3: ALL HAPPY COMPANIES ARE
DIFFERENT
THE BUSINESS VERSION of our contrarian question is: 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 is not 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’s 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.
“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. 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. 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.
LIES PEOPLE TELL
How much of the world is actually
monopolistic? How much is truly
competitive? It’s 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’s easy to perceive only small differences between
them.
But the reality is much more binary than that. There’s
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 self-serving ways:
both monopolists and competitors are incentivized to bend the truth.
Monopoly Lies
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.
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.
Competitive Lies
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 that serves British food in Palo Alto. “No one else is doing
it,” you might reason. “We’ll own the entire market.” But that’s 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’s 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. It’s
very possible they don’t exist.
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.
Creative industries work this way, too. No screenwriter wants to admit that her new movie script
simply rehashes what has already been done before. Rather, the pitch is: “This film will combine
various exciting elements in entirely new ways.” It could even be true. Suppose her idea is to have
Jay-Z star in a cross between Hackers and Jaws: rap star joins elite group of hackers to catch the
shark that killed his friend. That has definitely never
been done before. But, like the lack of British
restaurants in Palo Alto, maybe that’s a good thing.
Non-monopolists exaggerate their distinction by
defining their market as the intersection of various
smaller markets:
British food ∩ restaurant ∩ Palo Alto
Rap star ∩ hackers ∩ sharks
Monopolists, by contrast, disguise their monopoly by framing their market as the union of several
large markets:
search engine mobile phones wearable computers self-driving cars∪ ∪ ∪
What does a monopolist’s union story look like in practice? Consider a statement from Google
chairman Eric Schmidt’s testimony at a 2011 congressional hearing:
We face an extremely competitive landscape in which consumers have a
multitude of options to access information.
Or, translated from PR-speak to plain English:
Google is a small fish in a big pond. We could be swallowed whole at any
time. We are not the monopoly that the government is looking for.
RUTHLESS PEOPLE
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’s why small restaurants put Grandma to work at
the register and make the kids wash dishes in the back. Restaurants aren’t
much better even at the very highest rungs, where reviews and ratings like
Michelin’s star system enforce a culture of intense competition that can
drive chefs crazy. (French chef and winner of three Michelin stars Bernard
Loiseau was quoted as saying, “If I lose a star, I will commit suicide.”
Michelin maintained his rating, but Loiseau killed himself anyway in 2003
when a competing French dining guide downgraded his restaurant.) The
competitive ecosystem pushes people toward ruthlessness or death.
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’s also characteristic of a kind of
business that’s 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.
MONOPOLY CAPITALISM
So, a monopoly is good for everyone on the inside, but what about
everyone on the outside? Do outsized 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’s 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: it’s possible to 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’s 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’s possible to question whether anyone should really be awarded a
legally enforceable monopoly simply for having been the first to think of something like a mobile
software design. But it’s clear that something like Apple’s monopoly profits from designing,
producing, and marketing the iPhone were 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 decades-long operating system dominance. Before that, IBM’s hardware monopoly of
the ’60s 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 cell phone plan
from any number of providers. If the tendency of monopoly businesses were 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 to 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’s 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’s what’s easy to model, not because it
represents the best of business. But it’s worth recalling that 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’s 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 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.
4: THE IDEOLOGY OF COMPETITION
CREATIVE MONOPOLY means new products that benefit everybody and
sustainable profits for the creator. Competition means no profits for
anybody, no meaningful differentiation, and a struggle for survival. So
why do people believe that competition is healthy? The answer is that
competition is not just an economic concept or a simple inconvenience that
individuals and companies must deal with in the marketplace. More than
anything else, competition is an ideology—the ideology—that pervades
our society and distorts our thinking. We preach competition, internalize its
necessity, and enact its commandments; and as a result, we trap ourselves
within it—even though the more we compete, the less we gain.
This is a simple truth, but we’ve all been trained to ignore it. Our educational system both drives
and reflects our obsession with competition. Grades themselves allow precise measurement of each
student’s competitiveness; pupils with the highest marks receive status and credentials. We teach
every young person the same subjects in mostly the same ways, irrespective of individual talents
and preferences. Students who don’t learn best by sitting still at a desk are made to feel somehow
inferior, while children who excel on conventional measures like tests and assignments end up
defining their identities in terms of this weirdly contrived academic parallel reality.
And it gets worse as students ascend to higher levels of the tournament. Elite students climb
confidently until they reach a level of competition sufficiently intense to beat their dreams out of
them. Higher education is the place where people who had big plans in high school get stuck in
fierce rivalries with equally smart peers over conventional careers like management consulting and
investment banking. For the privilege of being turned into conformists, students (or their families)
pay hundreds of thousands of dollars in skyrocketing tuition that continues to outpace inflation.
