Magazine | October 6, 2014, Issue

Explosions of Creativity

Zero to One: Notes on Startups, or How to Build the Future, by Peter Thiel, with Blake Masters (Crown Business, 224 pp., $27)

Peter Thiel is a legend of the digital revolution.

Born in Germany in 1967, he was moved to California as a toddler, and showed early signs of intellectual gifts by becoming a young chess master. He seemed well launched on the cursus honorum of the American upper middle class as he majored in philosophy at Stanford and pushed on to Stanford Law School and to a clerkship at the Eleventh Circuit U.S. Court of Appeals.

But then he had a stroke of good fortune (his description). He lost out on a Supreme Court clerkship that he wanted avidly, and was rechanneled into the world of finance. He traded derivatives at Credit Suisse for three years, then left in 1996 to found Thiel Capital Management, and in 1998 he and some buddies founded PayPal.

PayPal’s sale to eBay in 2002 earned Thiel his first $55 million, and he founded Clarium Capital Management soon after. In 2004, he became the first outside investor in Facebook, paying half a million dollars for 10.2 percent of the company — a decision that earned him more than a billion when he sold most of his stake in 2012.

Throughout the Aughts, Thiel’s activity was frenetic as he provided money for dozens of startups, often in conjunction with the “PayPal Mafia” of former colleagues. His major current venture seems to be Palantir Technologies, a partnership with the CIA aimed at creating synergies of human and machine intelligences.

Clarium did poorly during the financial crisis and after, and investors lost faith. But in 2012, Thiel formed a new firm, Mithril Capital, with $402 million in capital (a good but undisclosed chunk of which was his own), and the entrepreneurial investments keep rolling on.

Thiel leads an active philanthropic and political life with a strong libertarian bent. In college, he founded the Stanford Review, still a leading conservative/libertarian voice; he created the Thiel Fellowships, which spur young people to quit college and found companies; he supports research on artificial intelligence, anti-aging initiatives, and seasteading; he donates freely to the causes of human rights, gay rights, and journalistic freedom. Thiel is a serious supporter of the Club for Growth and he helped conservative activist James O’Keefe early in his career. Even his investments have an evangelical side: He viewed PayPal not just as a business but as an instrument of human liberation, and other ventures have the same aura.

Zero to One is an outgrowth of careful notes taken by a student during a course on innovation Thiel taught at Stanford in 2012. One suspects that the course was more a seminar bull session than a rigorous academic analysis (not that there’s anything wrong with that!) and it does not escape the genre, set forth in the subtitle, of “Notes.” The result is a loose collection of aphorisms and bits of wisdom, not a sustained inquiry.

Nor does the book probe deeply into Thiel’s own experience. There are occasional references to PayPal, but the bloody details of entrepreneuring in one of the most cutthroat eras of business history are omitted. Most of what I learned about his background had to be gleaned from Wikipedia, not from this book.

So what can you learn from the book? Well, quite a few things.

One is the lesson taught by George Gilder in his book Knowledge and Power (2013), though this book is devoid of any reference to Gilder or information theory: that information is surprise. To Thiel, the only valuable ideas are those that most other people disagree with, and the initial point for successful entrepreneurs must be: “What valuable company is nobody building?” He thinks the dot-com crash taught the wrong lessons: It convinced Silicon Valley to eschew grand visions, avoid plans in favor of opportunistic flexibility, focus on improving on existing products already offered by competitors, and avoid products that need intensive sales efforts.

All of these ideas are wrong. A great startup must have a vision and a plan, it must avoid competition, and it should recognize that if a better mousetrap falls in a forest and no one knows about it, it might as well not exist. PayPal, for example, had a vision of the benefits it could offer its customers. It avoided direct confrontation with the big payments systems, instead offering complementary services that did not threaten. It focused on a niche market — frequent eBay sellers — for whom PayPal was particularly valuable, and dominating this market provided a solid base for expansion. “Successful network businesses,” Thiel writes, “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.” (The book does not mention Clayton Christensen and his theories of disruptive innovation, but, as with Gilder’s work, one hears echoes.)

