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Lecture 5 - How to Start a Startup

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Good afternoon. Today's speaker is Peter Thiel. Peter, was the founder of PayPal, and Palantir, and Founders Fund, and has invested in most of the tech companies in Silicon Valley. And he's going to talk about strategy and competition. Thank you for coming, Peter. >> Awesome. Thanks, Sam. Thanks for inviting me. Thanks for having me. I sorta, I have a single a day fixed that I'm completely obsessed with in. 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 that you want to always avoid competition. 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 this question, what makes a business valuable? And I wanna, suggest that there's basically, a very simple very simple formula that 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% of X. And the critical thing that I think people always miss in the sort of analysis is that X and y are completely independent variables, and so X can be very big. Y can be very small. X can be of intermediate size. And if Y is, is reasonably big you can still get a very big business. So, to create a valuable company you have to basically, both create something of value and capture some fraction of the value of what you've created. And sort of, just to illustrate this is a contrast. If you sorta, compare the US airline industry with a company like Google on search. If you sorta, measure by the size of these industries you could, you could say that airlines are still more important than search. If you just measure it say by revenues. There's 195 billion. In domestic revenues in 2012. Google had just north of 50 billion. And certainly, sort of on some intuitive level, if you said, if you were given a choice and said well 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 something that's more important than search. And this is, of course, just the domestic numbers. If you had looked at this globally, airlines are much, much bigger than search, or Google, is But the profit margins are quite a bit less. You know, they were marginally profitable in 2012. Think entire hundred year history of the airline industry. The cumulative profits in the U.S. have been approximately zero. The companies make money. They episodically go bankrupt. They get re-capitalized and you sort of cycle and repeat. And this is reflected in you know the combined market capitalization of the airline industries maybe something of the U.S. airline industry. Something like a quarter that of Google. So, you have a search engine much, much smaller than air travel but much more valuable and I think this reflects these very different valuations on X and Y. So, you know, if we look at perfect competition. You know there are, sort of, there's some pros and cons to the world of perfect competition. On a high level it's always, this is what you study in Econ One. It's always, 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 you have 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. You're involvement in anything that's hyper-competitive because you often don't make money off, 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 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 this, 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, this is in my mind, this is the most important. It's not necessarily the most important thing in business, but I think it's the most important business idea that people don't understand. That there are just these two kinds of businesses. And so let me say a little bit about the lies that people tell. And so you basically, the basic, if you sort of 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, and 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 will 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 will want to differentiate, you will want to track capital or something like that. So, if the monopolists pretend not to have a monopolies the non-monopolists pretend to have monopolies. The apparent difference is very small. Where as 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 sort of in these opposite directions. Let me, drill a little bit down further on the way these lies work. And so 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 this in sort of set theoretic terms. You could say that a monopoly tells a why, where you describe your business as the union of these vastly different markets, and the non-monopolies describes it as the intersection. So, that in effect, if you're non-monopolist, you will rhetorically describe your market as super small. You're the only person in that market. If you have monopoly, you'll describe it as super big, and there's lots of competition in it. So some examples of how this works in practice. So I always use restaurants as the example of a terrible business. And there's always, sort of, ideas that, you know, capitalism and competition are antonyms. Capital, someone who accumulates capital. 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 Paolo Alto. So, it's British, Paolo 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 Park. And there probably no people who eat nothing but British food. At least, no people are still alive. And so that is sort of a fictitiously narrow market. There's sort of a Hollywood version of this where. The way movies always get pitched is, it's like a college football star, joins an elite group of hackers to catch the shark that killed his friends. So, that is a movie that has not been made. But the question is, is that the right category or is the correct category? It's just another movie, in which case, you know, there are lots of those, it's super competitive, incredibly had to make money. No one ever makes money in Hollywood doing movies. It's really hard. And so you always have this question about. Does the intersection, does, is it real, does it make sense, does it have value that one should ask? And of course, there are start up versions of this. Where you, and the sort of the really bad versions you just take a whole series of buzz words. Sharing, mobile, social, apps, you combine them, and you have some kind of narrative. And, whether or not, that's a real business or not, is, it's generally a bad sign. So it's, it's almost this pattern recognition when you have this rhetoric of this sort of intersections, it generally does not work. The something of somewhere is really mostly just the nothing of nowhere. It's like the Stanford of North Dakota. 