Notes
“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? …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.”
“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.”
“Monopoly is the condition of every successful business.”
“But a great business is defined by its ability to generate cash flows in the future. Investors expect Twitter will be able to capture monopoly profits over the next decade, while newspapers’ monopoly days are over.”
“the value of a business today is the sum of all the money it will make in the future. (To properly value a business, you also have to discount those future cash flows to their present worth, since a given amount of money today is worth more than the same amount in the future.)”
Durability is as important as growth, but it is harder to measure.
“If you focus on near-term growth above all else, you miss the most important question you should be asking: will this business still be around a decade from now? Numbers alone won’t tell you the answer; instead you must think critically about the qualitative characteristics of your business.”
“What does a company with large cash flows far into the future look like? Every monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding.”
CHARACTERISTICS OF MONOPOLY
1. Proprietary Technology
The most substantive advantage a company can have because it makes your product difficult or impossible to replicate.
“As a good rule of thumb, proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage. Anything less than an order of magnitude better will probably be perceived as a marginal improvement and will be hard to sell, especially in an already crowded market.”
“The clearest way to make a 10x improvement is to invent something completely new. If you build something valuable where there was nothing before, the increase in value is theoretically infinite.”
“Or you can radically improve an existing solution: once you’re 10x better, you escape competition.”
ex: Amazon - “Earth’s largest bookstore”, PayPal - instant payments on eBay instead of mailing checks.
“You can also make a 10x improvement through superior integrated design.”
ex: Apple - iPad: “Design improvements are hard to measure, but it seems clear that Apple improved on anything that had come before by at least an order of magnitude: tablets went from unusable to useful.”
2. Network Effects
“Network effects make a product more useful as more people use it.” ex: Facebook
“Network effects can be powerful, but you’ll never reap them unless your product is valuable to its very first users when the network is necessarily small.”
“Paradoxically, then, network effects businesses must start with especially small markets. Facebook started with just Harvard students”
“This is why successful network businesses rarely get started by MBA types: the initial markets are so small that they often don’t even appear to be business opportunities at all.”
3. Economies of Scale
“A monopoly business gets stronger as it gets bigger: the fixed costs of creating a product (engineering, management, office space) can be spread out over ever greater quantities of sales. Software startups can enjoy especially dramatic economies of scale because the marginal cost of producing another copy of the product is close to zero.”
“A good startup should have the potential for great scale built into its first design. Twitter already has more than 250 million users today. It doesn’t need to add too many customized features in order to acquire more, and there’s no inherent reason why it should ever stop growing.”
4. Branding
“A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful way to claim a monopoly.”
ex: Apple
“And it enjoys strong network effects from its content ecosystem: thousands of developers write software for Apple devices because that’s where hundreds of millions of users are, and those users stay on the platform because it’s where the apps are. These other monopolistic advantages are less obvious than Apple’s sparkling brand, but they are the fundamentals that let the branding effectively reinforce Apple’s monopoly.”
“Beginning with brand rather than substance is dangerous.”
“No technology company can be built on branding alone.”
BUILDING A MONOPOLY
Start Small and Monopolize
“Every startup is small at the start. Every monopoly dominates a large share of its market. Therefore, every startup should start with a very small market.”
Always err on the side of starting too small.
“It’s easier to dominate a small market than a large one. If you think your initial market might be too big, it almost certainly is.”
“The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors. Any big market is a bad choice, and a big market already served by competing companies is even worse.”
Scaling Up
Gradually expand into related and slightly broader markets.
ex: Amazon
“Jeff Bezos’s founding vision was to dominate all of online retail, but he very deliberately started with books.”
“Amazon became the dominant solution for anyone located far from a bookstore or seeking something unusual. Amazon then had two options: expand the number of people who read books, or expand to adjacent markets. They chose the latter, starting with the most similar markets: CDs, videos, and software. Amazon continued to add categories gradually until it had become the world’s general store.”
ex 2: eBay
“eBay also started by dominating small niche markets. When it launched its auction marketplace in 1995, it didn’t need the whole world to adopt it at once; the product worked well for intense interest groups, like Beanie Baby obsessives. Once it monopolized the Beanie Baby trade, eBay didn’t jump straight to listing sports cars or industrial surplus: it continued to cater to small-time hobbyists until it became the most reliable marketplace for people trading online no matter what the item.”
“Sequencing markets correctly is underrated, and it takes discipline to expand gradually. The most successful companies make the core progression—to first dominate a specific niche and then scale to adjacent markets—a part of their founding narrative.”
Don’t Disrupt
“As you craft a plan to expand to adjacent markets, don’t disrupt: avoid competition as much as possible.”
THE LAST WILL BE FIRST
“But moving first is a tactic, not a goal. What really matters is generating cash flows in the future, so being the first mover doesn’t do you any good if someone else comes along and unseats you. It’s much better to be the last mover—that is, to make the last great development in a specific market and enjoy years or even decades of monopoly profits. The way to do that is to dominate a small niche and scale up from there, toward your ambitious long-term vision. In this one particular at least, business is like chess. Grandmaster José Raúl Capablanca put it well: to succeed, “you must study the endgame before everything else.””