Today we summarize Zero to One. Peter Thiel explores how we go about creating something new and shares his vision of humanity’s future progress.
The Challenge of the Future
“What important truth do very few people agree with you on?”
The question above seems simple, but in reality it’s hard to answer. Common responses tend to take sides in familiar debates. Being a contrarian is hard; you really need to think for yourself.
Progress can take two forms:
|0 to 1||1 to n|
|Vertical or intensive progress||Horizontal or extensive progress|
|Doing new things||Copying things that work|
On a macro level, horizontal progress is globalization. Third world countries adopt what has worked in the developed work (and skip a few steps along the way). Vertical progress represents technology. Vertical progress is harder because you need to do something that nobody has ever done.
Peter Thiel’s answer to his own contrarian question is that…
…most people think the future of the world will be defined by globalization, but the truth is that technology matters more.
Without technological improvements, the environmental and resource impacts of globalization will devastate the planet. Globalization without technology isn’t sustainable.
New technology tends to come from startups. Large organizations move too slowly, while individuals can’t create industries alone. But the most important strength of a startup isn’t its speed but rather its ability to exercise new ways of thinking. To succeed, the startup must rethink business from scratch.
Party Like It’s 1999
The first step to thinking clearly is to question what we think we know about the past.
Outdated conventional beliefs only appear arbitrary and wrong in retrospect. From then on, it’s referred to as a bubble. If you can identify a delusional popular belief (before it becomes obsolete), it’s easy to uncover the contrarian truth that conflicts with that belief.
A Brief History of the 1990’s
The rise and fall of the dot-com companies defined the 1990’s. The decade had roughly four stages that comprised the dot-com boom and bust.
1) A Bad Start
The 1990’s began with a recession. Recovering from the economic downturn triggered a painful shift for the United States from a focus in manufacturing to a service economy. Fears about jobs going to Mexico and Japan winning the semiconductor war didn’t help national morale either.
2) Irrational Exuberance
The availability of the Internet to the masses brought a swift end to the slump. Mosaic (later to be known as Netscape) released its browser in late 1993, beginning the economic upturn. (It would IPO two years later without being profitable.) Throughout the rest of the decade, other tech companies would also start, IPO, and see a dramatic growth in share prices. In late 1996, Fed chairman Alan Greenspan warned against “irrational exuberance” that may have swept the nation.
3) The Dot-Com Mania
The dot-com mania only lasted 18 months (September 1998 to March 2000). But during those times, money was everywhere. Startup after startup would throw lavish launch parties, and “successful” companies would lose money as they grew. It was right before this end of this era that PayPal secured much needed funding for itself.
4) The Dot-Com Bust
The stock market then crashed hard. The dot-com era was relabeled as an time of irrational greed. Globalization superseded technology as the big hope of the future. (The result would be a real estate bubble that popped a few years later.)
What’s the takeaway from all of this? Silicon Valley entrepreneurs gathered four “lessons” from the crash that still prevail today.
- Make incremental advances. Anything that’s ambitious and aims to change the world is a delusion of grandeur. Humble steps are the safe way forward.
- Stay lean and flexible. Companies should not be too well planned in advance.
- Improve on the competition. Don’t prematurely create a new market. Find an existing market that’s proven to work and then crush the competition.
- Focus on product, not sales. If you product requires salespeople, it’s not good enough. A great product will attract viral growth.
However, thinking about these “lessons,” the opposites are likely closer to the truth.
- It is better to risk boldness than triviality.
- A bad plan is better than no plan.
- Competitive markets destroy profits.
- Sales matter just as much as product.
So did we actually learn anything? The takeaway here is that not everything’s easily black and white. The 90’s were full of hubris and most people were all talk. But that doesn’t mean that all of the beliefs were wrong. We need technology, and some hubris might even help us get there.
We must reject the prevailing dogmas that formed after the crash, but that doesn’t mean the opposites are necessarily true. You have to think for yourself.
The most contrarian thing of all is not to oppose the crowd but to think for yourself.
All Happy Companies Are Different
When applied to business, the contrarian question can be framed like what’s below:
What valuable company is nobody building?
Like with the original contrarian question, finding a good answer is hard. Just because a company creates lots of value doesn’t mean it’s valuable. Creating value is only one variable in the question. You also need to capture some of the value you create.