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, you know? Is completely dominant in the search market. Google has not almost never describes itself. As a search engine, these days. And 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, well, it's, like, it has this huge market share that's really, really crazy. It's like a incredible monopoly. It's much bigger than, it's much, 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 is 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 3.5%. So a tiny part of this much larger market. Or if you don't want it to be an advertising company you could always say that you're a technology company. And so sorry. Let me just see. And so the technology market is something like a $1 trillion market, and the narrative that you tell is that 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 the narrow markets in the tech industry is if you basically just. If you look at sort of the, some of the big tech companies, Apple, Google, Microsoft, Amazon, they just they've just been building up cash for year after year and you have these incredibly high profit margins and I would, I would say that the. 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 business. And that's and it's reflected by these companies. Just accumulate so much cash. That they don't know what to do with it beyond a certain point. And so let me say a few things about how to build a monopoly. And, I think one of the sort of very counter intuitive 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 monopoly. You're starting a new company, you want to get to monopoly. Monopolies 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. 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. And it normally means that there is going to be too much competition. In one way or another. And so I think almost all the successful companies in Silicon Valley had some model of starting with small markets and expanding. And 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's starts in the 90's, 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. You know, eBay you start with Pez dispensers. You move on to Beanie Babies and eventually it's all these different auctions for all these sorts of different goods. And what was very counter intuitive about many of these companies is they often start with markets that are so small that people don't think that 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 of 2000 right after we launched, there was a sense that these were all, 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 be going after this market? But, you know, there was a way to get a product that was much better for everybody in that market. You could, and we got to something like 25, 30%, you know, market penetration in two or three months. And you got some walk in. You got brand recognition and your able to build the business from there. So I always think these, these very small markets are quite underrated. The Facebook version of this I always give is that you know if the initial market of Facebook was 10,000 people at Harvard, it went from zero to sixty percent market share in ten 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, they would have had little value had they stayed small, but it turned out they were ways to grow them concentrically and, that's what made them, that's what made them so valuable. Now I think the opposite version of this, is always where you have super big markets. And, and I, there's so much, so many different things that went wrong with all the clean tech companies in the last decade. But, but, one, one theme that ran through almost all of them, was that they all started with massive markets. And 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 of 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 tenth thin film solar panel company. You don't want to be the 100th restaurant in Palo Alto. Your 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, and it's often, large markets, large existing markets typically mean that you have tons of competition, very, very hard to differentiate. So the first very counterintuitive into a idea is to go after small markets, often markets that are so small people don't even notice them. They don't think that they make sense. That's where you got a foothold, and then if those markets are able to expand, you can scale into a big monopoly business. You know, a second sort of, the sort of several different characteristics of these monopoly businesses, that I like to focus on. There's probably no sort of single formula to it. I also ways think that that in technology there is always a sense that you know, the history of technology is such that every. Every moment happens only once, so you know 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. But it's, and so, there is always these very unique businesses that are doing something that's not been done before, end up, end of having the potential to be a monopoly. The opening line in Anna Karenina that all happy companies, sorry, all happy families. All happy families are alike. All unhappy families are unhappy in their own special way. And the opposite is true in business, where 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, and so one sort of characteristic of a monopoly technology company is some sort of proprietary technology. My sort of crazy, 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 ten times as many books, maybe not that high tech, but you figure out a way to sell ten times as many books in an efficient online way. You know, PayPal, the alternative for PayPal was using checks to send money on eBay, took seven to ten days to clear. PayPal could do it more than ten times as fast. So you wanna have some sort of very powerful improvement in some order, maybe an order of magnitude improvement on some key dimension. Of course, you know, if you actually come with