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Capitalism and Competition are Antonyms

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This is a post about secret #1 about startups by Peter Thiel. To see all 4 of the secrets start here.

These views and thoughts are all Peter’s and notes are from Blake Master’s. If you find any of these ideas intriguing I suggest reading through the full notes here.

TLDR: Capitalism and competition are antonyms (opposites of each other). Tweet this.

This is the first secret and most people would disagree with it. People generally believe that the differences between firms are pretty small. They miss the big monopoly secret because they don’t see through the human secrets behind it. Monopolists pretend that they’re not monopolists (“Don’t regulate us!”) and non-monopolists pretend that they are (“We are so big and important!”). Things only tend to look similar on the surface.

Usual Story
The usual story is capitalism and perfect competition are synonyms. No one is a monopoly and firms compete and profits are competed away. This however is a strange belief.

Capitalism is about the accumulation of capital whereas perfect competition is one where you can’t make profit. From this frame using capitalism and perfect competition as being interchangeable is a strange belief.

Why is competition favored?
Favoring competition seems justified because it’s deep-rooted within our culture. Competition is believed to build character, we learn from it, and it prepares us for the future. For example getting into medical school is extremely competitive but once you get in you get to be a well paid doctor afterwards.

Competition isn’t bad but too often in the race to compete, we learn to confuse what is hard with what is valuable. The intensity of competition becomes a proxy for value. And to the extent value it’s not there, you’re competing just for the sake of competition.

One problem with fierce competition is that it’s demoralizing. Top high school students who arrive at elite universities quickly find out that the competitive bar has been raised. But instead of questioning the existence of the bar, they tend to try to compete their way higher. That is costly.

Competition taught unquestioningly is dangerous because it leads to pointless competition.

Perfect competition vs. monopolies
Under the economic idea of supply and demand you get two options at the market equilibrium: perfect competition and monopolies.

Under perfect competition supply and demand is perfectly met so no firms in industry make profit. If there were profits to be made news firms would enter the market and take profits away. It’s just not new entrants but all firms in the industry don’t make a profit in perfect competition.

Under a monopoly a single firm (or few) own the market and are they are the only ones that produces the product for that market. Most economists spend a great deal of time studying perfect competition but very few look at monopolies seriously.

Perfect competition is fine when you don’t want to turn a profit but to the extent one wants to make money you should be quite skeptical about perfect competition.

Monopolies aren’t just an exception
Monopolies aren’t just a strange exception and we should consider monopolies as a valid alternative to the perfect market paradigm.

Monopolies tend to be viewed as bad because competition is assumed to be good. More competition = more perfect marketplace = more progress. If more competition equates to more progress then the opposite of that must be true. This is why the view that monopolies are bad are accepted as a given and why this view is worth questioning.

The bias towards perfect competition (its implicit in the word “perfect”) may be because its easiest to model. Economics is all about modeling the world to make it easier to deal with. Perfect competition is one of those variables that doesn’t change and is easier to model in a mathematical equation.

The two criticisms of perfect competition are people involved in a business might actually want to make a profit & things within the market are constantly changing which doesn’t lead to an equilibrium.

The good and bad of monopolies
Before getting into the good of monopolies lets talk about the bad aspects of Monopolies.

1. Monopolies tend to produce lower output and charge higher process than firms in competitive markets do.
2. Monopolies tend to be price setters not price takers.
3. Monopolies price discriminate since monopolists may capture more value by charing different groups different prices.
4. Monopolies stifles innovation since it earns profits whether it innovates or not.

The innovation argument can also be a good thing too. If the monopoly creates something better than the next best thing it can charge higher than its cost of product giving them reward for creating the new thing.

Since monopolies last longer than other firms (within perfect competition) it can conduct a more long term view on value.

If monopolies exist why don’t we see them?
Even if the world isn’t a perfect competition and monopolies do exist we wouldn’t know about them because:

  1. Companies don’t want to say they are monopolies for fear of the DOJ
  2. Monopolies insist they are in bigger markets than they area (we’re not the monopoly you’re looking for)
  3. Lies about market share. Is google in the search engine market or advertising market or a tech company? Depending on what you compare it against its market share is drastically different.

How a company can own a market
If monopolies do exist a new startup should set out to own an entire market. For a company to do this it has to have some combination of brand, scale cost advantages, network affects, or proprietary technology.

Of those brand is hardest to understand and identify in advance but if you build a brand you build a monopoly. Scale advantages, network effects, and proprietary technology are more easily understood.

  1. Scale advantages work best when their are high fixed costs and low marginal costs. Think about Amazon.
  2. Network effects locks people into their particular business. Think about the IPod and iTunes.
  3. Proprietary technology is technology, for whatever reason, no one can use besides yourself. Think about a new drug.

The archetypal monopoly story
The best business is one where you can tell a compelling story about the future which leads to a monopoly. All of the great companies have a similar archetypal story that follows something like this:

  1. Find a small target market
  2. Become the best in the world at it
  3. Take over adjacent markets
  4. Widen the aperture of what the companies doing
  5. Capture more and more of the market.
  6. Once the operation is quite large some combination of network effects, technology, scale advantages, and brand should make it very hard for others to follow.

Value of high growth monopolies
Valuations for high growth companies are different than valuations of businesses in decline because at first most of them loose money and most of the value exist far into the future. This is counterintuitive because most people, even ones working in startups, think you have to create value right off the bat. The focus is on the next month, quarters, or less frequently years. For startups this is too short of a timeline.

Paypal and Linkedin are good examples where much of the value is expected to be gained in 2020 and beyond.

This is why valuations driven by multiples and comparables tend to not work as well with high growth companies. They are too heavily based on the standards and conventions that exist at that time and not take into account the future value. In startups so much value is placed on having first mover advantage but the danger is you simply aren’t going to be around to success. More important is to be durable and last a long time.

Business is like chess where you have to study the endgame before anything else.

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Written by Chris McCann

May 15, 2012 at 5:35 am

Posted in Uncategorized

4 Responses

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  1. […] Capitalism and competition are antonyms. […]

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