Peter Thiel part 3. Good Monopoly and Bad Competition

I was born in a communist country and the secular communist "religion"  - officially called ideology (the world "ideology" has been invented by Karl Marx) - stated that monopolies are evil, private properties are evil. We were not allowed to state anything in the compulsory classes of Marxism - Leninism, except using the exact words and sentences from the official textbook approved by the Party.

One of the first thing I did after escaping the iron curtain was to read the Macroeconomics textbook from MIT written by Rudiger Dornbusch and Stanley Fischer . The second thing I did was to buy and read a book about the real person named Karl Marx - A life  by Francis Wheen.

After all dust settled, I learned almost everyone agrees today "communism" is bad, "capitalism" is good. This is a gross over simplification. Because some of Marx "badness-es" are today accepted in our capitalist United States. For example Marx studies of monopolies are considered a valid scientific discovery in political economy, and Marx inspired the Anti-Trust laws. Quoting Wikipedia:

United States antitrust law is a collection of federal and state government laws, which regulates the conduct and organization of business corporations, generally to promote fair competition for the benefit of consumers. The main statutes are the Sherman Act 1890, the Clayton Act 1914 and the Federal Trade Commission Act 1914. These Acts, first, restrict the formation of cartels and prohibit other collusive practices regarded as being in restraint of trade. Second, they restrict the mergers and acquisitions of organizations which could substantially lessen competition. Third, they prohibit the creation of a monopoly and the abuse of monopoly power.

I read this paragraph, scratching my head. These laws are very old. Sherman act is 7 years after Karl Marx passed away in 1883. And Clayton Act is from 1914, before the first world war, long before the 1929 stock crash.  Silicon Valley 1990 wasn't even a science fiction concept, Because high-tech boom no economist has predicted a century ago.

Economic books are written 99% by academics, politicians and  / or inflated bohemian revolutionaries who never had any business venture experience before, They lived times  when a startup was not an option

Peter Thiel book has a powerful new concept to help not only entrepreneurs, but statesmen and governments in their theory on how to get widespread society abundance. He takes a fresh look at Competition and Monopoly.

Competition is not good: it's bad

“Perfect competition” is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand. Every firm in a competitive market is undifferentiated and sells the same homogeneous products . Since no firm has any market power, they must all sell at whatever price the market determines. If there is money to be made, new firms will enter the market, increase supply, drive prices down, and thereby eliminate the profits that attracted them in the first place. If too many firms enter the market, they’ll suffer losses, some will fold, and prices will rise back to sustainable levels. Under perfect competition, in the long run no company makes an economic profit.

Thiel, Peter; Masters, Blake (2014-09-16). Zero to One: Notes on Startups, or How to Build the Future (Kindle Locations 275-280). Crown Publishing Group. Kindle Edition. 

Yes! It's true.  The so called perfect competition is what Italian call a dolce far niente which Webster dictionary  explains as "sweet doing nothing.. pleasant relaxation in carefree idleness"

Americans mythologize competition and credit it with saving us from socialist bread lines. Actually, capitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition all profits get competed away. The lesson for entrepreneurs is clear: if you want to create and capture lasting value, don’t build an undifferentiated commodity business.

Thiel's Monopoly definition is good

The opposite of perfect competition is monopoly. Whereas a competitive firm must sell at the market price, a monopoly owns its market, so it can set its own prices. Since it has no competition, it produces at the quantity and price combination that maximizes its profits. To an economist , every monopoly looks the same, whether it deviously eliminates rivals, secures a license from the state, or innovates its way to the top.

In this book, we’re not interested in illegal bullies or government favorites: by “monopoly,” we mean the kind of company that’s so good at what it does that no other firm can offer a close substitute.

This is the Zero to One company is needed to be successful.

In 2001, my co-workers at PayPal and I would often get lunch on Castro Street in Mountain View. We had our pick of restaurants, starting with obvious categories like Indian, sushi, and burgers. There were more options once we settled on a type: North Indian or South Indian, cheaper or fancier, and so on. In contrast to the competitive local restaurant market, PayPal was at that time the only email -based payments company in the world. We employed fewer people than the restaurants on Castro Street did, but our business was much more valuable than all of those restaurants combined. Starting a new South Indian restaurant is a really hard way to make money. If you lose sight of competitive reality and focus on trivial differentiating factors— maybe you think your naan is superior because of your great-grandmother’s recipe— your business is unlikely to survive.

This made me curious and I looked for listings of restaurants for sale in Mountain View . Most  are sold for around $200,000. However I assume 2.5x this average price, as $500,000.

Pay Pal was sold to eBay for $1.5 billion. It means the value of Pay Pal was equivalent to 3,000 restaurants on Castro street.

Here is another example, relevant to the profit per employee. It's about WhatsApp and I need some more research to see whether WhatsApp was a zero-to-one company, or a company that we need to wait until a book is written about them.

Safeway  supermarket chain was sold for $9.4 billions. They have 180,000 employees.  They have 1,335 stores in the United States and 195 in Mexico with its partnership with Casa Ley. This means the Safeway's selling price is $52,000 or $0.05 million per employee.

WhatsApp was sold to Facebook for $16 billions ($19B everyone reports includes performance bonuses payable later). They had one location and 55 employees. This means the WhatsApp's selling price is $291 millions per employee.  WhatsApp made the human beings it hired 5,820 times more productive than the same human beings working as Safeway employees.

Example of 1 to n failures

"Competition can make people hallucinate opportunities where none exist."

With this back insight, we can see clearly how very successful super entrepreneurs like Richard Branson failed each time they tried 1 to n (me-too) venture.