something totally new it's, it's just, it's just like an infinite improvement. So I would say the, the iPhone was the first smartphone that worked and so that's, you know that's like I mean, I mean maybe not infinite, but it's sort of definitely order of magnitude or more of improvement. So I think, the, the technology is designed to give you a massive delta over, over the next, the next best thing. I think, I think there often are network effects that can kick in that, really help. The thing that's very, and these, these lead to monopolies over time, the thing that's very tricky about network effects is, they're often. They're often very hard to get started. So even though everyone understands how valuable they are, there is always this incredibly tricky question why is it valuable to the first person who is doing something? Economies of scale, if you have something of a very high fixed costs, very low marginal cost. That's typically a monopoly like business. And then there's this thing of branding. Which is sort of like 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, I think, a real phenomenon that creates real value. I think one of the things, I'm gonna come back to this a little bit, towards the end. But one of the things that's very striking, is that software businesses are often, are, for some reason, 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. And 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. And so in Silicon Valley there's always this idea that you wanna be the first mover. And I, I always think it's, it's, in some ways, the better framing is you wanna be the last mover, or you wanna be the last company in a category. Those are the ones that are really valid. Microsoft was the last operating system, at least 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 of value is this idea 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 look at, you have sort of all these profit streams. You have a growth rate. The growth rate's much higher than the discount rate. And 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. And we sort of had, the growth rate was 100% a year. We were discounting future cashflows 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. And whenever you do the math on any of these tech companies, you get an answer that's something like that. So if you are trying to analyze any other tech companies in Silicon Valley, Arabian B, Twitter. Facebook, any emerging internet companies, any of 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, very far in the future. And, so one of the things that 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 gonna be around a decade from now. That's actually what, what dominates the value equation and that sort of is a much more qualitative sort of a thing. And so if we, if we went back to this 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 when you capture a market and take it over. But you also want to think about, are these things going to last over time. And, so, there's a time dimension to all these characteristics. So, net worth effects also have a great time element, where as the network scales the network effects actually get more robust, and 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 little bit of a tricky one, so you want something that's order magnitude better. Than, the state of the art in the world today. And that's how you get people's attention. That's how you initially break through. But then, you don't wanna be superseded by somebody else. And so there are all these areas of innovation where, there was tremendous innovation, but no one made any money. So, you know? Describe manufacturing in the 1980's. You could im-, you could do a better disk, build a better disk drive than anybody else. You could take over the whole world. And two years later someone else would come along and replace yours. And the course of 15 years, you got vastly improved disk drives, so it had great benefit to consumers, but it didn't actually help the people who started these companies. And so there's always this question about having a huge breakthrough in technology, but then also being able to say, explain why, yours will be the last breakthrough, or at least the last breakthrough for a long time, or when you make a breakthrough. And then you can keep improving on it at a quick enough pace that no one can ever catch up. So, if you have a structure of 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. It's actually not that good for your business, typically. And then economies of scale, we've already talked about. So I think this last mover thing is very critical. I'm always, you know, I don't wanna overdo the chess analogies, but the first mover in chess is someone who plays white. White is about a 1/3 of a pawn advantage, so there's a small advantage to going first. You wanna be the last mover, who wins the game, so there's always the, Capablanca world champion, Capablanca must begin by studying the end game, and I do think that's, while I wouldn't say that's the only thing you should study. I think the sort of perspective of asking these questions, why will this still be the leading company 10, 15, 20 years from now, is a, is a really critical one to try to think through. Let me, let me sort of, I want to sort of go in two slightly other directions with this monopoly vs competition idea. And I think so I think this is the, the central idea, in my mind for, for business for starting business for thinking about them and there are some, interesting perspectives I think it gives on the whole you know, on the whole history of innovation and technology and science. Because, yeah we've, we've lived through, 250, 300 years of incredible technological progress in you know many, many different domains. You know, steam engine to railways to telephones, refrigeration, household appliances, you know the computer revolution, aviation. All sorts of different areas of technological innovation and then there's sort of analogous thing that one can say about science, where we've lived through centuries of enormous amounts of innovation in science as well. And the thing that I think 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, who