants in Mountain View. You’re not that different from dozens of your competitors, so you’ve got to fight hard to survive. If you offer affordable food with low margins, you can probably pay employees only minimum wage. And you’ll need to squeeze out every efficiency: that’s why small restaurants put Grandma to work at the register and make the kids wash dishes in the back. Restaurants aren’t much better even at the very highest rungs, where reviews and ratings like Michelin’s star system enforce a culture of intense competition that can drive chefs crazy. (French chef and winner of three Michelin stars Bernard Loiseau was quoted as saying, “If I lose a star, I will commit suicide.” Michelin maintained his rating, but Loiseau killed himself anyway in 2003 when a competing French dining guide downgraded his restaurant.) The competitive ecosystem pushes people toward ruthlessness or death.
A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products, and its impact on the wider world. Google’s motto—“Don’t be evil”—is in part a branding ploy, but it’s also characteristic of a kind of business that’s successful enough to take ethics seriously without jeopardizing its own existence. 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. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.
MONOPOLY CAPITALISMMonopolies 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 therefore not a pathology or an exception. Monopoly is the condition of every successful business.
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.
WAR AND PEACEWhy do people compete with each other? Marx and Shakespeare provide two models for understanding almost every kind of conflict.
According to Marx, people fight because they are different. The proletariat fights the bourgeoisie because they have completely different ideas and goals (generated, for Marx, by their very different material circumstances). The greater the differences, the greater the conflict. To Shakespeare, by contrast, all combatants look more or less alike. It’s not at all clear why they should be fighting, since they have nothing to fight about. Consider the opening line from Romeo and Juliet: “Two households, both alike in dignity.” The two houses are alike, yet they hate each other. They grow even more similar as the feud escalates. Eventually, they lose sight of why they started fighting in the first place.
In the world of business, at least, Shakespeare proves the superior guide. Inside a firm, people become obsessed with their competitors for career advancement. Then the firms themselves become obsessed with their competitors in the marketplace. Amid all the human drama, people lose sight of what matters and focus on their rivals instead.
Let’s test the Shakespearean model in the real world. Imagine a production called Gates and Schmidt, based on Romeo and Juliet. Montague is Microsoft. Capulet is Google. Two great families, run by alpha nerds, sure to clash on account of their sameness. As with all good tragedy, the conflict seems inevitable only in retrospect. In fact it was entirely avoidable. These families came from very different places. The House of Montague built operating systems and office applications. The House of Capulet wrote a search engine. What was there to fight about?
Lots, apparently. As a startup, each clan had been content to leave the other alone and prosper independently. But as they grew, they began to focus on each other. Montagues obsessed about Capulets obsessed about Montagues. The result? Windows vs. Chrome OS, Bing vs. Google Search, Explorer vs. Chrome, Office vs. Docs, and Surface vs. Nexus. Just as war cost the Montagues and Capulets their children, it cost Microsoft and Google their dominance: Apple came along and overtook them all. In January 2013, Apple’s market capitalization was $500 billion, while Google and Microsoft combined were worth $467 billion. Just three years before, Microsoft and Google were each more valuable than Apple. War is costly business.
Competition can make people hallucinate opportunities where none exist. The crazy ’90s version of this was the fierce battle for the online pet store market. It was Pets.com vs. PetStore.com vs. Petopia.com vs. what seemed like dozens of others. Each company was obsessed with defeating its rivals, precisely because there were no substantive differences to focus on. Amid all the tactical questions—Who could price chewy dog toys most aggressively? Who could create the best Super Bowl ads?—these companies totally lost sight of the wider question of whether the online pet supply market was the right space to be in. Winning is better than losing, but everybody loses when the war isn’t one worth fighting. When Pets.com folded after the dot-com crash, $300 million of investment capital disappeared with it.
CHARACTERISTICS OF MONOPOLYWhat does a company with large cash flows far into the future look like? Every monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding. This isn’t a list of boxes to check as you build your business—there’s no shortcut to monopoly. However, analyzing your business according to these characteristics can help you think about how to make it durable.
