Peter Thiel Stanford lecture (Competition is for Losers)

Sam, thanks for inviting me. Thanks for having me. I have a single idée fixe that I'm completely obsessed with on the business side, which is that if you're starting a company, if you're the founder entrepreneur starting a company, you always want to aim for monopoly. And you want to always avoid competition. And so hence competition is for losers, something we'll be talking about today. I'd like to start by saying something about the basic idea of when you start one of these companies, how you go about creating value. And there's question, what makes a business valuable? I want to suggest that there's basically a very simple formula: you have a valuable company, two things are true. Number one, that it creates X dollars of value for the world, and number two, that you capture Y percent of X. And the critical thing that people always miss in the analysis is that X and Y are completely independent variables. So X can be very big, Y can be very small, X can be of intermediate size, and if Y is reasonably big, you can still get a very valuable business. So to create a valuable company, you have to both create something of value and capture some fraction of the value of what you've created. And to illustrate, this is a contrast: if you compare the US airline industry with a company like Google on search. If you measure by the size of these industries, you could say that airlines are still more important than search. If you measure it by revenues, there was 195 billion in domestic revenues in 2012, Google had just north of 50 billion. And on some intuitive level, if you were given a choice and said, 'Do you want to get rid of all air travel or do you want to get rid of your ability to use search engines?', the intuition would be that air travel is more important than search. But the profit margins are quite a bit less. The entire 100-year history of the airline industry, the cumulative profits in the US have been approximately zero. The companies make money, they episodically go bankrupt, they get recapitalized, and you cycle and repeat. And this is reflected in the combined market capitalization of the US airline industry is maybe something like a quarter that of Google. So you have a search engine much smaller than air travel, but much more valuable. And I think this reflects these very different valuations on X and Y.

So, if we look at perfect competition, there are some pros and cons to the world of perfect competition. On a high level, it's always what you study in econ one. It's easy to model, which I think is why econ professors like talking about perfect competition. It somehow is efficient, especially in a world where things are static, because all the consumer surplus gets captured by everybody. And politically, it's what we're told is good in our society, that you want to have competition, and this is somehow a good thing. Of course, there are a lot of negatives. It's generally not that good if you're involved in anything that's hyper-competitive, because you often don't make money. I'll come back to this a little bit later. So I think at one end of the spectrum, you have industries that are perfectly competitive. And at the other end of the spectrum, you have things that I would say are monopolies. And they're much more stable longer-term businesses, you have more capital, and if you get a creative monopoly for inventing something new, I think it's symptomatic of having created something really valuable. And so I do think the extreme binary view of the world I always articulate is that there are exactly two kinds of businesses in this world. There are businesses that are perfectly competitive, and there are businesses that are monopolies. And there's shockingly little that is in between. And this dichotomy is not understood very well, because people are constantly lying about the nature of the businesses they're in. And this is why in my mind, this is the most important business idea that people don't understand, that there are just these two kinds of businesses. So let me say a little bit about the lies that people tell. And so basically, if you imagine that there was a spectrum of companies from perfect competition to monopoly, the apparent differences are quite small, because the people who have monopolies pretend not to. They will basically say, you know, it's because you don't want to get regulated by the government, you don't want the government to come after you. So you will never say that you have a monopoly. So anyone who has a monopoly will pretend that they're in incredible competition. And on the other end of the spectrum, if you are incredibly competitive, and if you're in some sort of business where you will never make any money, you will be tempted to tell a lie that goes in the other direction, where you will say that you're doing something unique that is somehow less competitive than it looks, because you want to differentiate, you want to try to attract capital or something like that. So if the monopolists pretend not to have monopolies, the non-monopolists pretend to have monopolies, the apparent difference is very small, whereas the real difference I would submit is actually quite big. And so there's this distortion that happens because of the lies people tell about their businesses, and the lies are in these opposite directions. Let me drill a little bit further on the way these lies work.