come up with them, do not get rewarded for this. And certainly, you can go back to, you need to create X dollars in value, you create Y percent of X. I would suggest that the history of science has generally been one where Y is 0% across the board. The scientists never make any money. They're always deluded into thinking that they live in a just universe that will reward them for their work and for their inventions. And this is probably the fundamental delusion that scientists tend to suffer from in our society. And even in technology, there are, sort of, many different areas of technology, where there were great innovations that created tremendous value for society. But the people did not actually capture that much of the value. And so I think there is a sort of whole history of. Science and technology that can be told from the perspective of how much value was actually captured. And certainly, there are entire sectors where people didn't capture anything. So you're the smartest Physicist of the 20th century, you come up with special relativity, you come up with general relativity. You don't get to be a billionaire, you don't even get to be a millionaire. It somehow doesn't work that way. The railroads, incredibly valuable. Most of them just went bankrupt, because there was too much competition. Wright brothers, you fly the first plane, you don't make any money. And so I think there is sort of a structure to these industries, that's very important. And I think the thing that's actually rare, are the success cases. Most the, so it's actually unique when you really think about the history in this, in this 250 year sweep, it's unusual, Y is almost always zero percent. It's always zero in science. It's almost always in technology, and so it's very rare where people made money. You know, the early, the late 18th, early 19th century, the first industrial revolution was textile mills, steam engine, the sort of automated things. And you had these relentless improvements, that people improved efficiency of textile factories, manufacturing generally. At a clip of 5 to 7% every year. Year after year, decade after decade. You had 60, 70 years of tremendous improvement 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, you know, 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 textiles factories. It was an industry that just, the structure of the competition prevented people from making any money. And so I think there are, in my mind, there probably are only two broad categories in the entire history, the last 250 years, where people have actually come up with new things, and made money doing so. One is these sort of vertically integrated complex monopolies which people did build in the second industrial revolution at the end of the 19th and started the 20th century. And so this was like Ford, it was the vertically integrated oil companies like Standard Oil. And what these vertically integrated monopolies typically required was this very complex coordination. You've 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. And so I think this is sort of a business form that when people can pull it off is very valuable. It's typically fairly capital intensive. We live sort of in a, in a culture where is very hard to get people to buy into anything that's super complicated, and it takes very long to build. But I, you know, when I sort of think about my colleague Elon Musk from PayPal success with Tesla and Space X, I think the key to these companies was the complex vertically integrated monopoly structure they had. So if you sort of look at Tesla or Space X you ask, you know, was there sort of single breakthrough? They certainly innovated on a lot of dimensions. I don't think there was a single tennex breakthrough and battery storage, or you know, maybe working on some things in rocketry. But they hadn't, there was no sort of single massive breakthrough, but what was really impressive was integrating all these pieces together, and doing it in a way that was more vertically integrated than most of their competitors. So, Tesla, you also integrated the car distributors, so they wouldn't steal all the money, as has happened with the rest of the car industry in the US. Or SpaceX, you basically pulled in all the subcontractors where most of the large aerospace companies have single source subcontractors that are able to sort of charge monopoly profits, and make it very hard for the integrated aerospace companies to make money. And so vertical integration I think is sort of a very under explored modality of technological progress, that people would do well to look at more. And then I think there is, there is something about software itself that's very, very powerful. Software has these incredible economies of scale, these low marginal costs and there is something about the world of bits, as opposed to the world of adams, where you can often get very fast adoption. And, and the 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 cannot take over this market. And so I think this is one of the reasons Silicon Valley has done so well, and why software has been this phenomenal industry. And what I, what I would suggest, what I would want to leave you with is there are sort of these different rationalizations people give for why certain things work, and why certain things don't work. And I think these rationalizations always obscure this question of creating X dollars in value, and capturing Y percent of X. So the science rationalization we're always told, is that the scientists aren't interested in making money. They're doing it for charitable reasons, and that you're not a good scientist if you're motivated by money. And I'm not even saying people should always be motivated by money or something like this. But I think we should be a little more critical of this as a rationalization. We should ask, is this a rationalization to obscure the fact that Y equals zero percent. And the scientists are operating in this sort of world where all the innovation is effectively competed away, and they can't capture any of it directly. The software distortion that often happens, is because people are making such a vast fortunes in software, we infer that this