For example, airlines pull in more revenue than Google, but Google has over 100 times the profit margins of any airline. As a result, Google is worth more than three times all of the airlines combined. Such phenomena can be modeled through perfect competition and monopoly.
In a market with perfect competition, prices converge to the true market value. There’s no differentiation among different companies, so any company is replaceable. As a result, companies must obey the whims of the market. Companies will join and leave the market depending on if there’s profit to be made, such that there’s equilibrium between supply and demand. When there’s perfect competition, nobody makes a profit in the long run.
A monopoly is the opposite of perfect competition. Since a monopoly owns its respective market, it can set its own prices. Similarly, it can produce at a quantity and price combination that best maximizes its profits. Companies can become monopolies by sabotaging competitors, government favoritism, or innovation. This book concerns itself with the company that’s so good that no other company can compare.
|Number of players||Several (up until there’s no more profit to be shared)||One|
|Price||Converges to market value||Converges to whatever maximizes profits|
|Supply||Converges to match demand||Converges to whatever maximizes profits|
|Profit||Converges to zero||Converges to the size of the market|
|Barrier of entry||None||High|
|Advertised market||Intersection of smaller markets||Union of large markets|
Americans glorify competition and contrast it with socialist economies. Contrary to popular belief, competition and capitalism are actually opposites. Under perfect competition, profits get competed away. Avoid creating an undifferentiated commodity business if you want to create and capture lasting value.
Where along the competition-monopoly spectrum do most companies live? At first glance, it seems most companies are quite similar, but the reality is that the distribution is bimodal. Most businesses tend to fall on either extreme. There’s confusion about whether companies are monopolies or competitors because all companies are incentivized to lie.
Monopolists lie to protect themselves. Advertising a monopoly invites scrutiny from the government and other entities. To keep their profits from being disturbed, they conceal their monopoly by exaggerating the (nonexistent) competition. Google claims not to be a monopoly by framing itself as an advertising company. But nothing comes close when you look at the search market.
On the other hand, companies that haven’t escaped competition frame the story in the opposite direction. They claim to be in a league of their own by describing the market so narrowly that they dominate it by definition. A restaurant can claim to be the only one of its kind in the city, but odds are that you can get your meal from any other restaurant.
If you lose sight of the competitive reality and focus on trivial differentiating factors…your business is unlikely to survive.
To summarize, monopolies claim that their market is the union of several larger markets. Non-monopolists on the other hand define their market as the intersection of several smaller markets. To notice if someone is defining their market too broadly or narrowly, figure out what’s the relevant market for their business, rather than the market the claim to have.
Competitive markets push people towards ruthlessness (or death). Since there are minimal margins you need to squeeze out every last drop of efficiency. That’s why restaurant owners tend to have family members helping out every now and then. A perfect competition has to be so focused on immediate margins that it can’t afford to plan for a long-term future.
In business, money is either a important thing or it is everything.
Since monopolies don’t have to worry about competing for profits, it has the time and resources to care about its workers, its product, and its greater impact on the world. Monopolies can afford to think about things other than money. Only monopoly profits can allow a business to transcend the daily struggle to survive.
Are monopolies bad for society? Yes, but only in a static world where nothing changes. In such a case, monopolies are glorified rent collectors.
But we live in a dynamic world where better products arise, and existing monopolies can become obsolete. New monopolies give people more choices by creating new things for the world.
IBM lost its monopoly to Microsoft, and AT&T no longer has a telephone monopoly since it failed to continue innovating. Note that any business or system that impedes progress or innovation would indeed be bad. But history shows that progress takes the form of better monopolies unseating incumbents. Monopolies end up driving progress because the promise of securing monopoly profits is a great incentive to innovate.
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.
At the end of the day, a business must become a monopoly to be successful.
The Ideology of Competition
Competition is an ideology that pervades our society. People embrace competition and assert its necessity.
We’ve been trained throughout our lives to accept competition as the way of life. In school, for example, there’s are strict metrics used to compare everyone. Children grow up to continue seeking such direction and miss the opportunity costs of taking other paths in life.
Competition happens in business because organizations are too similar. People focus on beating their rivals such that they lose sight of what really matters. As Google and Microsoft grew, they began to focus on one another, leading to products like Bing and Chrome OS. The result was that Apple overtook their dominance. By 2013, it was worth more than Google and Microsoft combined. Three years ago, each company was worth more than Apple.