The basic lie you tell as a non-monopoly is that we're in a very small market. The basic lie you tell as a monopoly is that the market you're in is much bigger than it looks. And so typically, if you want to think of this in set theoretic terms, you could say that a monopoly tells a lie where you describe your business as the union of these vastly different markets, and a non-monopolist describes it as the intersection. So in effect, if you're a non-monopolist, you will rhetorically describe your market as super small, you're the only person in that market. If you have a monopoly, you will describe it as super big, and there's lots of competition in it. So some examples of how this works in practice. I always use restaurants as the example of a terrible business. This is always my idea: capitalism and competition are antonyms. A capitalist is someone who accumulates capital. A world of perfect competition is a world where all the capital gets competed away. So you're opening a restaurant business, no one wants to invest because you just lose money. So you have to tell some idiosyncratic narrative, and you will say something like, 'Well, we're the only British food restaurant in Palo Alto.' So it's British, Palo Alto, and of course that's too small a market, because people may be able to drive all the way to Mountain View or even Menlo Park. And there probably are no people who eat nothing but British food, at least no people still alive. And so that is a sort of fictitiously narrow market. There's a Hollywood version of this, where the way movies always get pitched is, you know, it's like a college football star joins an elite group of hackers to catch the shark that killed his friend. Sorry. And so that is a movie that has not yet been made. But the question is whether that is the right category, or is the correct category it's just another movie, in which case there are lots of those, it's super competitive, incredibly hard to make money. No one ever makes money in Hollywood doing movies. It's really, really hard. And so you always have this question about whether the intersection is real, does it make sense, does it have value, that one should ask. And of course, there are startup versions of this, where the really bad versions, you just take a whole series of buzzwords, sharing mobile social apps, you combine them, and you have some kind of narrative, and whether or not that's a real business is generally a bad sign. So it's almost this pattern recognition. When you have this rhetoric of these sorts of intersections, it generally does not work. The something of somewhere is really mostly the nothing of nowhere. And it's like the Stanford of North Dakota. Uh, one of a kind, but it's not Stanford.

So let's look at the opposite. The opposite lie is if you are, let's say, the search company that's down the street from here and has about a happy 66% market share. And is completely dominant in the search market. Google has almost never describes itself as a search engine these days. Instead, it describes itself in all these different ways. So, it sometimes says it's an advertising company. So, if it was search you'd say, 'Wow, this has this huge market share. That's really crazy. It's an incredible monopoly. It's much more robust monopoly than Microsoft ever had in the '90s. Maybe that's why it's making so much money.' But if you say it's an advertising market, you could say, 'Well, there's search advertising at 17 billion. And that's part of online advertising which is much bigger. And then all US advertising is bigger. And then by the time you get to global advertising, that's close to 500 billion. And so, you're talking about 3 and a half percent. So a tiny part of this much larger market.' Or if you don't want to be an advertising company, you can always say that you're a technology company. And so, the technology market is something like a $1 trillion market. And the narrative that you tell is Google in the technology market is, well, we're competing with all the car companies with our self-driving cars. We're competing with Apple on TVs and iPhones. We're competing with Facebook. We're competing with Microsoft on office products. We're competing with Amazon on cloud services. And so, we are in this giant technology market where there's competition in every direction you look. And no, we're not the monopoly the government's looking for and we should not get regulated in any way whatsoever. And so, I think one has to always be super aware that there are these very powerful incentives to distort the nature of these markets one way or the other. So, the evidence of narrow markets in the tech industry is if you look at some of the big tech companies, Apple, Google, Microsoft, Amazon, they've just been building up cash for year after year. And you have these incredibly high profit margins. And I would say that one of the reasons the tech industry in the US has been so successful financially is because it's prone to creating all these monopoly-like businesses. And that's reflected by the fact that these companies just accumulate so much cash they don't even know what to do with it beyond a certain point.