is the most valuable thing in the world being done full stop. And so if people at Twitter make billions of dollars, it must be that Twitter is worth far more than anything that Einstein did. What that sort of rationalization tends to obscure, is again that X and Y are independent variables. And there are these businesses where you capture a lot of X and there others where you don't. And so, I do think the history of innovation has been this history where the microeconomics, the structure of these industries has mattered a tremendous amount. And when there is sort of this story where 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 these sort of very competitive things. And we shouldn't just rationalize that away, I think it's worth understanding this better. And then finally, let me come back to this sort of overarching theme for this talk, this competition is for losers idea. Which is always a 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 sports team, 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, and I want us to really rethink, and revalue this and consider whether it's possible that competition itself is off. That we've sort of, it's not just the case and we don't understand this monopoly competition dichotomy intellectually. So that's, sort of, why you wouldn't understand intellectually, because people lie about it. It's distorted. We have all these history of innovation rationalizes what's happening in all these very, very strange ways. But I think it's more than just an intellectual blind spot, I think it's also a psychological blind spot where we find ourselves, you know, very attracted to competition in one form or another. We find it reassuring if other people do things. The word ape, already in the time of Shakespeare, meant both primate and imitate. And there is something about human nature that's deeply mimetic. Imitative. Apelike, sheeplike, lemminglike, herdlike. And it's this very problematic thing that we need to always think through and try to overcome. And 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, and it's not that there is wisdom in crowds, it's not when lots of people are trying to do something that, that's proof of it being valuable. I think it's when lots of people are trying to do something that is often proof of insanity. There are twenty thousand 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 of a dead weight loss to society. You know? >> You the sort of educational experience at a place, the pre Stanford educational experience. There's always sort of a non-competitive characterization, where I think most of the people in this room had machine guns, that 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? And there is always this question 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. That the battles were so ferocious, because the stakes were so small. Describing sort of academia. And you start to think 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, I think simply a function of the logic of the situation. When it's really hard to differentiate yourself from other people. When the differences are, when the objective differences really are small. Then you have to compete ferociously to maintain a difference of one sort or another, that's often more imaginary than real. There's always a sort of a personal version of this that I tell where I was sort of hyper tracked. My 8th grade junior high school yearbook, one of my friends wrote in, I know you'll get into Stanford in four years as a Sophomore, sort of when it is going to Stanford four years later, the end of high school. Went to Stanford Law School. You know, 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. >> And it was this very strange dynamic, where after I sort of realized that this was not the best idea, and left after seven months and three days. You know, 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 identities got wrapped in winning these competitions, that they somehow lost site of what was important. What was valuable. And you know, competition does make you better at whatever it is you're competing on. Because when you're competing, you're comparing yourself with the people around you. You're figuring out, how do I beat the people next to me? How do I do somewhat better at whatever it is they're doing. And you will get better at that thing. I'm not questioning that, I'm not denying that. But, it often comes at this tremendous price that you stop asking some bigger questions, about what's truly important and truly valuable. And 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. I guess there's time for, do you want to take a few questions? >> Sorry? >> Oh yes, people want to take, I'll take a few questions with few minutes time. Yeah, go ahead. >> Since, yeah, as you mentioned, you already mentioned further competition often look similar because the narrative of people tell our selves. Do you have any ways to easily determine the difference when your looking at an idea that is better than your own idea? >> Well I'd say the question I always try to focus on is what is the actual market? So not what's the narrative of the market, because you can always tell a fictional story about a market that's much bigger or much smaller. But what is the real objective market? So, it's always, yeah, you always try to figure it out. And you realize people have incentives to powerfully distort these things. Yeah? >> Which of the aspects of monopolies that you mentioned would you say >> Well they have network effects with the ad network. They had proprietary technology that gave them the initial lead, because they had the page rank algorithm which was sort of, an order of magnitude better than any other search engine. You have economies of scale, because of the need to store all these different sites. And at this point, you have brand, so Google has all four. Maybe the proprietary technology's somewhat weaker at this point. But, definitely, it had all four, and maybe three out of four now. Yeah. >> How does this apply to and, second, what's it like. The seconds what? >> What's with the i-Phone? >> That's sort of a set of companies that are doing different copycat payment systems on