In hindsight these conflicts are completely avoidable. Google and Microsoft were very different, yet they opted to fight each other. Rivalry causes us to overemphasize old opportunities and copy what’s worked in the past. It also makes us see “opportunities” that don’t actually exist. Focus on what’s actually important. If you play stupid games, you’ll win stupid prizes.
Sometimes fighting is truly inevitable. But when that’s the case, you must fight and win. There’s no middle ground: either don’t fight or fight hard and win quickly. Just make sure you’re fighting for something that matters. If you can’t beat a rival, it’s sometimes better to merge. Peter Thiel and Elon Musk ended up merging PayPal and X.com, which allowed them to survive the dot-com crash.
If you can recognize competition as a destructive force instead of a sign of value, you’re already more sane than most.
Last Mover Advantage
Escaping competition gives you a monopoly, but you only have a great business if if it can endure for the long term.
A great business is defined by its ability to generate cash flows in the future.
The value of a business today is the sum of all the money it will make in the future. That’s why investors can pay a large premium for growing startups. (Though you should also take into account net present value since making immediate money now is worth more than delayed money.)
We notice a contrast in cash flows over time when comparing traditional businesses and high-growth startups. A normal company may have decent cash flow today, but over time it’s cash flow will converge to nothing as its profits get competed away. On the other hand, a startup follows the opposite trajectory. It loses money at the beginning, but its value will skyrocket years later. Hence large valuations make sense when accounting for projected future cash flows.
Unfortunately, most entrepreneurs in Silicon Valley stilll don’t understand the importance of future profits. It’s partially because growth is easy to measure while durability is not. It’s a pitfall that Zynga and Groupon fell victim to.
For a company to be valuable it must grow and endure, but many entrepreneurs focus only on short-term growth.
When considering growth, the most crucial question is whether the business will still be around in a decade. You can’t answer the question with just numbers; you must also do some critical thinking about the qualitative aspects of the business.
Characteristics of Monopoly
Monopolies usually share some combination of the four characteristics detailed in the following subsections. There’s no list of checkboxes to make a durable business, but thinking over certain important characteristics can help.
Proprietary technology makes your product difficult or impossible to replicate. It’s the most important advantage you can leverage. The proprietary technology should be at least 10 times better than the closest substitute, otherwise it will only be seen as a marginal improvement. The clearest way to get a 10x improvement is by doing something completely new, but radically improving an existing solution works too.
Products become more useful as more people use it if the product leverages network effects. Having a network effect means that each new user will benefit the existing userbase. You’ll never benefit from the network effect when getting your first users since the network has to first hit a critical mass. As a result, businesses relying on network effects must must start with and be able to handle small markets.
Economies of Scale
Monopolies should become strong as they grow because the benefits of fix costs scale quickly. Software, for example, can take great advantage of economies of scale since the marginal cost of reproducing software products is almost nothing. Contrast that with a lemonade stand. Serving twice the amount of customers requires double the effort (unless one takes some means of automating the business). The potential for scale should be taken into account when designing the initial startup.
Creating a strong brand contributes to the perception of a startup’s exceptionalism. In a sense, brand captures recognition for the substance a company creates. Note that a technology company can’t be build on brand alone; there must be real substance to back everything up.
Building a Monopoly
To get a monopoly working, you need to be intentional with picking your market and expanding.
Start Small and Monopolize
- Every startup starts as a small company.
- Every monopoly dominates a large share of its market.
- Therefore, every startup should start with a very small market.
Start with a small market and dominate it. Err on the side of starting in too small of a market. If you think the initial market is too big, then it probably is. On the flip side, small doesn’t mean nonexistent. Make sure you find a legitimate market that isn’t neglibile.
The perfect target market for a startup is a small group of particular people concentrated together and served by a few or no competitors.
A big market is bad, and a saturated market is worse. Large markets lack good starting points and are open to competition. It’s a red flag when an entrepreneur wants a small piece of a big pie.
After creating and dominating a niche market, expand into related and slightly broader markets gradually. It takes discipline to expand gradually, but it’s important to conquer the current market you’re in before broadening the market.
Amazon is the perfect example of scaling well. Jeff Bezos’s initial vision was to dominate online retail, but Amazon intentionally started with books. After becoming the de facto internet bookstore, it expanded to adjacent markets (such as videos and software).
Having the plan to dominate a specific niche and then scale to adjacent markets should be part of the founding vision for successful companies.
