Monday, October 20, 2014

Zero to One by Peter Thiel (Book Review #99 of 2014)

Zero to One: Notes on Startups, or How to Build the Future.
This book is touted by many as the "Business Book of the Year" for 2014, so I was eager to read it. If it really is the best biz book of 2014, then it's a disappointment. Thiel writes that the book is compiled from notes of his course lectures at Stanford's business school. Forbes Magazine got it partly right, Thiel's weakness is his attempt at amateur philosophy. He quotes Marx and Engels frequently, blasts Rawls and his contemporaries, and even ends with a critique of Ayn Rand. Tyler Cowen praises the book, but I think that's mainly because Thiel's hypothesis about the future of technology and the labor force jives with Cowens' in Average is Over.

There are some contradictions within the book's chapters that I hope Thiel's students raise in class. The author's personal anecdotes from his various start-ups such as Paypal are interesting, but one senses he has huge cognitive biases-- he assumes he's the smartest person in the room. Much of the book reads like a standard microeconomics or managerial economics text-- what is competition, what is monopoly, etc. Thiel's ideas are Marxist in that he believes capitalism is destroying itself via competition. He writes that "capitalism" is a misnomer since profits get competed away. "The more we compete, the less we gain." We have an absurd system of government-enforced property rights where one hand grants monopoly (patents) while the other prosecutes it (antitrust prosecution).

It should be obvious, but his venture capital firm searches out start-ups that they think have the best shot at developing a monopoly. He writes much on how to capture dominant market share:

1. Proprietary technology - Create a product that is 10 times better than its closest substitute. Invent something new, or completely different.

Thiel writes that people with Aspergers do well in Silicon Valley because they do things differently, they do not follow the crowds. He looks for contrarians when he interviews people, asking job candidates "What's something you believe that others do not?" However, he would seem to contradict himself as later in the book he critiques Ayn Randian solo crusaders. Stanford MBAs all carry Clausewitz and Sun Tzu, they're mostly carbon copies of one another-- and that's the problem.

2. Capture network effects - Make being part of the network essential. People use PayPal because it's popular-- a lot of others use it. Go after small markets where network effects will take hold faster.

3. Achieve economies of scale - High fixed costs, low marginal costs. Achieve scale quickly and keep competitors from being able to enter without a lot of help.

4. Brand - aka differentiation, value proposition, etc. "Brand" is a code word for monopoly.

Apple is an example of a company that accomplished all four of the above.

Thiel hates the modern idea that success is largely a product of chance and circumstances, which was popularized recently by Malcolm Gladwell in Outliers. Thiel wants to eradicate Rawls and Gladwell from our universities, and eliminate pollsters from politics who make winning seem like pure statistical probability, and teach everyone that success comes from effort and winning. He does not seem to think his own birth into an educated German household that happened to migrate to America had anything to do with his own success.

The author decries the modern sense of pessimism, pointing out that the 1800s Industrial Revolution was a very optimistic time, even though living standards were quite less than today. Optimism birthed creativity which brought productivity and greater prosperity, all the way through the Reagan 1980s. Now, everyone is skeptical and bought into the belief that success is luck or beyond most to achieve.

Thiel gives some insight into how his VC fund vets prospective companies for investment. He studies the founders and examines their background and personal chemistry. He looks for companies that have found a secret. Secrets are important, the key to any startup's success is to find secrets that are hidden in plain sight-- like Uber and Dryve. Keep your secret hidden from some, but not all, find that "golden mean" between disclosure and non-disclosure.

Other observations from Thiel that are pretty textbook:
Organizations should be run by interchangeable managers rather than dynamic individuals.(This is generally the purpose of a board of directors, to free up the dynamic individual to be the creative frontman). Never let your board exceed five people, three is ideal. The bigger the board, the less effective the oversight. Thiel only invests in companies where the CEO is dependent on profit, or takes the lowest salary to mitigate the principle-agent problem. He demands that firms demand "total commitment" from employees.

Thiel also writes of the Power Law, or the 80-20 rule.  "The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined." Returns are not normally distributed, the author writes Taleb-like. Can you be a power? Obviously, if you could identify the grand champion, you'd be rich.Thiel seems to suggest he has an ability to spot the champion. "You are not a lottery ticket," he writes, but I disagree. Thiel himself writes that his friend Elon Musk got lucky in his timing, securing crucial federal funding for Tesla right before the green bubble burst and such investment became anathema.

Social entrepreneurship-- people who combine non-profit ideas with for-profit enterprises, come under fire from Thiel. They may aim for social impact, but are they actually good for society? Thiel heavily critiques the companies that got squashed when the green energy bubble burst. He refused to invest in "greens that wore suits." Solyndra is one of many examples of green energy companies that had poor management, silly ideas, and unrealistic projections. Tesla is the one exception, because Tesla answers the "seven questions:"

1. The Engineering Question: Do you have a breakthrough technology?
        - is it 10x better than the alternative?
“Horizontal or extensive progress means copying things that work— going from 1 to n. Horizontal progress is easy to imagine because we already know what it looks like. Vertical or intensive progress means doing new things—going from 0 to 1. Vertical progress is harder to imagine because it requires doing something nobody else has ever done.”
2. The Timing Question: Is your timing right?
3. The Monopoly Question: Do you have something no-one else has?
4.  The People Question: Do you have the right people?
    "As a general rule, everyone you involve with your company should be involved full-time…anyone who doesn’t own stock options or draw a regular salary from your company is fundamentally misaligned. At the margin, they’ll be biased to claim value in the near term, not help you create more in the future. That’s why hiring consultants doesn’t work. Part-time employees don’t work. Even working remotely should be avoided… If you’re deciding whether to bring someone on board, the decision is binary. Ken Kesey was right: you’re either on the bus or off the bus.”
5. The Distribution Question: Can you sell and market your stuff?
        - sales and marketing matter, but Thiel critiques companies who don't have a product 10x greater than others for failing to market. This seems another contradiction.
6. The Durability Question: Will you be still around in 10 years?
        - network effects matter here.
7. The Secret Question: Do you know something nobody else does?

Thiel is apparently a die-hard libertarian but ends his book with a critique of Ayn Rand. "Rand's villains were real but her heroes were fake. There is no Galt's Gulch." However, he concludes the book with an exhortation to "think for yourself."

In all, I give this book 3 stars out of 5. It has good stories and a good critique of recent events, such as the green energy bubble, but the philosophy is pretty weak and much of it is textbook material.

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