So, let me say a few things about how to build a monopoly. I think one of the very counterintuitive ideas that comes out of this monopoly thread is that you want to go after small markets. If you're a startup, you want to get to a monopoly. Monopoly is you have a large share of a market. How do you get to a large share of a market? You start with a really small market and you take over that whole market. And then over time you find ways to expand that market in concentric circles. And the thing that's always a big mistake is going after a giant market on day one, because that's typically evidence that you somehow haven't defined the categories correctly. It normally means that there's going to be too much competition. So I think almost all the successful companies in Silicon Valley had some model of starting with small markets and expanding. If you take Amazon, you start with just a bookstore. We have all the books in the world. So it's a better bookstore than anybody else has in the world when it starts in the '90s. It's online. There's things you can do you can't do before. And then you gradually expand into all sorts of different forms of e-commerce and other things beyond that. eBay, you start with Pez dispensers. You move on to Beanie Babies. And eventually it's all these different auctions for all sorts of different goods. And what was very counterintuitive about many of these companies is they often start with markets that are so small that people don't think they're valuable at all when you get started. The PayPal version of this was we started with power sellers on eBay, which was about 20,000 people. When we first saw this happening in December of '99, January 2000 right after we launched, there was a sense that it was such a small market it was terrible. We thought these were terrible customers to have. It's just people selling junk on the internet. Why in the world do we want to go after this market? But there was a way to get a product that was much better for everybody in that market. We got to something like 25, 30% market penetration in two or three months. And we got some lock-in. We got brand recognition. And we were able to build the business from there. So I always think these very small markets are quite underrated. The Facebook version of this I always give is that the initial market at Facebook was 10,000 people at Harvard. It went from 0 to 60% market share in 10 days. That was a very auspicious start. The way this gets analyzed in business schools is always that's ridiculous, it's such a small market it can't have any value at all. And so I think the business school analysis of Facebook early on, or of PayPal early on, or of eBay early on, is that the markets were perhaps so small as to have almost no value. And they would have had little value had they stayed small. But it turned out there were ways to then grow them concentrically. And that's what made them so valuable.

Now, I think the opposite version of this is always where you have super big markets. There are so many different things that went wrong with all the clean tech companies in the last decade. But one theme that ran through almost all of them was they all started with massive markets. Every clean tech PowerPoint presentation that one saw in the years 2005 to 2008, which was the clean tech bubble in Silicon Valley, started with we're in the energy market. We're in a market that's measured in hundreds of billions or trillions of dollars. And then, once you're a minnow in a vast ocean, that's not a good place to be. That means that you have tons of competitors and you don't even know who all the competitors are. And so, you want to be a one-of-a-kind company where it's the only one in a small ecosystem. You don't want to be the fourth online pet food company. You don't want to be the 10th thin film solar panel company. You don't want to be the 100th restaurant in Palo Alto. Restaurant industry is a trillion-dollar industry. So if you do a market size analysis, you conclude restaurants are a fantastic business to go into. But large existing markets typically mean that you have tons of competition. Very hard to differentiate. So the first very counterintuitive idea is to go after small markets, often markets that are so small people don't even notice them. They don't think they make sense. That's where you got to put hold. And then if those markets are able to expand, you can scale into a big monopoly business.

