With a net worth of $3.4B, Peter Thiel is one of the most successful (and eccentric) startup investors of our generation - with investments in companies such as Facebook, Palantir, and Paypal. He gave a lesson at Stanford on how to identify monopolistic businesses - companies with dominant market-share that become incredible investment opportunities. As startup investors, it’s important that we absorb these lessons and build up our pattern recognition, so when we see a company with similar characteristics, we can move quickly! Here’s how to identify monopolistic companies.
With a net worth of $3.4B, Peter Thiel is one of the most successful (and eccentric) startup investors of our generation - with investments in companies such as Facebook, Palantir, and Paypal.
He gave a lesson at Stanford on how to identify monopolistic businesses - companies with dominant market-share that become incredible investment opportunities.
As startup investors, it’s important that we absorb these lessons and build up our pattern recognition, so when we see a company with similar characteristics, we can move quickly!
Here’s how to identify monopolistic companies.
Today we’ll explore:
💡 Capturing Value: A business must create and capture value
🥧 Big Piece of a small pie: Finding small, but high growth markets
🥊 Competition vs Monopoly: With perfect competition, profits are eroded
⚔️ The Lies People Tell: Monopolies don’t want to be found
🧱 How to build a monopoly: Let’s open the playbook
🔍 Characteristics of a Monopoly: How to spot monopolistic businesses
What makes a business valuable? Peter suggests a very simple formula.
“A business creates X dollars of value for the world and captures Y% of X”
This can often be difficult to achieve. Scientists and inventors often create immense value for the world, but they rarely capture that value in the way that technology companies do.
What do these variables look like?
Product and business systems create value (Y variable) - Think of this as Shopify's technology and the ability for anyone to spin up an eCommerce company with a few clicks of a button.
The business model is the key to capturing value (X variable) - This is the monthly fee and percentage of a transaction that Shopify charges its users.
Funnily enough, big markets are often a bad place to start looking for monopolies - let’s explore that further.
Big Piece of a small pie:
If you only view the world by how large a market is, you’ll miss real innovation and the opportunity to capture value.
Let’s compare the Airlines industry to the Search industry in 2012.
Entire US Airline Revenues: $195B
Search Revenues: $50B
If you only look at revenue, you would think Airlines were a better industry. However, there is a big difference in the market dynamics.
Airlines have perfect competition - it's a low margin and incredibly competitive industry. This leads to a low market capitalization ($112B). Search, a category in which Google plays, is the opposite. The market was growing very quickly and Google's business model sustainably captured a fraction of the value it created.
These differences created a Search market that was almost 4X that of the Airlines industry, despite having lower revenues.
Competition vs Monopoly:
There are exactly two types of businesses in this world - companies with perfect competition (bad) and monopolies (good).
Industries with perfect competition are easier to start a business in because you can see the playing field.
This is not to say that these businesses are bad investments, often an innovative business in a competitive market can outcompete its peers and create value - but we do not see the same outsized impact that comes with a monopolistic business.
Monopolistic businesses often start in small, but high growth markets. If you create a monopolistic business, you can capture an extremely high percentage of that value and create an enduring business that compounds at an extremely high growth rate.
The Lies People Tell:
The apparent difference between monopolies and non-monopolies is quite small, but in reality these businesses differ greatly. The reason the apparent difference is small, is because nobody is telling the truth:
Monopolies: Monopolistic companies often pretend they don’t have a monopoly because they don’t want to get regulated by the government. So they’ll resegment their market to make the market look much larger. For example, Google will say it plays in the global advertising market (A ~$500 billion market where they have 3% market share) opposed to the search market (A market where they have 90% market share).
Non-Monopolies: Those that are in highly competitive markets often pretend they aren’t. They want to give the illusion that they have something unique to offer.
The reality is that these two types of businesses differ enormously, so it's very important that you are able to recognize monopolistic characteristics.
How to build a monopoly:
Monopolies often start with a small market and monopolize it. It’s easier to dominate a small market than a large one because larger markets almost always have a lot of competition. Once you dominate a small market, you can figure out ways to expand that market.
Take Amazon, they started by creating a bookstore. Because it was the first book store built on the internet, it became the best bookstore in the world, offering millions of titles to the end consumer.
Characteristics of a Monopoly:
All great companies are different because they’re doing something very unique - all unhappy companies are alike because they fail to escape the essential sameness that is competition. These are a few characteristics that enable companies to escape this “sameness”:
Proprietary technology: You want to have unique product or technology characteristics that are 10x better than anyone else. Examples: Amazon sold 10X as many books, Paypal could clear payments 10X faster than a paper check. YouTube makes it 10X easier to upload and search for video content (they also have 10X as much content).
Network Effects: With each person that joins the network, it gets more powerful. They’re hard to get started, but once the flywheel has started, they’re almost impossible to stop.
Economies of Scale: Walmart and Costco are often known for their economies of scale. They can buy products at such large volumes that they can sell for much better prices to their end customers.
Branding: While challenging to quantify, a brand can symbol trust, and in the digital era trust is the only thing we can rely on.
Software businesses are particularly good at garnering these characteristics because they have no marginal cost to scale - once a software has built its product, it can scale it incredibly quickly.
Peter believes that all companies should aspire to be monopolies. Businesses that endure the test of time and create immense value for the world.
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