“Disruption” has become buzzword in Silicon Valley. The problem with the word is that it has a connotation of competing with the big incumbent companies. If your company is focused on disruption (i.e. opposing existing firms), it’s unlikely to end up as a monopoly since the company can’t be that original.
Disruptors also attract negative attention and the wrath of companies being threatened. Contrast this with PayPal, which was an alternative to Visa but gave the company more business than it took. Since it increased the overall market size, it played a positive-sum game.
When planning to expand into adjacent markets, avoid competition as much as possible. Don’t disrupt.
The Last will be First
Having the “first mover advantage” is a tactic, not a strategy. At the end of the day, what matters most is generating cash flows for the future. After all, being the first mover in a space doesn’t mean much if someone else introduces a better product that makes your business obsolete.
It’s better to be the last mover. Making the last great development in a market means you reap the benefits of a monopoly for the forseeable future. Hence the founding vision must study the endgame first.
You Are Not a Lottery Ticket
How much does success come from luck compared to skill?
While some claim success isn’t accidental, many successful people admit that they’re lucky. On the other hand, there are serial entrepreneurs who end up with many multi-million and multi-billion dollar companies. Such events happening randomly have very low probability, but perhaps there’s some survivorship bias in the mix too.
There’s ultimately no way to objectively tell how much luck plays in the world since we lack a controlled sample. Maybe not everythiing is dumb luck though. Prior generations believed in making your own luck by working hard. Focus on what you can control, not what’s out of your control.
Interpretations of the Future
Based on your locus of control, you can expect a definite or indefinite future. An indefinite future is subject to randomness; you don’t have the ability to predict or control what’s predestined to happen. Those who subscribe to an indefinite future tend to lack a concrete plan and will follow formal processes that seem generally correct. (Take for example, a college resume full of extracurriculars.)
On the other hand, those with a definite view of the future benefit from having firm convictions. Believers of a definite future will want to pick the one best thing and do it. By being great at something realy meaningful, you become a monopoly of one.
Besides interpretations of how much control you have over the future, you can also expect the future to be better or worse than the present. Depending on your locus of control and whether you’re optimistic or pessimistic about the future, we have four overall interpretations of the future.
|Indefinite Pessimism||Definite Pessimism||Definite Optimism||Indefinite Optimism|
|Present-day Europe||Present-day China||United States (1950s-1060s)||United States (1982-present)|
|Epicurus, Lucretius||Plato, Aristotle||Hegel, Marx||Nozick, Rawls|
|High investment, high savings||Low investment, high savings||High investment, low savings||Low investment, low savings|
An indefinite pessimist expects a bleak future and has no idea what to do about it. Such an attitude explains why most of Europe takes vacations and enjoys life while they hope thing don’t get worse. Such a mindset is self-consistent because it’s self-fulfilling; you’re a slacker with low expectations.
Definite pessimists also expect a bleak future but believe the future will be known. China exhibits such a mindset since it experienced disaster and famine in the past. Now it strives to copy and grow as quickly as possible to prepare for the worst, while knowing its population will only push resource prices higher. This mindset also works since one is building what can be copied without expecting anything new.
Definite optimists expect the future to be better if they plan and work to make it better. Such a mindset pervaded the United States in previous decades, when the country grew to be the leader of the free world. Such optimism works since you are building the future you envision.
Indefinite optimists are bullish of a better future, but they don’t know how the future will be better. As a result, they don’t make specific plans. The modern United States has fallen into an entitlement trap that started with the Baby Boomers. Life is good and seems to be improving, so they’d might as well accept it. Unfortunately, this mindset is extremely pervasive in most aspects of American society (and is arguably the most dangerous mindset).
Unlike the other three mindsets, indefinite optimism is not sustainable. The future can’t get better if no one plans for it. A common counter-point is that progress without planning is “evolution.” However, being adaptive as the central goal just leads to incremental improvements; it won’t take you from zero to one.
A company is the strangest place of all for an indefinite optimist: why should you expect your own business to succeed without a plan to make it happen?
Designing the Future
It’s true that every great entrepreneur is first and foremost a designer.
Long-term planning is undervalued in our current world. Designing a good plan leads to massive yields that can only be seen years later. Hence it explains why valuing private companies is so difficult.
When a company tries to acquire a startup, the offer is always too high or too low. If the startup sees where it’ll be going in the future, the offer is definitely too low; otherwise the company is likely going nowhere.
