Recently, I had a chance to read Zero to One by Peter Thiel. Out of all of the pieces of wisdom that he offered, one really stuck out like a sore thumb: competition is not synonymous with capitalism.
Like other American children, I was always raised with the notion that capitalism was essentially free and open competition in its purest form. It has even been defined in pseudo-Darwinian contexts where companies compete in a quest of “survival of the fittest.” However, Thiel offered a compelling argument for why this isn’t necessarily true or accurate. Let’s take a look:
In order to understand Thiel’s argument, it’s important to clearly define some core definitions and concepts from economics.
Capitalism (courtesy of Wikipedia): an economic system in which trade, industry, and the means of production are largely or entirely privately owned and operated for profit.
*The main point here is that the ultimate goal of capitalism is the accumulation of profit.
Perfect competition (Courtesy of Google): In economic theory, perfect competition (sometimes called pure competition) describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product.
Realities of business climates: Unfortunately, there are also harsh business realities to consider as well:
- Big competitors - try building a new search engine =]
- Lack of capital
- Lack of talented people
- Bad timing
- Barriers to entry
- Regulatory challenges
Capitalism under perfect competition
According to Thiel, under perfect competition the profits simply “get competed away.” Consider the example that Thiel used to illustrate this. There are lots of restaurants in San Francisco. If you wanted to open a new one, you would be offering a fairly homogeneous product (food) to a geographically restricted area. Under perfect competition, you would have to eventually lower your prices until market equilibrium was met (between supply and demand). In this circumstance, you may make a profit but it would be incredibly difficult to scale your business with capitalistic (ideal) profit margins.
Also, since you offer nothing extremely proprietary, it wouldn’t be difficult for someone else to enter that market as well. Because the barriers to entry for that business are low, even a successful restaurant would be subject to being copied over time with a high degree of accuracy.
In short, it’s tough to accumulate capital under perfect competition.
Already, this concept deeply challenges the status-quo of how many business schools teach younger people to succeed. Indeed, the notion of being a “ruthless competitor” is thrown around pretty often as well. The reality is that competition fosters lower profit margins, which is the antithesis of capitalism.
How does a business avoid competition then?
This is a loaded question, but it’s not impossible. Surely, it’s impossible to entirely avoid competition. With so many companies in different spaces, you are always going to be walking on someone else’s toes.
Thiel offered a solution for this problem by arguing that in order for a business to avoid the rough and tumble of competition, it’s important to focus on solving problems and attacking markets that have no competitors. Imagine starting a new business where you solve such a unique problem that the first customer you get gives you 100% market share. No one else is doing what you’re doing so you don’t have to worry about competitors for at least a few years (after which, you need to secure your dominance through more traditional channels).
Essentially, the goal is to build a business where you have a monopoly. Note, Thiel doesn’t mean an illegal monopoly where you bully competitors, but instead a business where you have such a strong product offering that it is incredibly difficult for other businesses to catch up. When you have such a business, you can charge higher rates and can earn what Thiel dubs as “monopoly profits” that will last for years to come.
“In order to build a monopoly, you have to be at least 10 times better than you closest competitor.” - Peter Thiel
Let’s take a look at some case studies to see if this theory plays out in the real world.
Monopolies in action - AirBnB and Google
Let’s talk about Google. According to a recent study by Search Engine Watch, Google has almost a 70% market share rate in the United States alone for search (In Europe, it’s over 90% and the reason why the EU is probing them to be broken up under anti-trust laws). The fact is that while Google entered a saturated internet space, it just delivered a better end-product for users. This is the reason that it attracts users and can charge its rates for ad display. This business will yield monopoly profits for the decade to come.
Now let’s consider AirBnB. When it started, it was considered a strange and bizarre business mostly dominated by people posting their place on Craigslist. However, now it’s a travel-site powerhouse with destinations to almost every country on the planet. Yes, AirBnB isn’t the first company to solve the lodging problem, but they were the first ones to do it in their own unique way. AirBnB rose to prominence in a large part because of its unique approach that had little competition (rent people’s rooms safely on our secure platform which verifies people and offers crowd-sourced reviews). Was Craigslist there first? Yes. Did AirBnB solve the unique problem of making this experience safer and more elegant? Absolutely.
It’s clear that AirBnB has built its business on a monopoly that even big hotels and hospitality companies wouldn’t dare to touch. By tapping further into the sharing economy and offering affordable, personalized lodging at scale, the company created a truly unique solution that kept itself at arm’s length from any good competitors. Even if we call Craigslist a competitor, AirBnB is still 10x better on the merits of safety, availability, scale and reliability.
By the time AirBnB reaches maturity, I bet you they will be reaping monopoly profits (and be publically traded).
The main take away here is that while offering homogenous products and services can be fulfilling and profitable, building more profitable and sustainable businesses can be easier done by solving unique problems and owning 100% market share from day one.
The real question to ask before starting a business is: can we build a monopoly out of this from day one?