#page#To have a shot at success, a startup must have good answers to seven questions: Engineering — can you create a breakthrough, not just incremental improvements? He uses the figure that technical improvements must be ten times as good as incumbents to succeed. Timing — is now right? Monopoly — are you starting with a big share of a small market? People — do you have the right team? Distribution — can you deliver the product? Durability — is your market position defensible over time? The secret — have you identified a unique opportunity that others do not see?

The goal is market power, usually based on combinations of technical superiority, network effects, scale economies, and branding.

These are not earth-shaking insights, but it is useful to be reminded of them, because they are regularly ignored. Thiel notes the problem with the wave of green tech that swept over Silicon Valley in the Aughts: The companies lacked good answers not just to one or two of these questions; they had bad answers for all seven.

One reason for the failure was management by non-techies, by salesmen-executives good at raising capital and getting government subsidies but not at making desirable products. Thiel’s Founders Fund developed a quick metric for weeding out these companies without wasting time reading pitch documents: “Never invest in a tech CEO [who] wears a suit.”

His exception is Tesla, run by PayPal Mafia member Elon Musk, which scores seven-for-seven on the Thiel questions. Hmm; from a libertarian point of view, one might question Musk’s correct answer on “timing,” because it consisted of getting $464 million in government subsidies at the exactly opportune moment, but I suppose this counts from an entrepreneurial standpoint. Still, one is reminded again of Gilder, and his lament over the “general Gadarene rush for green subsidies” and the “transform[ation of] venture capitalists . . . into a pack of grubby petitioners for pork.” It would have been interesting to hear a bit more from Thiel the libertarian about the impact of the government on the innovative culture of the tech industry.

The book is sprinkled with other insights: the importance of avoiding competition, which sends prices into marginal-cost hell, and the absurdity of economists’ belief that perfect competition, where no company can make a profit, is a desirable state. He’s also right about the crucial nature of personnel decisions in a startup, the need for the people to form a cult of true believers to have a chance at success, and the uses of equity rather than cash compensation to ensure that everyone is committed to creating value over time: “A company does better the less it pays the CEO — that’s one of the single clearest patterns I’ve noticed from investing in hundreds of startups.”

There’s also the need to keep one’s eye on the money: The value of a business is its future cash flow, and, while other metrics, such as eyeball views, can be useful, they mean nothing unless they produce the cash in the long run. Thiel further notes the mistake techies frequently make in assuming that a good product will sell itself and in not paying attention to the devices that are necessary to match essential marketing to the situation. For PayPal, which needed to reach a finite number of eBay “PowerSellers,” marketing meant paying people to sign up to create a critical mass that would then drive network effects. It worked.

Tantalizing questions remain, such as why PayPal succeeded and other startups did not. Thiel has a sketch of the core team circa 1999: six people who “could have been considered eccentric.” Five of them were younger than 23; four were born outside the U.S., and three in Communist nations; four had built bombs in high school. (Thiel drops that tidbit without elaboration as to what happened to the bombs.)

From this he speculates on the nature of founders, who are, he notes, a peculiar lot, which is a good thing, because normal people do not transcend the bounds of bureaucracy and convention and build great, novel enterprises.

This speculation about founders is as close to autobiography as Thiel gets. His own path has been far distant from that of the conventional Stanford Law boy; he does not much discuss his own tech background, and one is left to wonder how a philosophy major/lawyer got into and succeeded in businesses for which the crucial factor is technological superiority. There must be an untold tale there.

It would be interesting to read an actual autobiography, with more about the gritty experiences that led him to the aphorisms. It would also be interesting to sit in on the next course he gives, and see what new lessons he has. The final exam would probably be to go out and build a company.

– Mr. DeLong is the vice president of, and a senior analyst at, the Convergence Law Institute.

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