A business with a good definite plan will always be underrated in a world where people see the future as random.
We must return to being a society of definite optimists. You can start by rejecting a world ruled by chance.
Follow the Money
Exponential growth is the most powerful force that frequently appears in nature. Our world is not normal (in the distribution sense); rather, we live under a power law. Small minorities often achieve disproportionate results, and money begets more money. The power law is hard to observe because it seems like nothing during early stages, but you’ll notice its impact if you follow the money.
Power Law in Venture Capital
VC funds aim to profit by investing in early-stage companies. Once the company gets acquired or IPOs, they fund makes back its money. However, due to the power law, most startups fail, and the fund loses its investment. Instead, a few handful of companies radically outperform the others and account for the losses of all the other startups. “Randomly” investing usually creates a portfolio full of failures, since startup success doesn’t have a normal distribution.
The biggest secret in venture capital is that the best invement in a successful fund equals or outperforms the entire rest of the fund combined.
Hence VC must only invest in companies that have the potential of returning the value of the entire fund. Similarly, when a company is more hopeful, the VC should double down and keep investing in the company’s growth. A diversified hedging strategy is a recipe for failure in this field.
How to Use the Power Law
Everybody is an investor. You invest your time and your career. Common wisdom states that the diversified portfolio makes you robust against the future. But life isn’t a portfolio; you can only make so many choices. Thus it’s best to avoid dabbling and do a few things well.
You should focus relentlessly on something you’re good at doing, but before that you must think hard about whether it will be valuable in the future.
This does not mean you should necessarily start a startup. If anything, it could have high opportunity costs compared to joining a high growth startup. Having 100% of a worthless pie is worth nothing.
However, if you do start a startup, you can’t not afford to ignore the power law. One market will be better than all the others combined. One strategy will give you disproportionate results. And certain moments in time will be far more important than others.
Any correct answer to the contrarian business question is a secret. (A secret in this context is any truth that’s unknown to us.) Finding secrets is hard.
People have largely given up on finding secrets for four reasons.
- Incrementalism: We’re taught to do piecemeal steps in life rather than taking leaps into the unknown.
- Risk aversion: You risk railure being wrong when searching for secrets.
- Complacency: Modern life has gotten pretty good, so there’s no onus to search for secrets.
- Flatness: People perceive a world where someone else would find the secret first anyway before they could try.
But there are still many secrets. We’d otherwise live in an enlightened society with no diseases or market inefficiencies.
When a company stops believing in secrets, it starts its own collapse. Hewlett-Packard grew during its age of inventing the printer and laptops. However, once a dysfunctional board started introducing politics and beauracracy, HP became a shadow of its former self.
You can’t find secrets without looking for them…they will yield only to relentless searchers.
How to Find Secrets
There are two kinds of secrets.
- Secrets of nature: some undiscovered aspect of the world
- Secrets about people: something people don’t know about themselves or something they’re hiding from you
Hence when on the hunt for secrets, think about that nature isn’t telling you and what people aren’t telling you. Sometimes looking for secrets through nature and people can lead to the same conclusion. For example, the relationship between capitalism and monopoly can be discovered by either observing the markets or by observing how people described their businesses.
The best place to look for secrets is where nobody else is looking.
Most people’s thinking revolves around what they’ve been taught. That’s why physics is well-studied, but nutrition (an equally rigorous field) is not. There’s plenty more to learn about nutrition which will be immediately useful. If people aren’t paying much attention to a certain area, it’s a good opportunity to search for secrets.
What to do with a Secret
If you discover a secret, do you share it? Tell it only to people who you need to know and nobody else. It’s probably bad to reveal everything you know to everyone in general.
In practice, there’s a golden mean between telling nobody and telling everybody–and that’s a company.
Great businesses are built around a secret that’s leveraged to change the world.
A startup messed up at its foundation cannot be fixed.
Good companies cannot be built upon flawed foundations. Fundamental problems will compound over time.
Choosing a cofounder is like getting married. It’s uncomfortable to think about bad things that could happen, but if there’s conflict between founders, the company suffers. When investing, Peter Thiel studies the teams in terms of how well the founders know each other in addition to skills. Founders without a prehistory are rolling the dice.
Men are not angels. People will have misalignment on where to take the company next. Thus you need a clear power structure to determine who controls what.
There are three concepts to distinguish to handle potential misalignment:
- Ownership: Who owns a company’s equity? (Founders, employees, and investors.)
