Competition Is for Losers

Competition Is for Losers

If you want to create and capture lasting
value, look to build a monopoly, writes Peter
Thiel
Only one thing can allow a business to
transcend the daily brute struggle for
survival: monopoly profits. JAVIER JAÉN
By PETER THIEL
Sept. 12, 2014 WSJ
What valuable company is nobody building?
This question is harder than it looks, because
your company could create a lot of value
without becoming very valuable itself.
Creating value isn’t enough—you also need to
capture some of the value you create.
This means that even very big businesses can
be bad businesses. For example, U.S. airline
companies serve millions of passengers and
create hundreds of billions of dollars of value
each year. But in 2012, when the average
airfare each way was $178, the airlines made
only 37 cents per passenger trip. Compare
them to Google , which creates less value but
captures far more. Google brought in $50
billion in 2012 (versus $160 billion for the
airlines), but it kept 21% of those revenues as
profits—more than 100 times the airline
industry’s profit margin that year. Google
makes so much money that it is now worth
three times more than every U.S. airline
combined.
The airlines compete with each other, but
Google stands alone. Economists use two
simplified models to explain the difference:
perfect competition and monopoly.
Monopolies are a good thing for society,
venture capitalist Peter Thiel argues in an
essay on WSJ. The PayPal co-founder joins
Sara Murray to discuss his business
philosophy, his take on Apple Pay, and what’s
a deal breaker in pitch meetings.
“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.
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. I’m not interested in illegal
bullies or government favorites: By
“monopoly,” I mean the kind of company that
is so good at what it does that no other firm
can offer a close substitute. Google is a good
example of a company that went from 0 to 1:
It hasn’t competed in search since the early
2000s, when it definitively distanced itself
from Microsoft and Yahoo!
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.
How much of the world is actually
monopolistic? How much is truly
competitive? It is hard to say because our
common conversation about these matters is
so confused. To the outside observer, all
businesses can seem reasonably alike, so it is
easy to perceive only small differences
between them. But the reality is much more
binary than that. There is an enormous
difference between perfect competition and
monopoly, and most businesses are much
closer to one extreme than we commonly
realize.
The confusion comes from a universal bias
for describing market conditions in selfserving
ways: Both monopolists and
competitors are incentivized to bend the truth.
Monopolists lie to protect themselves. They
know that bragging about their great
monopoly invites being audited, scrutinized
and attacked. Since they very much want their
monopoly profits to continue unmolested,
they tend to do whatever they can to conceal
their monopoly—usually by exaggerating the
power of their (nonexistent) competition.
Google makes so much money that it is now
worth three times more than every U.S.
airline combined. ASSOCIATED PRESS
Think about how Google talks about its
business. It certainly doesn’t claim to be a
monopoly. But is it one? Well, it depends: a
monopoly in what? Let’s say that Google is
primarily a search engine. As of May 2014, it
owns about 68% of the search market. (Its
closest competitors, Microsoft and Yahoo! ,
have about 19% and 10%, respectively.) If
that doesn’t seem dominant enough, consider
the fact that the word “google” is now an
official entry in the Oxford English
Dictionary—as a verb. Don’t hold your breath
waiting for that to happen to Bing.
But suppose we say that Google is primarily
an advertising company. That changes things.
The U.S. search-engine advertising market is
$17 billion annually. Online advertising is
$37 billion annually. The entire U.S.
advertising market is $150 billion. And global
advertising is a $495 billion market. So even
if Google completely monopolized U.S.
search-engine advertising, it would own just
3.4% of the global advertising market. From
this angle, Google looks like a small player in
a competitive world.
What if we frame Google as a multifaceted
technology company instead? This seems
reasonable enough; in addition to its search
engine, Google makes dozens of other
software products, not to mention robotic
cars, Android phones and wearable
computers. But 95% of Google’s revenue
comes from search advertising; its other
products generated just $2.35 billion in 2012
and its consumer-tech products a mere
fraction of that. Since consumer tech is a
$964 billion market globally, Google owns
less than 0.24% of it—a far cry from
relevance, let alone monopoly. Framing itself
as just another tech company allows Google
to escape all sorts of unwanted attention.
Non-monopolists tell the opposite lie: “We’re
in a league of our own.” Entrepreneurs are
always biased to understate the scale of
competition, but that is the biggest mistake a
startup can make. The fatal temptation is to
describe your market extremely narrowly so
that you dominate it by definition.
Suppose you want to start a restaurant in Palo
Alto that serves British food. “No one else is
doing it,” you might reason. “We’ll own the
entire market.” But that is only true if the
relevant market is the market for British food
specifically. What if the actual market is the
Palo Alto restaurant market in general? And
what if all the restaurants in nearby towns are
part of the relevant market as well?
These are hard questions, but the bigger
problem is that you have an incentive not to
ask them at all. When you hear that most new
restaurants fail within one or two years, your
instinct will be to come up with a story about
how yours is different. You’ll spend time
trying to convince people that you are
exceptional instead of seriously considering
whether that is true. It would be better to
pause and consider whether there are people
in Palo Alto who would rather eat British