1. Proprietary Technology
Proprietary technology is the most substantive advantage a company can have because it makes your product difficult or impossible to replicate. Google’s search algorithms, for example, return results better than anyone else’s. Proprietary technologies for extremely short page load times and highly accurate query autocompletion add to the core search product’s robustness and defensibility. It would be very hard for anyone to do to Google what Google did to all the other search engine companies in the early 2000s.
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. Anything less than an order of magnitude better will probably be perceived as a marginal improvement and will be hard to sell, especially in an already crowded market.
The clearest way to make a 10x improvement is to invent something completely new. If you build something valuable where there was nothing before, the increase in value is theoretically infinite. A drug to safely eliminate the need for sleep, or a cure for baldness, for example, would certainly support a monopoly business.
Or you can radically improve an existing solution: once you’re 10x better, you escape competition. PayPal, for instance, 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. Sellers received their proceeds right away, and unlike with a check, they knew the funds were good. Amazon made its first 10x improvement in a particularly visible way: they offered at least 10 times as many books as any other bookstore. When it launched in 1995, 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. This quantum improvement was so effective that a very unhappy Barnes & Noble filed a lawsuit three days before Amazon’s IPO, claiming that Amazon was unfairly calling itself a “bookstore” when really it was a “book broker.”
You can also make a 10x improvement through superior integrated design. Before 2010, tablet computing was so poor that for all practical purposes the market didn’t even exist. “Microsoft Windows XP Tablet PC Edition” products first shipped in 2002, and Nokia released its own “Internet Tablet” in 2005, but they were a pain to use. Then Apple released the iPad. Design improvements are hard to measure, but it seems clear that Apple improved on anything that had come before by at least an order of magnitude: tablets went from unusable to useful.
2. Network Effects
Network effects make a product more useful as more people use it. For example, if all your friends are on Facebook, it makes sense for you to join Facebook, too. Unilaterally choosing a different social network would only make you an eccentric.
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. For example, in 1960 a quixotic company called Xanadu set out to build a two-way communication network between all computers—a sort of early, synchronous version of the World Wide Web. After more than three decades of futile effort, Xanadu folded just as the web was becoming commonplace. Their technology probably would have worked at scale, but it could have worked only at scale: it required every computer to join the network at the same time, and that was never going to happen.
Paradoxically, then, network effects businesses must start with especially small markets. Facebook started with just Harvard students—Mark Zuckerberg’s first product was designed to get all his classmates signed up, not to attract all people of Earth. This is why successful network businesses rarely get started by MBA types: the initial markets are so small that they often don’t even appear to be business opportunities at all.
3. Economies of Scale
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.
Many businesses gain only limited advantages as they grow to large scale. Service businesses especially are difficult to make monopolies. If you own a yoga studio, for example, you’ll only be able to serve a certain number of customers. You can hire more instructors and expand to more locations, but your margins will remain fairly low and you’ll never reach a point where a core group of talented people can provide something of value to millions of separate clients, as software engineers are able to do.
A good startup should have the potential for great scale built into its first design. Twitter already has more than 250 million users today. It doesn’t need to add too many customized features in order to acquire more, and there’s no inherent reason why it should ever stop growing.
4. Branding
A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful way to claim a monopoly. Today’s strongest tech brand is Apple: the attractive looks and carefully chosen materials of products like the iPhone and MacBook, the Apple Stores’ sleek minimalist design and close control over the consumer experience, the omnipresent advertising campaigns, the price positioning as a maker of premium goods, and the lingering nimbus of Steve Jobs’s personal charisma all contribute to a perception that Apple offers products so good as to constitute a category of their own.
Many have tried to learn from Apple’s success: paid advertising, branded stores, luxurious materials, playful keynote speeches, high prices, and even minimalist design are all susceptible to imitation. But these techniques for polishing the surface don’t work without a strong underlying substance. Apple has a complex suite of proprietary technologies, both in hardware (like superior touchscreen materials) and software (like touchscreen interfaces purpose-designed for specific materials). It manufactures products at a scale large enough to dominate pricing for the materials it buys. And it enjoys strong network effects from its content ecosystem: thousands of developers write software for Apple devices because that’s where hundreds of millions of users are, and those users stay on the platform because it’s where the apps are. These other monopolistic advantages are less obvious than Apple’s sparkling brand, but they are the fundamentals that let the branding effectively reinforce Apple’s monopoly.