- Possession: Who actually runs the company on a day-to-day basis? (Managers and employees.)
- Control: Who formally governs the company’s affairs? (The board of directors.)
Early stage startups are small enough such that founders have both ownership and possession (and control). Most early conflicts tend to erupt between those with ownership and control. For example, the investors may want to take a company public to liquidate while the founder wants to keep growing. In general, the potential for conflict grows as the company grows; there are more people who can become misaligned.
Smaller boards are better. It’s easier to communicate, reach consensus, and exercise power. Every single board member matters. Picking the wrong person can jeopardize the company. A board of three is ideal, and it should never exceed five people.
Everybody in your company should be full time. If they’re not drawing a salary or options, they have no skin in the game and are fundamentally misaligned. Hence consultants and part-timers are bad, and you avoid remote workers if possible. You’re either on the bus or off the bus.
People should be properly compensated. But be careful with cash. A company does better the less it pays its CEO; paying yourself too much sets the wrong example. Cash (and cash bonuses) fundamentally incentivize short term gain.
High cash compensation teaches workers to claim value from the company as it already exists instead of investing their time to create new value in the future.
Equity is a great incentivize for people to make a company go well. Dividing up equity is hard; not everybody can get the same amount. Keep the distribution a secret or resentment will endanger the entire company. Equity is powerful because it can be worthless if the company fails. Those who prefer equity over cash demonstrate some preference in the long term prosperity of the business.
The Mechanics of Mafia
A stereotypical view of Silicon Valley culture has an open office with absurd perks. But there’s no substance. A company is a team people of people on a mission. That team is the culture.
Time is your most valuable asset, so you should spend it working with people where you can envision a long-term future together. Stronger relationships can make people happier, more productive, and more successful in their careers beyond the original team. So beware picking those who look best on paper. Avoid a workplace where people have no relationship outside of the office.
If you can’t count durable relationships among the fruits of your time at work, you haven’t invested your time well–even in purely financial terms.
Recruiting is a core competency for any company. It should never be outsourced.
Talented people have plenty of options. Why should they join your tiny startup among all the other places? Offering valuable stock, smart people, and interesting work is fine, but everybody promises those. Instead, sell the mission. Talk about what you’re doing that’s so important but nobody else is going to get done.
You must also make sure that the employee will enjoy working with the team. There should be some explanation on why the company and candidate are a unique fit for each other, otherwise it’s probably not a good fit. Don’t fight the perk war. Competing with perks attracts the wrong people. Having the basics like health insurance should suffice.
On Internal Alignment
The people in a startup should be like-minded and devoted to the company’s mission. Their backgrounds can be diverse, but their values should be aligned.
On the inside, every individual should be sharply distinguished by her work.
Internal conflicts happen because coworkers compete for the same responsibilities. Startups have high risk since job roles tend to be fluid. As a result, it’s best to align talents with tasks. Defining roles will reduce conflict.
The best startups can be seen as less extreme cults. However, the difference is that the people in the startup are fanatically right about something the rest of the world missed. It’s okay if it doesn’t make sense to conventional professionals.
If You Build It, Will They Come?
What nerds miss is that it takes hard work to make sales look easy.
Customers will not come just because you’re building cool stuff. Nerds tend to dismiss advertising, marketing, and sales as superficial and irrational.
Distribution: A catchall term for everything it takes to sell a product. Advertising, marketing, and sales are part of distribution.
Salesmen are actors. The job is to persuade, not to be sincere. Like acting, distribution works best when hidden. The fundamental reason people underestimate the importance of sales is because of the systematic efforts to hide the act of selling. But everything meaningful that has happened in society (including results of science) are due to persuasion.
Products don’t sell themselves, and the best product doesn’t always win. Think of distribution as something essential to the design of your product.
If you’ve invested something new but you haven’t invented an effective way to sell it, you have a bad business–no matter how good the product.
Two metrics affect the viability of distribution.
- Customer Lifetime Value (CLV): the total profit made throughout the relationship with the customer.
- Customer Acquisition Cost (CAC): the amount you spend to acquire a new customer.
The CLV must exceed the CAC, otherwise you don’t gain any money from the customer. The higher the price of your product, the most you have to spend to make a sale (and the more it makes sense to spend on a sale).
There are different methods of distribution spending on the size and quantity of customers.