You know, a second characteristic of these monopoly businesses that I like to focus on. There's probably no single formula to it. I always think that in technology, the history of technology is such that every moment happens only once. So the next Mark Zuckerberg won't build a social network. The next Larry Page won't be building a search engine. The next Bill Gates won't be building an operating system. And if you're copying these people, you're not learning from them. So there are always these very unique businesses that are doing something that's not been done before and end up having the potential to be a monopoly. The opening line in Anna Karenina is that all happy families are alike, all unhappy families are unhappy in their own special way. And the opposite is true in business. I think all happy companies are different because they're doing something very unique. All unhappy companies are alike because they fail to escape the essential sameness that is competition. So one characteristic of a monopoly technology company is some sort of proprietary technology. My somewhat arbitrary rule of thumb is you want to have a technology that's an order of magnitude better than the next best thing. So Amazon had over 10 times as many books. It's maybe not that high-tech, but you figure out a way to sell 10 times as many books in an efficient online way. PayPal, the alternative was using checks to send money on eBay. Took 7 to 10 days to clear. PayPal could do it more than 10 times as fast. So you want to have a very powerful improvement, maybe an order of magnitude improvement on some key dimension. Of course, if you come with something totally new, it's just like an infinite improvement. I would say the iPhone was the first smartphone that worked. That's maybe not infinite, but it's definitely an order of magnitude or more improvement. So I think the technology is designed to give you a massive delta over the next best thing. I think there often are network effects that can kick in that really help. The thing that's very tricky about network effects is they're often very hard to get started. So even though everyone understands how valuable they are, there's always this incredibly tricky question: why is it valuable to the first person who's doing something? Economies of scale: if you have something with very high fixed costs, very low marginal costs, that's typically a monopoly-like business. And then there's branding, which is sort of this idea that gets lodged in people's brains. I never quite understand how branding works. So I never invest in companies where it's just about branding, but it is a real phenomenon that creates real value. I think one of the things I'm going to come back to towards the end, but one of the things that's very striking is that software businesses are often very good at some of these things. They're especially good at the economies of scale part because the marginal cost of software is zero. So if you get something that works in software, it's often significantly better than the existing solution. And then you have these tremendous economies of scale and you can scale fairly quickly. So even if the market starts small, you can grow your business quickly enough to stay at the same size as the growing market and maintain the sort of monopoly power.

Now, the critical thing about these monopolies is it's not enough to have a monopoly for just a moment. The critical thing is to have one that lasts over time. In Silicon Valley there's always this idea that you want to be the first mover. I always think the better framing is you want to be the last mover. You want to be the last company in a category. Those are the ones that are really valuable. Microsoft was the last operating system for many decades. Google is the last search engine. Facebook will be valuable if it turns out to be the last social networking site. One way to think of this last mover value is that most of the value in these companies exists far in the future. If you do a discounted cash flow analysis of a business, you have all these profit streams, a growth rate much higher than the discount rate, so most of the value exists far in the future. I did this exercise at PayPal in March of 2001. We'd been in business for about 27 months. The growth rate was 100% a year. We were discounting future cash flows by about 30%. And it turned out that about three quarters of the value of the business as of 2001 came from cash flows in years 2011 and beyond. Whenever you do the math on any of these tech companies, you get to an answer like that. So if you are trying to analyze any of the tech companies in Silicon Valley, Airbnb, Twitter, Facebook, any emerging internet companies, all the ones in Y Combinator, the math tells you that three quarters, 80, 85% of the value is coming from cash flows in years 2024 and beyond. It's very far in the future. And so one of the things we always overvalue in Silicon Valley is growth rates and we undervalue durability, because growth is something you can measure in the here and now and you can always track that very precisely. The question of whether a company's still going to be around a decade from now, that's actually what dominates the value equation and that's a much more qualitative thing. So if we go back to the idea of these characteristics of monopoly: proprietary technology, network effects, economies of scale, you can think of these characteristics as ones that exist at a moment in time where you capture a market and take it over, but you also want to think about whether these things are going to last over time. There's a time dimension to all these characteristics. Network effects often have a great time element where as the network scales, the network effects actually get more robust. So if you have a network effect business, that's often one that can become a bigger and stronger monopoly over time. Proprietary technology is always a tricky one. You want something that's order of magnitude better than the state of the art in the world today. That's how you get people's attention, that's how you initially break through, but then you don't want to be superseded by somebody else. There are all these areas of innovation where there was tremendous innovation, but no one made any money. Disk drive manufacturing in the 1980s. You could build a better disk drive than anybody else, take over the whole world, and two years later someone else would come along and replace yours. In the course of 15 years, you got vastly improved disk drives. It had great benefit to consumers, but it didn't actually help the people who started these companies. So there's always this question about having a huge breakthrough in technology, but then also being able to explain why yours will be the last breakthrough, or at least the last breakthrough for a long time, or where you make a breakthrough and then you can keep improving on it at a quick enough pace that no one can ever catch up. If you have a structure of the future where there's a lot of innovation and other people will come up with new things in the thing you're working on, that's great for society, but it's actually not that good for your business typically. And then economies of scale we already talked about. So I think this last mover thing is very critical. I'm always tempted, I don't want to overdo the chess analogies, but the first mover in chess is someone who plays white. White is about a third of a pawn advantage. So there's a small advantage to going first. You want to be the last mover who wins the game. There's the Capablanca line: you must begin by studying the end game. I think this perspective of asking these questions, why will this still be the leading company 10, 15, 20 years from now, is a really critical one to think through.