food above all else. They may well not exist.
In 2001, my co-workers at PayPal and I
would often get lunch on Castro Street in
Mountain View, Calif. 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 then 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
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.
The problem with a competitive business
goes beyond lack of profits. Imagine you’re
running one of those restaurants in Mountain
View. You’re not that different from dozens of
your competitors, so you’ve got to fight hard
to survive. If you offer affordable food with
low margins, you can probably pay
employees only minimum wage. And you’ll
need to squeeze out every efficiency: That is
why small restaurants put Grandma to work at
the register and make the kids wash dishes in
the back.
A monopoly like Google is different. Since it
doesn’t have to worry about competing with
anyone, it has wider latitude to care about its
workers, its products and its impact on the
wider world. Google’s motto—”Don’t be
evil”—is in part a branding ploy, but it is also
characteristic of a kind of business that is
successful enough to take ethics seriously
without jeopardizing its own existence. In
business, money is either an important thing
or it is everything. Monopolists can afford to
think about things other than making money;
non-monopolists can’t. In perfect competition,
a business is so focused on today’s margins
that it can’t possibly plan for a long-term
future. Only one thing can allow a business to
transcend the daily brute struggle for survival:
monopoly profits.
So a monopoly is good for everyone on the
inside, but what about everyone on the
outside? Do outsize profits come at the
expense of the rest of society? Actually, yes:
Profits come out of customers’ wallets, and
monopolies deserve their bad reputation—but
only in a world where nothing changes.
In a static world, a monopolist is just a rent
collector. If you corner the market for
something, you can jack up the price; others
will have no choice but to buy from you.
Think of the famous board game: Deeds are
shuffled around from player to player, but the
board never changes. There is no way to win
by inventing a better kind of real-estate
development. The relative values of the
properties are fixed for all time, so all you can
do is try to buy them up.
But the world we live in is dynamic: We can
invent new and better things. Creative
monopolists give customers more choices by
adding entirely new categories of abundance
to the world. Creative monopolies aren’t just
good for the rest of society; they’re powerful
engines for making it better.
Even the government knows this: That is why
one of its departments works hard to create
monopolies (by granting patents to new
inventions) even though another part hunts
them down (by prosecuting antitrust cases). It
is possible to question whether anyone should
really be awarded a monopoly simply for
having been the first to think of something
like a mobile software design. But something
like Apple ‘s monopoly profits from
designing, producing and marketing the
iPhone were clearly the reward for creating
greater abundance, not artificial scarcity:
Customers were happy to finally have the
choice of paying high prices to get a
smartphone that actually works. The
dynamism of new monopolies itself explains
why old monopolies don’t strangle
innovation. With Apple’s iOS at the forefront,
the rise of mobile computing has dramatically
reduced Microsoft’s decadeslong operating
system dominance.
Before that, IBM ‘s hardware monopoly of the
1960s and ’70s was overtaken by Microsoft’s
software monopoly. AT&T had a monopoly
on telephone service for most of the 20th
century, but now anyone can get a cheap
cellphone plan from any number of providers.
If the tendency of monopoly businesses was
to hold back progress, they would be
dangerous, and we’d be right to oppose them.
But the history of progress is a history of
better monopoly businesses replacing
incumbents. Monopolies drive progress
because the promise of years or even decades
of monopoly profits provides a powerful
incentive to innovate. Then monopolies can
keep innovating because profits enable them
to make the long-term plans and finance the
ambitious research projects that firms locked
in competition can’t dream of.
So why are economists obsessed with
competition as an ideal state? It is a relic of
history. Economists copied their mathematics
from the work of 19th-century physicists:
They see individuals and businesses as
interchangeable atoms, not as unique creators.
Their theories describe an equilibrium state of
perfect competition because that is what’s
easy to model, not because it represents the
best of business. But the long-run equilibrium
predicted by 19th-century physics was a state
in which all energy is evenly distributed and
everything comes to rest—also known as the
heat death of the universe. Whatever your
views on thermodynamics, it is a powerful
metaphor. In business, equilibrium means
stasis, and stasis means death. If your industry
is in a competitive equilibrium, the death of
your business won’t matter to the world; some
other undifferentiated competitor will always
be ready to take your place.
Perfect equilibrium may describe the void
that is most of the universe. It may even
characterize many businesses. But every new
creation takes place far from equilibrium. In
the real world outside economic theory, every
business is successful exactly to the extent
that it does something others cannot.
Monopoly is therefore not a pathology or an
exception. Monopoly is the condition of every
successful business.
Tolstoy famously opens “Anna Karenina” by
observing: “All happy families are alike; each
unhappy family is unhappy in its own way.”
Business is the opposite. 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.
Adapted from Mr. Thiel’s new book, with
Blake Masters, “Zero to One: Notes on
Startups, or How to Build the Future,” which
will be published by Crown Business on Sept.
16. Mr. Thiel co-founded PayPal and Palantir
and made the first outside investment in
Facebook.

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