Beginning with brand rather than substance is dangerous. Ever since Marissa Mayer became CEO of Yahoo! in mid-2012, she has worked to revive the once-popular internet giant by making it cool again. In a single tweet, Yahoo! summarized Mayer’s plan as a chain reaction of “people then products then traffic then revenue.” The people are supposed to come for the coolness: Yahoo! demonstrated design awareness by overhauling its logo, it asserted youthful relevance by acquiring hot startups like Tumblr, and it has gained media attention for Mayer’s own star power. But the big question is what products Yahoo! will actually create. When Steve Jobs returned to Apple, he didn’t just make Apple a cool place to work; he slashed product lines to focus on the handful of opportunities for 10x improvements. No technology company can be built on branding alone.
BUILDING A MONOPOLY1. Start Small and Monopolize
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. Always err on the side of starting too small. The reason is simple: it’s easier to dominate a small market than a large one. If you think your initial market might be too big, it almost certainly is.
Small doesn’t mean nonexistent. We made this mistake early on at PayPal. Our first product let people beam money to each other via PalmPilots. It was interesting technology and no one else was doing it. However, the world’s millions of PalmPilot users weren’t concentrated in a particular place, they had little in common, and they used their devices only episodically. Nobody needed our product, so we had no customers.
With that lesson learned, we set our sights on eBay auctions, where we found our first success. In late 1999, eBay had a few thousand high-volume “PowerSellers,” and after only three months of dedicated effort, we were serving 25% of them. It was much easier to reach a few thousand people who really needed our product than to try to compete for the attention of millions of scattered individuals. The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors. Any big market is a bad choice, and a big market already served by competing companies is even worse. This is why it’s always a red flag when entrepreneurs talk about getting 1% of a $100 billion market. In practice, a large market will either lack a good starting point or it will be open to competition, so it’s hard to ever reach that 1%. And even if you do succeed in gaining a small foothold, you’ll have to be satisfied with keeping the lights on: cutthroat competition means your profits will be zero.
2. Scaling Up
Once you create and dominate a niche market, then you should gradually expand into related and slightly broader markets. Amazon shows how it can be done. Jeff Bezos’s founding vision was to dominate all of online retail, but he very deliberately started with books. There were millions of books to catalog, but they all had roughly the same shape, they were easy to ship, and some of the most rarely sold books—those least profitable for any retail store to keep in stock—also drew the most enthusiastic customers. Amazon became the dominant solution for anyone located far from a bookstore or seeking something unusual. Amazon then had two options: expand the number of people who read books, or expand to adjacent markets. They chose the latter, starting with the most similar markets: CDs, videos, and software. Amazon continued to add categories gradually until it had become the world’s general store. The name itself brilliantly encapsulated the company’s scaling strategy. The biodiversity of the Amazon rain forest reflected Amazon’s first goal of cataloging every book in the world, and now it stands for every kind of thing in the world, period.
eBay also started by dominating small niche markets. When it launched its auction marketplace in 1995, it didn’t need the whole world to adopt it at once; the product worked well for intense interest groups, like Beanie Baby obsessives. Once it monopolized the Beanie Baby trade, eBay didn’t jump straight to listing sports cars or industrial surplus: it continued to cater to small-time hobbyists until it became the most reliable marketplace for people trading online no matter what the item. Sometimes there are hidden obstacles to scaling—a lesson that eBay has learned in recent years. Like all marketplaces, the auction marketplace lent itself to natural monopoly because buyers go where the sellers are and vice versa. But eBay found that the auction model works best for individually distinctive products like coins and stamps. It works less well for commodity products: people don’t want to bid on pencils or Kleenex, so it’s more convenient just to buy them from Amazon. eBay is still a valuable monopoly; it’s just smaller than people in 2004 expected it to be. Sequencing markets correctly is underrated, and it takes discipline to expand gradually. The most successful companies make the core progression—to first dominate a specific niche and then scale to adjacent markets—a part of their founding narrative.