Let me sort of go in two slightly other directions with this monopoly versus competition idea. I think this is the central idea in my mind for business, for starting business, for thinking about them. There are some very interesting perspectives it gives on the whole history of innovation and technology and science. We've lived through 250, 300 years of incredible technological progress in many domains: steam engine to railways, telephones, refrigeration, household appliances, the computer revolution, aviation, all sorts of areas. And there's an analogous thing in science where we've lived through centuries of enormous amounts of innovation. The thing that people always miss when they think about these things is that because X and Y are independent variables, some of these things can be extremely valuable innovations, but the people who invent them do not get rewarded. You need to create X dollars in value, you capture Y percent of X. I would suggest that the history of science has generally been one where Y is 0% across the board. Scientists never make any money. They're always deluded into thinking they live in a just universe that will reward them for their work and inventions. This is probably the fundamental delusion that scientists tend to suffer from. Even in technology, there are many areas where there were great innovations that created tremendous value for society, but people did not actually capture that much of the value. So I think there is a whole history of science and technology that can be told from the perspective of how much value was actually captured. There are entire sectors where people didn't capture anything. The smartest physicist of the 20th century, you come up with special relativity, general relativity, you don't get to be a billionaire, you don't even get to be a millionaire. It just doesn't work that way. The railroads, incredibly valuable, most of them went bankrupt because there was too much competition. Wright brothers, fly the first plane, don't make any money. So I think the structure of these industries is very important. The thing that's actually rare are the success cases. When you really think about the history in this 250-year sweep, Y is almost always 0%. It's always zero in science, almost always in technology. Very rare where people made money. The early Industrial Revolution, textile mills, steam engine, you had relentless improvements in efficiency of textile factories at 5 to 7% every year for 60, 70 years from 1780 to 1850. But even in 1850, most of the wealth in Britain was still held by the landed aristocracy. The workers didn't make that much, the capitalists didn't make that much either. It was all competed away. There were hundreds of people running textile factories. The structure of competition prevented people from making money. In my mind, there are probably only two broad categories in the entire history of the last 250 years where people have actually come up with new things and made money doing so. One is these vertically integrated complex monopolies, which people built in the second industrial revolution at the end of the 19th and start of the 20th century. This is like Ford, vertically integrated oil companies like Standard Oil. What these vertically integrated monopolies typically required was very complex coordination. You got a lot of pieces to fit together in just the right way. When you assembled it, you had a tremendous advantage. This is actually done surprisingly little today. I think this is a business form that when people can pull it off is very valuable. It's typically fairly capital intensive. We live in a culture where it's very hard to get people to buy into anything that's super complicated and takes very long to build. But when I think about my colleague Elon Musk from PayPal's success with Tesla and SpaceX, I think the key to these companies was the complex vertically integrated monopoly structure they had.