Why are we doing this to ourselves?
I wish I had asked myself when I was younger. My path was so tracked that in my 8th-grade
yearbook, one of my friends predicted—accurately—that four years later I would enter Stanford as
a sophomore. And after a conventionally successful undergraduate career, I enrolled at Stanford
Law School, where I competed even harder for the standard badges of success.
The highest prize in a law student’s world is unambiguous: out of tens of thousands of graduates
each year, only a few dozen get a Supreme Court clerkship. After clerking on a federal appeals court
for a year, I was invited to interview for clerkships with Justices Kennedy and Scalia. My meetings
with the Justices went well. I was so close to winning this last competition. If only I got the
clerkship, I thought, I would be set for life. But I didn’t. At the time, I was devastated.
In 2004, after I had built and sold PayPal, I ran into an old friend from law school who had helped
me prepare my failed clerkship applications. We hadn’t spoken in nearly a decade. His first question
wasn’t “How are you doing?” or “Can you believe it’s been so long?” Instead, he grinned and
asked: “So, Peter, aren’t you glad you didn’t get that clerkship?” With the benefit of hindsight, we
both knew that winning that ultimate competition would have changed my life for the worse. Had I
actually clerked on the Supreme Court, I probably would have spent my entire career taking
depositions or drafting other people’s business deals instead of creating anything new. It’s hard to
say how much would be different, but the opportunity costs were enormous. All Rhodes Scholars
had a great future in their past.
WAR AND PEACE
Professors downplay the cutthroat culture of academia, but managers never
tire of comparing business to war. MBA students carry around copies of
Clausewitz and Sun Tzu. War metaphors invade our everyday business
language: we use headhunters to build up a sales force that will enable us
to take a captive market and make a killing. But really it’s competition, not
business, that is like war: allegedly necessary, supposedly valiant, but
ultimately destructive.
Why do people compete with each other? Marx and Shakespeare provide two models for
understanding almost every kind of conflict.
According to Marx, people fight because they are different. The proletariat fights the bourgeoisie
because they have completely different ideas and goals (generated, for Marx, by their very different
material circumstances). The greater the differences, the greater the conflict.
To Shakespeare, by contrast, all combatants look more or less alike. It’s not at all clear why they
should be fighting, since they have nothing to fight about. Consider the opening line from Romeo
and Juliet: “Two households, both alike in dignity.” The two houses are alike, yet they hate each
other. They grow even more similar as the feud escalates. Eventually, they lose sight of why they
started fighting in the first place.
In the world of business, at least, Shakespeare proves the superior guide. Inside a firm, people
become obsessed with their competitors for career advancement. Then the firms themselves become
obsessed with their competitors in the marketplace. Amid all the human drama, people lose sight of
what matters and focus on their rivals instead.
Let’s test the Shakespearean model in the real world. Imagine a production called Gates and
Schmidt, based on Romeo and Juliet. Montague is Microsoft. Capulet is Google. Two great families,
run by alpha nerds, sure to clash on account of their sameness.
As with all good tragedy, the conflict seems inevitable only in retrospect. In fact it was entirely
avoidable. These families came from very different places. The House of Montague built operating
systems and office applications. The House of Capulet wrote a search engine. What was there to
fight about?
Lots, apparently. As a startup, each clan had been content to leave the other alone and prosper
independently. But as they grew, they began to focus on each other. Montagues obsessed about
Capulets obsessed about Montagues. The result? Windows vs. Chrome OS, Bing vs. Google Search,
Explorer vs. Chrome, Office vs. Docs, and Surface vs. Nexus.
Just as war cost the Montagues and Capulets their children, it cost Microsoft and Google their
dominance: Apple came along and overtook them all. In January 2013, Apple’s market
capitalization was $500 billion, while Google and Microsoft combined were worth $467 billion.
Just three years before, Microsoft and Google were each more valuable than Apple. War is costly
business.
Rivalry causes us to overemphasize old opportunities and slavishly copy what has worked in the
past. Consider the recent proliferation of mobile credit card readers. In October 2010, a startup
called Square released a small, white, square-shaped product that let anyone with an iPhone swipe
and accept credit cards. It was the first good payment processing solution for mobile handsets.
Imitators promptly sprang into action. A Canadian company called NetSecure launched its own card
reader in a half-moon shape. Intuit brought a cylindrical reader to the geometric battle. In March
2012, eBay’s PayPal unit launched its own copycat card reader. It was shaped like a triangle—a
clear jab at Square, as three sides are simpler than four. One gets the sense that this Shakespearean
saga won’t end until the apes run out of shapes.