3. Don’t Disrupt
Silicon Valley has become obsessed with “disruption.” Originally, “disruption” was a term of art to describe how a firm can use new technology to introduce a low-end product at low prices, improve the product over time, and eventually overtake even the premium products offered by incumbent companies using older technology. This is roughly what happened when the advent of PCs disrupted the market for mainframe computers: at first PCs seemed irrelevant, then they became dominant. Today mobile devices may be doing the same thing to PCs. However, disruption has recently transmogrified into a self-congratulatory buzzword for anything posing as trendy and new. This seemingly trivial fad matters because it distorts an entrepreneur’s self-understanding in an inherently competitive way. The concept was coined to describe threats to incumbent companies, so startups’ obsession with disruption means they see themselves through older firms’ eyes. If you think of yourself as an insurgent battling dark forces, it’s easy to become unduly fixated on the obstacles in your path. But 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.
Disruption also attracts attention: disruptors are people who look for trouble and find it. Disruptive kids get sent to the principal’s office. Disruptive companies often pick fights they can’t win. Think of Napster: the name itself meant trouble. What kinds of things can one “nap”? Music … Kids … and perhaps not much else. Shawn Fanning and Sean Parker, Napster’s then-teenage founders, credibly threatened to disrupt the powerful music recording industry in 1999. The next year, they made the cover of Time magazine. A year and a half after that, they ended up in bankruptcy court. PayPal could be seen as disruptive, but we didn’t try to directly challenge any large competitor. It’s true that we took some business away from Visa when we popularized internet payments: you might use PayPal to buy something online instead of using your Visa card to buy it in a store. But since we expanded the market for payments overall, we gave Visa far more business than we took. The overall dynamic was net positive, unlike Napster’s negative-sum struggle with the U.S. recording industry. As you craft a plan to expand to adjacent markets, don’t disrupt: avoid competition as much as possible.
THE LAST WILL BE FIRSTYou’ve probably heard about “first mover advantage”: if you’re the first entrant into a market, you can capture significant market share while competitors scramble to get started. But moving first is a tactic, not a goal. What really matters is generating cash flows in the future, so being the first mover doesn’t do you any good if someone else comes along and unseats you. It’s much better to be the last mover—that is, to make the last great development in a specific market and enjoy years or even decades of monopoly profits. The way to do that is to dominate a small niche and scale up from there, toward your ambitious long-term vision. In this one particular at least, business is like chess. Grandmaster José Raúl Capablanca put it well: to succeed, “you must study the endgame before everything else.”
YOU ARE NOT A LOTTERY TICKETTHE MOST CONTENTIOUS question in business is whether success comes from luck or skill.
What do successful people say? Malcolm Gladwell, a successful author who writes about successful people, declares in Outliers that success results from a “patchwork of lucky breaks and arbitrary advantages.” Warren Buffett famously considers himself a “member of the lucky sperm club” and a winner of the “ovarian lottery.” Jeff Bezos attributes Amazon’s success to an “incredible planetary alignment” and jokes that it was “half luck, half good timing, and the rest brains.” Bill Gates even goes so far as to claim that he “was lucky to be born with certain skills,” though it’s not clear whether that’s actually possible.
Perhaps these guys are being strategically humble. However, the phenomenon of serial entrepreneurship would seem to call into question our tendency to explain success as the product of chance. Hundreds of people have started multiple multimillion-dollar businesses. A few, like Steve Jobs, Jack Dorsey, and Elon Musk, have created several multibillion-dollar companies. If success were mostly a matter of luck, these kinds of serial entrepreneurs probably wouldn’t exist.
In January 2013, Jack Dorsey, founder of Twitter and Square, tweeted to his 2 million followers: “Success is never accidental.”
Most of the replies were unambiguously negative. Referencing the tweet in The Atlantic, reporter Alexis Madrigal wrote that his instinct was to reply: “ ‘Success is never accidental,’ said all multimillionaire white men.” It’s true that already successful people have an easier time doing new things, whether due to their networks, wealth, or experience. But perhaps we’ve become too quick to dismiss anyone who claims to have succeeded according to plan.
Is there a way to settle this debate objectively? Unfortunately not, because companies are not experiments. To get a scientific answer about Facebook, for example, we’d have to rewind to 2004, create 1,000 copies of the world, and start Facebook in each copy to see how many times it would succeed. But that experiment is impossible. Every company starts in unique circumstances, and every company starts only once. Statistics doesn’t work when the sample size is one.