Virgin Cola, introduced by Richard Branson in 1994 as the rival to Coca-Cola, has practically disappeared. Virgin Clothes, launched on the stock exchange in 1996, folded with losses to shareholders, after debuting with promising new trends in providing more edgy wardrobe to the young. Virgin Money was launched with a viral and somewhat controversial advertising campaign, panned by critics with Richard Branson emerging naked from the sea, but did not deliver the expected big financial rewards to its shareholders. Then came Virgin Vie, Virgin Vision, Virgin Vodka, Virgin Wine, Virgin Jeans, Virgin Brides, Virgin Cosmetics and Virgin Cars – All the major brands who wanted to compete and earn a huge market share from established brands in those areas, failed to live up towards expectations.

Amazon Web Services was a monopoly, because it was always ahead of of all other players in Cloud IaaS. The myriad of companies trying to compete are 1 to n companies Even Microsoft is a now a 1 to n because it tries to better than others who are already the best  - tablets, laptops, cloud services.

Building a "happy" monopoly

If even the most successful entrepreneurs failed to see in the past the distinction Zero to One versus 1 to n. probably the  entrepreneurs will be the fist to act differently from now on. Thus we can divide entrepreneurs and venture capitalists in two groups. Note that mostly the same people will belong to the two groups

1. Before the Zero to One book - September 2014
2. After the Zero to One book - September 2014

Group 2 is made out of people who opened the eyes and said "Aha!" 

Because success means building a monopoly as per Peter's definition, that will endure over time.

Simply stated, the value of a business today is the sum of all the money it will make in the future.  Comparing discounted cash flows shows the difference between low-growth businesses and high-growth startups at its starkest . Most of the value of low-growth businesses is in the near term.

Image 1 

 But although it is counter-intuitive, high growth businesses loose money for a years before showing a profit

Technology companies follow the opposite trajectory. They often lose money for the first few years: it takes time to build valuable things, and that means delayed revenue. Most of a tech company’s value will come at least 10 to 15 years

Image 2: Cash Flows LinkedIn 2014 to 2026

The overwhelming importance of future profits is counterintuitive even in Silicon Valley. For a company to be valuable it must grow and endure, but many entrepreneurs focus only on short-term growth. They have an excuse: growth is easy to measure, but durability isn’t . Those who succumb to measurement mania obsess about weekly active user statistics, monthly revenue targets, and quarterly earnings reports. However, you can hit those numbers and still overlook deeper, harder-to-measure problems that threaten the durability of your business.

Durability is a new beautiful word. The company that lasts longer will be the most profitable for the investors .

European versus American 

Thomas Piketty, a professor at Paris School of Economics, wrote the book "Capital in the Twenty-First Century"  - a 700-page tome about inequality that has become a blockbuster hit on Amazon.

Using wealth data and tax data in France and other countries stables enough to keep such records, he stated the privately owned capital growth R exceeds the economic overall growth G

His equation which alarms everybody is

R  >  G

What does it mean?  Paul Krugman says in his blurb promoting the book

"if this inequality persists, we are on the way back to patrimonial capitalism, in which the commanding heights of the economy  are dominated, not just by wealth, but also by inherited wealth, in which birth matters more than effort and talent"

I look at Piketty's versus Thiel's book. In Piketty book, the word entrepreneurship, does not exists, or, if it exists is so well hidden that a casual reader like me missed it. Not only that. If we are worried about this R is bigger than G, what is the solution? All we read are recommendation for some unified tax  policies, fiscal policies, new laws in an Europe fragmented by so many governments. He also proposes a Global Tax on Wealth, which brought shivers in US and Europe equally.

According to the Tax Foundation special report in August 2014, "Thomas Piketty’s False Depiction of Wealth in America"

In his book, Capital in the 21st Century, Thomas Piketty portrays the rich as heirs with privileged access to high rates of return, stating “it is almost inevitable that inherited wealth will dominate wealth amassed from a lifetime’s labor.” He points to the Forbes wealth rankings for support.

In fact, the Forbes 400—an annual ranking of the richest Americans—indicates wealth is much more fleeting than Piketty suggests and is characterized more by entrepreneurship than by inheritance.

Key Findings

Of the Forbes 400 from 1987, 327 people have dropped off the list. Of the remaining 73 people, those with the highest annual rates of return are generally self-made entrepreneurs and investors—not heirs—with an average annual real rate of return of 5.6 percent over the last 26 years.

The rate of return for the Forbes 400 as a whole, 2.4 percent, is roughly equal to Piketty’s estimated returns for the entire population.

Wealth today is largely generated by entrepreneurial skill, with the number of entrepreneurs on the Forbes 400 list rising from 40 percent in 1982 to 69 percent in 2011.

The role of inheritance has diminished over the last generation; the share of the Forbes 400 that grew up wealthy has fallen from 60 percent in 1982 to 32 percent today.

If we read Zero to One, - after browsing through Piketty's book - it offers a practical ideas on how to solve the wealth inequality.

Because on way to solve the inequality, rather cut R, let's elevate G. This is the implicit answer of Peter Theil to Pikkety's dilemma.

To me, Peter Thiel Zero to One book solves in great part all the issues Thomas Piketty exposes in his book.

In an interview with Rebecca Jarvis on ABC News, 9 Things You Never Knew About PayPal's Peter Thiel, here is the last question:

9. Last thing Thiel bought online?

Hard-cover book from Amazon. “Capital in the Twenty-First Century” by Thomas Piketty.

It looks like Peter Thiel  only bought the Capital  book about a week ago (November 1, 2014) . I expect Peter and also Thomas will make some further comments discoveries which I am very curious to read.

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