For sales upwards of a million dollars, every detail matters, and the process may take months. You have to get buy-in from the most crucial people and uphold the relationship after the sale.
Complex sales work best when there are no traditional salesmen. At that price point, customers want to talk to the CEO.
Businesses with complex sales models succeed if they have 50-100% YoY growth over a decade. It may seem small, but it’s because new customers are unlikely to scale up their spending too quickly given the size of the sale. But in the long term, deals can get very large.
Most sales range from $10,000 to $100,000. The challenge isn’t around individual sales but exposing the product to a wide audience. This distribution channel tends to create relationships with individuals until some of them become customers.
At the price range of $1000, we enter a dead zone. The price point is too expensive for advertising, but it’s not enough to warrant an account executive.
Marketing and Advertising
Marketing and advertising work best for relatively low-priced products (that aren’t viral). These products will typically have mass appeal. The price point in this channel is around the order of $100.
A product is viral if its core functionality encourages users to invite their friends to become users too.
Viral marketing hopes to achieve the most new customers. However, it needs to have a niche of customers who are involved and well-connected. The first to dominate the most important segment of a market through viral means will be the last mover in the whole market.
The Power Law of Distribution
Distribution follows a power law. One of the methods will be far more effective than all the other combined. If one distribution channel works well, double down on it; you’ve got a great business. If no distribution channels work, it’s likely due to poor sales, and the days of the company are numbered.
Sales goes beyond the product. You’re also selling the company to employees, investors, and the media. All of these play a key role in putting the organization in a good light and opening up opportunities.
Man and Machine
The advancement of technology begs the following question: will a machine replace you? Futurists hope so, while luddites fear the future. However, the premise is wrong. computers are complements for humans, not substitutes.
The most valuable businesses of coming decades will be built by entrepreneurs who seek to empower people rather than try to make them obsolete.
People compete for jobs and for resources; computers don’t need either. Globalization causes substitution: more people compete to provide the same labor and demand the same resources. On the other hand, technology is complementary. Computers excel at data processing, while humans are better at making decisions in complex situations. The strengths and weaknesses are opposites.
Computers should be viewed as high-powered tools to help humans solve hard problems. Society has romanticized computers are being able to do everything alone because the reality is far less interesting.
There’s nothing wrong with a CEO who can sell, but if he actually looks like a salesman, he’s probably bad at sales and worse at tech.
Every business must answer seven questions.
- The Engineering Question: Can you create breakthrough technology instead of incremental improvements?
- The Timing Question: Is now the right time to start your particular business?
- The Monopoly Question: Are you starting with a big share of a small market?
- The People Question: Do you have the right team?
- The Distribution Question: Do you have a way to not just create but deliver your product?
- The Durability Question: Will your market position be defensible 10 and 20 years into the future?
- The Secret Question: Have you identified a unique opportunity that others don’t see?
Any great business plan must address all seven of them. If you don’t have good answers, your company will run into lots of “bad luck.” The companies in the cleantech bubble had no answers to these questions and failed. On the other hand, Tesla worked in the same industry and addressed these questions well.
There was nothing wrong with the cleantech field, but replicating old approaches won’t lead to prosperity. Indefinitely optimistic investors and entrepreneurs in cleantech lacked specific plans, which resulted in a bubble.
An entrepreneur can’t benefit from macro-scale insight unless his own plane begin at the micro-scale.
The Founder’s Paradox
Do all founders have their own quirks, or is that just our biased perception? What traits actually matter with founders? In a startup, it’s more powerful (but also more dangerous) to be lead by a distinctive individual.
Personality traits among humans follow a normal distribution. People with extreme personalities are rare. However if you plot the personalities of founders, it creates the reverse distribution. Founders with personality traits on either extreme are the norm, while “normal people” are the rarest.
Was it part of their nature, or did the attention and expectations influence their personalities? The famous and infamous have always served as vessels for public sentiment. Hence it’s plausible, but hard to determine.
At the end of the day, businesses need to learn that founders are necessary. If anything, we should be tolerant of founders with strange or extreme traits. We need people with the audacity to lead us beyond incrementalism.
Founders should be aware that individual prominence will also lead to individual notoriety. Fame is a double-edged sword.
But most importantly, it’s the team that matters. Founders shine because they can bring the best work out of everybody in the company.
Our task today is to find singular ways to create new things that will make the future not just different, but better–to go from 0 to 1. The essential first step is to think for yourself.