From the Renaissance and the Enlightenment to the mid-20th century, luck was something to be mastered, dominated, and controlled; everyone agreed that you should do what you could, not focus on what you couldn’t. Ralph Waldo Emerson captured this ethos when he wrote: “Shallow men believe in luck, believe in circumstances.… Strong men believe in cause and effect.” In 1912, after he became the first explorer to reach the South Pole, Roald Amundsen wrote: “Victory awaits him who has everything in order—luck, people call it.” No one pretended that misfortune didn’t exist, but prior generations believed in making their own luck by working hard.
If you believe your life is mainly a matter of chance, why read this book? Learning about startups is worthless if you’re just reading stories about people who won the lottery. Slot Machines for Dummies can purport to tell you which kind of rabbit’s foot to rub or how to tell which machines are “hot,” but it can’t tell you how to win.
Did Bill Gates simply win the intelligence lottery? Was Sheryl Sandberg born with a silver spoon, or did she “lean in”? When we debate historical questions like these, luck is in the past tense. Far more important are questions about the future: is it a matter of chance or design?
Futurists fall into four categories:
Vertical dimension has people who are either “Optimistic” view or “Pessimistic” view about the future.
Horizontal dimension has people who are either “Definite” about what they are going to do to build their future, or the second category of people who are “Indefinite” about what should be done to build the future.
The chart above also show how their investment and savings behavior will be.
THE POWER LAW OF VENTURE CAPITAL
If you rank the best companies to invest in the past year on the horizontal axis and the returns that these companies provided on the vertical axis, you will find that the drop in the returns with respect to ranked companies is exponential.
FOUNDATIONSEVERY GREAT COMPANY is unique, but there are a few things that every business must get right at the beginning. I stress this so often that friends have teasingly nicknamed it “Thiel’s law”: a startup messed up at its foundation cannot be fixed.
Beginnings are special. They are qualitatively different from all that comes afterward. This was true 13.8 billion years ago, at the founding of our cosmos: in the earliest microseconds of its existence, the universe expanded by a factor of 1030—a million trillion trillion. As cosmogonic epochs came and went in those first few moments, the very laws of physics were different from those we know today.
It was also true 227 years ago at the founding of our country: fundamental questions were open for debate by the Framers during the few months they spent together at the Constitutional Convention. How much power should the central government have? How should representation in Congress be apportioned? Whatever your views on the compromises reached that summer in Philadelphia, they’ve been hard to change ever since: after ratifying the Bill of Rights in 1791, we’ve amended the Constitution only 17 times. Today, California has the same representation in the Senate as Alaska, even though it has more than 50 times as many people. Maybe that’s a feature, not a bug. But we’re probably stuck with it as long as the United States exists. Another constitutional convention is unlikely; today we debate only smaller questions.
Companies are like countries in this way. Bad decisions made early on—if you choose the wrong partners or hire the wrong people, for example—are very hard to correct after they are made. It may take a crisis on the order of bankruptcy before anybody will even try to correct them. As a founder, your first job is to get the first things right, because you cannot build a great company on a flawed foundation.
OWNERSHIP, POSSESSION, AND CONTROLTo 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.
In the boardroom, less is more. The smaller the board, the easier it is for the directors to communicate, to reach consensus, and to exercise effective oversight. However, that very effectiveness means that a small board can forcefully oppose management in any conflict. This is why it’s crucial to choose wisely: every single member of your board matters. Even one problem director will cause you pain, and may even jeopardize your company’s future.
A board of three is ideal. Your board should never exceed five people, unless your company is publicly held. (Government regulations effectively mandate that public companies have larger boards —the average is nine members.) By far the worst you can do is to make your board extra large. When unsavvy observers see a nonprofit organization with dozens of people on its board, they think: “Look how many great people are committed to this organization! It must be extremely well run.” Actually, a huge board will exercise no effective oversight at all; it merely provides cover for whatever microdictator actually runs the organization. If you want that kind of free rein from your board, blow it up to giant size. If you want an effective board, keep it small.
ON THE BUS OR OFF THE BUSAs a general rule, everyone you involve with your company should be involved full-time. Sometimes you’ll have to break this rule; it usually makes sense to hire outside lawyers and accountants, for example. However, 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 in the future. That’s why hiring consultants doesn’t work. Part-time employees don’t work. Even working remotely should be avoided, because misalignment can creep in whenever colleagues aren’t together full-time, in the same place, every day. If you’re deciding whether to bring someone on board, the decision is binary. Ken Kesey was right: you’re either on the bus or off the bus.