The hazards of imitative competition may partially explain why individuals with an Asperger’s-like
social ineptitude seem to be at an advantage in Silicon Valley today. If you’re less sensitive to social
cues, you’re less likely to do the same things as everyone else around you. If you’re interested in
making things or programming computers, you’ll be less afraid to pursue those activities singlemindedly
and thereby become incredibly good at them. Then when you apply your skills, you’re a
little less likely than others to give up your own convictions: this can save you from getting caught
up in crowds competing for obvious prizes.
Competition can make people hallucinate opportunities where none exist. The crazy ’90s version of
this was the fierce battle for the online pet store market. It was Pets.com vs. PetStore.com vs.
Petopia.com vs. what seemed like dozens of others. Each company was obsessed with defeating its
rivals, precisely because there were no substantive differences to focus on. Amid all the tactical
questions—Who could price chewy dog toys most aggressively? Who could create the best Super
Bowl ads?—these companies totally lost sight of the wider question of whether the online pet
supply market was the right space to be in. Winning is better than losing, but everybody loses when
the war isn’t one worth fighting. When Pets.com folded after the dot-com crash, $300 million of
investment capital disappeared with it.
Other times, rivalry is just weird and distracting. Consider the Shakespearean conflict between
Larry Ellison, co-founder and CEO of Oracle, and Tom Siebel, a top salesman at Oracle and
Ellison’s protégé before he went on to found Siebel Systems in 1993. Ellison was livid at what he
thought was Siebel’s betrayal. Siebel hated being in the shadow of his former boss. The two men
were basically identical—hard-charging Chicagoans who loved to sell and hated to lose—so their
hatred ran deep. Ellison and Siebel spent the second half of the ’90s trying to sabotage each other.
At one point, Ellison sent truckloads of ice cream sandwiches to Siebel’s headquarters to try to
convince Siebel employees to jump ship. The copy on the wrappers? “Summer is near. Oracle is
here. To brighten your day and your career.”
Strangely, Oracle intentionally accumulated enemies. Ellison’s theory was that it’s always good to
have an enemy, so long as it was large enough to appear threatening (and thus motivational to
employees) but not so large as to actually threaten the company. So Ellison was probably thrilled
when in 1996 a small database company called Informix put up a billboard near Oracle’s Redwood
Shores headquarters that read: CAUTION: DINOSAUR CROSSING. Another Informix billboard
on northbound Highway 101 read: YOU’VE JUST PASSED REDWOOD SHORES. SO DID WE.
Oracle shot back with a billboard that implied that Informix’s software was slower than snails. Then
Informix CEO Phil White decided to make things personal. When White learned that Larry Ellison
enjoyed Japanese samurai culture, he commissioned a new billboard depicting the Oracle logo
along with a broken samurai sword. The ad wasn’t even really aimed at Oracle as an entity, let alone
the consuming public; it was a personal attack on Ellison. But perhaps White spent a little too much
time worrying about the competition: while he was busy creating billboards, Informix imploded in a
massive accounting scandal and White soon found himself in federal prison for securities fraud.
If you can’t beat a rival, it may be better to merge. I started Confinity with my co-founder Max
Levchin in 1998. When we released the PayPal product in late 1999, Elon Musk’s X.com was right
on our heels: our companies’ offices were four blocks apart on University Avenue in Palo Alto, and
X’s product mirrored ours feature-for-feature. By late 1999, we were in all-out war. Many of us at
PayPal logged 100-hour workweeks. No doubt that was counterproductive, but the focus wasn’t on
objective productivity; the focus was defeating X.com. One of our engineers actually designed a
bomb for this purpose; when he presented the schematic at a team meeting, calmer heads prevailed
and the proposal was attributed to extreme sleep deprivation.
But in February 2000, Elon and I were more scared about the rapidly inflating tech bubble than we
were about each other: a financial crash would ruin us both before we could finish our fight. So in
early March we met on neutral ground—a café almost exactly equidistant to our offices—and
negotiated a 50-50 merger. De-escalating the rivalry post-merger wasn’t easy, but as far as problems
go, it was a good one to have. As a unified team, we were able to ride out the dot-com crash and
then build a successful business.
Sometimes you do have to fight. Where that’s true, you should fight and win. There is no middle
ground: either don’t throw any punches, or strike hard and end it quickly.
This advice can be hard to follow because pride and honor can get in the way. Hence Hamlet:
Exposing what is mortal and unsure
To all that fortune, death, and danger dare,
Even for an eggshell. Rightly to be great
Is not to stir without great argument,
But greatly to find quarrel in a straw
When honor’s at the stake.
For Hamlet, greatness means willingness to fight for reasons as thin as an eggshell: anyone would
fight for things that matter; true heroes take their personal honor so seriously they will fight for
things that don’t matter. This twisted logic is part of human nature, but it’s disastrous in business. If
you can recognize competition as a destructive force instead of a sign of value, you’re already more
sane than most. The next chapter is about how to use a clear head to build a monopoly business.