And then I think there is something about software itself that's very powerful. Software has these incredible economies of scale, low marginal costs. There is something about the world of bits as opposed to atoms where you can often get very fast adoption. Fast adoption is critical to capturing and taking over markets because even if you have a small market, if the adoption rate is too slow, there'll be enough time for other people to enter that market and compete with you. Whereas if you have a small to mid-size market and have a fast adoption rate, you can take over this market. So I think this is one of the reasons Silicon Valley has done so well and why software has been a phenomenal industry. What I would suggest to leave you with is that there are these different rationalizations people give for why certain things work and why certain things don't work. These rationalizations always obscure this question of creating X dollars in value and capturing Y percent of X. The science rationalization is that scientists aren't interested in making money, they're doing it for charitable reasons, and you're not a good scientist if you're motivated by money. I'm not saying people should always be motivated by money, but we should be a bit more critical of this as a rationalization. We should ask if this is a rationalization to obscure the fact that Y equals 0% and that scientists are operating in a world where all the innovation is effectively competed away and they can't capture any of it directly. The software distortion is that people are making such vast fortunes in software, we infer that this is the most valuable thing in the world being done. So if people at Twitter make billions of dollars, it must be that Twitter is worth far more than anything Einstein did. That rationalization tends to obscure that X and Y are independent variables and there are businesses where you capture a lot of X and others where you don't. I do think the history of innovation has been a history where the microeconomics, the structure of these industries, has mattered a tremendous amount. Some people have made vast fortunes because they were in industries with the right structure and other people made nothing at all because they were in very competitive things. We shouldn't just rationalize that way. It's worth understanding this better.

And then finally, let me come back to this overarching theme for this talk, this competition is for losers idea, which is always this provocative way to title things because we always think of the losers as the people who are not good at competing. We think of the losers as the people who are slow on the track team in high school or who do a little bit less well on the standardized tests and don't get into the right schools. So we always think of losers as people who can't compete. I want us to really rethink and revalue this and consider whether it's possible that competition itself is off. It's not just that we don't understand this monopoly competition dichotomy intellectually. I've been talking about why you wouldn't understand it intellectually because people lie about it, it's distorted, the history of innovation rationalizes what's happening in very strange ways. But I think it's more than an intellectual blind spot. I think it's also a psychological blind spot where we find ourselves very attracted to competition. We find it reassuring if other people do things. The word ape already in the time of Shakespeare meant both primate and imitate. There is something about human nature that's deeply mimetic, imitative, ape-like, sheep-like, lemming-like, herd-like. It's a very problematic thing that we need to always think through and try to overcome. There is always this question about competition as a form of validation where we go for things that lots of other people are going for. It's not that there is wisdom in crowds. When lots of people are trying to do something, that is often proof of insanity. There are 20,000 people a year who move to Los Angeles to become movie stars. About 20 of them make it. I think the Olympics are a little bit better because you can figure out pretty quickly whether you're good or not, so there's a little bit less deadweight loss to society. The educational experience at a place like the pre-Stanford educational experience, I think most of the people in this room had machine guns, they were competing with people with bows and arrows. So it wasn't exactly a parallel competition when you were in junior high school and high school. There's always a question, does the tournament make sense as you keep going? If people go on to grad school or post-doctoral educations, does the intensity of the competition really make sense? There's the classic Henry Kissinger line describing his fellow faculty at Harvard: the battles were so ferocious because the stakes were so small, describing academia. On one level, this is a description of insanity. Why would people fight like crazy when the stakes are so small? But it's also a function of the logic of the situation. When it's really hard to differentiate yourself from other people, when the objective differences are small, then you have to compete ferociously to maintain a difference that's often more imaginary than real. There's a personal version of this that I tell. I was hyper-tracked. I know my eighth grade junior high school yearbook one of my friends wrote, 'I know you'll get into Stanford in four years as a sophomore.' So I went into Stanford four years later at the end of high school. Went to Stanford Law School. Ended up at a big law firm in New York where from the outside everybody wanted to get in, on the inside everybody wanted to leave. It was this very strange dynamic. After I realized this was maybe not the best idea, I left after 7 months and 3 days. One of the people down the hall from me told me, 'It's really reassuring to see you leave, Peter. I had no idea that it was possible to escape from Alcatraz.' Which of course all you had to do was go out the front door and not come back. But so much of people's identities got wrapped up in winning these competitions that they lost sight of what was important and valuable. Competition does make you better at whatever it is you're competing on. When you're competing, you're comparing yourself with the people around you, figuring out how to beat the people next to you, and you will get better at that thing. I'm not denying that. But it often comes at a tremendous price that you stop asking bigger questions about what's truly important and truly valuable. So I would say don't always go through the tiny little door that everyone's trying to rush through. Maybe go around the corner and go through the vast gate that no one's taking. Thank you very much.