SALES IS HIDDENAll salesmen are actors: their priority is persuasion, not sincerity. That’s why the word “salesman” can be a slur and the used car dealer is our archetype of shadiness. But we only react negatively to awkward, obvious salesmen—that is, the bad ones. There’s a wide range of sales ability: there are many gradations between novices, experts, and masters. There are even sales grandmasters. If you don’t know any grandmasters, it’s not because you haven’t encountered them, but rather because their art is hidden in plain sight. Tom Sawyer managed to persuade his neighborhood friends to whitewash the fence for him—a masterful move. But convincing them to actually pay him for the privilege of doing his chores was the move of a grandmaster, and his friends were none the wiser. Not much has changed since Twain wrote in 1876.
Like acting, sales works best when hidden. This explains why almost everyone whose job involves distribution—whether they’re in sales, marketing, or advertising—has a job title that has nothing to do with those things. People who sell advertising are called “account executives.” People who sell customers work in “business development.” People who sell companies are “investment bankers.” And people who sell themselves are called “politicians.” There’s a reason for these redescriptions: none of us wants to be reminded when we’re being sold. Whatever the career, sales ability distinguishes superstars from also-rans. On Wall Street, a new hire starts as an “analyst” wielding technical expertise, but his goal is to become a dealmaker. A lawyer prides himself on professional credentials, but law firms are led by the rainmakers who bring in big clients. Even university professors, who claim authority from scholarly achievement, are envious of the self-promoters who define their fields. Academic ideas about history or English don’t just sell themselves on their intellectual merits. Even the agenda of fundamental physics and the future path of cancer research are results of persuasion. The most fundamental reason that even businesspeople underestimate the importance of sales is the systematic effort to hide it at every level of every field in a world secretly driven by it.
The engineer’s grail is a product great enough that “it sells itself.” But anyone who would actually say this about a real product must be lying: either he’s delusional (lying to himself) or he’s selling something (and thereby contradicting himself). The polar opposite business cliché warns that “the best product doesn’t always win.” Economists attribute this to “path dependence”: specific historical circumstances independent of objective quality can determine which products enjoy widespread adoption. That’s true, but it doesn’t mean the operating systems we use today and the keyboard layouts on which we type were imposed by mere chance. It’s better to think of distribution as something essential to the design of your product. If you’ve invented something new but you haven’t invented an effective way to sell it, you have a bad business—no matter how good the product.
SEEING GREENAT THE START of the 21st century, everyone agreed that the next big thing was clean technology. It had to be: in Beijing, the smog had gotten so bad that people couldn’t see from building to building—even breathing was a health risk. Bangladesh, with its arsenic-laden water wells, was suffering what the New York Times called “the biggest mass poisoning in history.” In the U.S., Hurricanes Ivan and Katrina were said to be harbingers of the coming devastation from global warming. Al Gore implored us to attack these problems “with the urgency and resolve that has previously been seen only when nations mobilized for war.” People got busy: entrepreneurs started thousands of cleantech companies, and investors poured more than $50 billion into them. So began the quest to cleanse the world.
It didn’t work. Instead of a healthier planet, we got a massive cleantech bubble. Solyndra is the most famous green ghost, but most cleantech companies met similarly disastrous ends—more than 40 solar manufacturers went out of business or filed for bankruptcy in 2012 alone. The leading index of alternative energy companies shows the bubble’s dramatic deflation:
Conservatives think they already know the answer: as soon as green energy became a priority for the government, it was poisoned. But there really were (and there still are) good reasons for making energy a priority. And the truth about cleantech is more complex and more important than government failure. Most cleantech companies crashed because they neglected one or more of the seven questions that every business must answer:
1. The Engineering Question
Can you create breakthrough technology instead of incremental improvements?
2. The Timing Question
Is now the right time to start your particular business?
3. The Monopoly Question
Are you starting with a big share of a small market?
4. The People Question
Do you have the right team?
5. The Distribution Question
Do you have a way to not just create but deliver your product?
6. The Durability Question
Will your market position be defensible 10 and 20 years into the future?