mobile phones. There's Square, there's PayPal. They just have sort of different shapes. That's how they differentiate themselves. One is a triangle, one is a square. And so you know... >> Maybe at some point the apes weren't out of shape or something like that. But I think, pounds here we started with focus on the intelligence community which is small sub-market, you had a proprietary technology that used a very different approach. Were it was focused on the human computer synthesis rather than the substitution, which I think is the dominant paradigm. So there's a whole set of things I would say on the market approach, and on the proprietary technology. Yes? >> When you have design thinking methodology in a start-up thinking, which is used to mitigate risk by not creating things that people don't want. But I think young innovators have inspiration create complex systems that last's through time. >> Could you repeat the question? >> Yeah. So the quest is what do I think about lean start-up's, iterative thinking, where you get feedback from people, versus complexity that may not work. So, I am personally quite skeptical of all the lean start-up methodology. I think the really great companies did something that was, sort of. Somewhat more of a quantum improvement that really differentiated them from everybody else. They typically did not do massive, you know, customer surveys. The people who ran these companies sometimes, not always, suffer from mild forms of Aspberger's, so they were not actually that influenced, not that easily deterred by what other people thought or told them to do. So I do think we're way too focused on iteration as a modality, and not enough on trying to have a virtual esp link with the public and figuring it out ourselves. I would say that, the risk question is always a very tricky one because there are, you know? They're, they're, it's not, it's often. I think it's often the case that you don't have enough time to really mitigate risk. If, if you're gonna take enough time to figure out what people want. You often will have missed the boat by then. and, and then, of course, there's always the risk of, of doing something that's, that's not that, significant or meaningful. So, you know? You could say a track in law school is a low risk track from one perspective, it may still be a very high risk track in the sense that maybe your not, have a high risk of not doing something meaningful with your life. So, we have to think about risk in these, very complicated way. I think risk is for a very complicated concept. Yes. I was just checking for the last advantage, but then doesn't that imply that there's already competition to begin with between the chess pieces on the chess board? >> Yeah, so, there's always this terminology thing, so I would say that there are categories in which people sort of are bundled together. I would say the monopoly businesses were in effect they really were a big first mover in some sense. You could say Google was not the first search engine. There were other search engines before, but on one dimension, they were dramatically better than everybody else, they were the first one with page rank, with sort of an automated approach. Facebook was not the first social networking site. My friend, Reed Hoffman, started one in 1997, and they called it Social Net. So they already had the name, Social networking, in the name of their company, seven years before Facebook. Their idea was that it was gonna be this virtual cyberspace, where I'd be a dog and you'd be a cat. And we'd have all these different rules about how we'd interact with each other. >> In this virtual alternate reality. Facebook was the first one to get real identity. So, it was, so I would say, I hope Facebook will be the last social networking site, it was the first one in a very important dimension. People often would not think of it as the first because they, sort of, lump all these things together. >> I have one more question. >> Okay, one question, let's take one here. >> If you're theoretically someone who, worked at Golden College and left there after six months, and is now going to do science at Standford. How would you recommend rethinking >> I don't have a great, I'm not great at the psychotherapy stuff so I don't quite know how to >> solve this. There are these very odd studies they've done on people who go to business school. There's one they've done at Harvard Business school where it's sort of the anti-Asperger, personality. We have people who are super extroverted, generally have low convictions, few ideas. And you have sort of a hothouse environment. You put all these people in for two years. And at the end of it, they systematically end up, the largest cohort systematically ends up doing the wrong thing. They tried to catch the last wave. You know in 1989 everyone in Harvard tried to work for Mike Milken, it was one or two years before he went to jail for all the junk bond stuff. They were never interested in Silicon Valley or tech, except for '99 and 2000 when they timed the dot com bubble peaking perfectly. They did, and then '05 to '07 was housing. Private equity, stuff like this. I do think this tendency for us to see competition as validation is very deep. I don't think there's any sort of easy psychological formula to avoid it. I don't know what sort of therapy to recommend. >> But my first. My first starting point, which is only like maybe ten percent of the way, is to never under estimate how big a problem it is. We always think this is something that afflicts other people. It's easy for me to point to people in business schools or people at Harvard or people on Wall Street, I think it actually does afflict all of us to a very profound degree. We always think of advertising as things that work on other people. How, who are all these stupid people who fall for all those ads on tv, they obviously work to some extent and they work, to a disturbing extant on all of us. And it's something we, we all should work to overcome. Thank you very much.

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Posted by: pulak on Oct 10, 2014

Lecture 5 - How to Start a Startup

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