7. The Secret Question
Have you identified a unique opportunity that others don’t see?
Whatever your industry, any great business plan must address every one of them. If you don’t have good answers to these questions, you’ll run into lots of “bad luck” and your business will fail. If you nail all seven, you’ll master fortune and succeed. Even getting five or six correct might work. But the striking thing about the cleantech bubble was that people were starting companies with zero good answers—and that meant hoping for a miracle.
It’s hard to know exactly why any particular cleantech company failed, since almost all of them made several serious mistakes.
TESLA: 7 FOR 7Tesla is one of the few cleantech companies started last decade to be thriving today. They rode the social buzz of cleantech better than anyone, but they got the seven questions right, so their success is instructive:
1: TECHNOLOGY. Tesla’s technology is so good that other car companies rely on it: Daimler uses Tesla’s battery packs; Mercedes-Benz uses a Tesla powertrain; Toyota uses a Tesla motor. General Motors has even created a task force to track Tesla’s next moves. But Tesla’s greatest technological achievement isn’t any single part or component, but rather its ability to integrate many components into one superior product. The Tesla Model S sedan, elegantly designed from end to end, is more than the sum of its parts: Consumer Reports rated it higher than any other car ever reviewed, and both Motor Trend and Automobile magazines named it their 2013 Car of the Year.
2: TIMING. In 2009, it was easy to think that the government would continue to support cleantech: “green jobs” were a political priority, federal funds were already earmarked, and Congress even seemed likely to pass cap-and-trade legislation. But where others saw generous subsidies that could flow indefinitely, Tesla CEO Elon Musk rightly saw a one-time-only opportunity. In January 2010—about a year and a half before Solyndra imploded under the Obama administration and politicized the subsidy question—Tesla secured a $465 million loan from the U.S. Department of Energy. A half-billion-dollar subsidy was unthinkable in the mid-2000s. It’s unthinkable today. There was only one moment where that was possible, and Tesla played it perfectly.
3: MONOPOLY. Tesla started with a tiny submarket that it could dominate: the market for high-end electric sports cars. Since the first Roadster rolled off the production line in 2008, Tesla’s sold only about 3,000 of them, but at $109,000 apiece that’s not trivial. Starting small allowed Tesla to undertake the necessary R&D to build the slightly less expensive Model S, and now Tesla owns the luxury electric sedan market, too. They sold more than 20,000 sedans in 2013 and now Tesla is in prime position to expand to broader markets in the future.
4: TEAM. Tesla’s CEO is the consummate engineer and salesman, so it’s not surprising that he’s assembled a team that’s very good at both. Elon describes his staff this way: “If you’re at Tesla, you’re choosing to be at the equivalent of Special Forces. There’s the regular army, and that’s fine, but if you are working at Tesla, you’re choosing to step up your game.”
5: DISTRIBUTION. Most companies underestimate distribution, but Tesla took it so seriously that it decided to own the entire distribution chain. Other car companies are beholden to independent dealerships: Ford and Hyundai make cars, but they rely on other people to sell them. Tesla sells and services its vehicles in its own stores. The up-front costs of Tesla’s approach are much higher than traditional dealership distribution, but it affords control over the customer experience, strengthens Tesla’s brand, and saves the company money in the long run.
6: DURABILITY. Tesla has a head start and it’s moving faster than anyone else—and that combination means its lead is set to widen in the years ahead. A coveted brand is the clearest sign of Tesla’s breakthrough: a car is one of the biggest purchasing decisions that people ever make, and consumers’ trust in that category is hard to win. And unlike every other car company, at Tesla the founder is still in charge, so it’s not going to ease off anytime soon.
7: SECRETS. Tesla knew that fashion drove interest in cleantech. Rich people especially wanted to appear “green,” even if it meant driving a boxy Prius or clunky Honda Insight. Those cars only made drivers look cool by association with the famous eco-conscious movie stars who owned them as well. So Tesla decided to build cars that made drivers look cool, period—Leonardo DiCaprio even ditched his Prius for an expensive (and expensive-looking) Tesla Roadster. While generic cleantech companies struggled to differentiate themselves, Tesla built a unique brand around the secret that cleantech was even more of a social phenomenon than an environmental imperative.
