Introduction:
Why Mass Diversification Is Bad:
Power Law:
Common Features Of 10X Companies:
Introduction:
Peter Thiel, often deemed as a major contrarian, within 0-to-1 outlined his philosophy for understanding the next innovative company.
Whilst conventional wisdom often posits forward the view that one should diversify their portfolio majorly, Peter Thiel disagrees.
It is wise to note, this style of investing is historically very controversial, and often causes mas debate & discussion. Fundamentally, investing styles vary based on risk profile, lifestyle aims & skills within analysing equities.
It is far to state that most certainly everyone should not blindly abide by this philosophy. Investing is very personal, and comes with huge levels of risk.
Why Mass Diversification Is Bad:
The error lies in expecting that venture returns will be normally distributed: that is, bad companies
will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x.
Fundamentally, mass diversification is a method of leaving the future to chance. When one diversifies their equities, what this means is that you have no real conviction upon the future, and you are willing to solely let fate decide ones financial future.
Often, via mass diversification, Peter Thiel believes that this leads to very mediocre results. This is in comparison to being deterministic about the future, and using knowledge to generate conviction.
“You can expect the future to take a definite form or you can treat it as hazily uncertain. If you treat the future as something definite, it makes sense to understand it in advance and to work to shape it. But if you expect an indefinite future ruled by randomness, you’ll give up on trying to master it.”
“The most common answer to the question of future value is a diversified portfolio: “Don’t put all
your eggs in one basket,” everyone has been told. As we said, even the best venture investors have a
portfolio, but investors who understand the power law make as few investments as possible.”
The more you diversify, the more uncertainty you leave for the future.
Whenever you shift from the substance of a business to the financial question of whether or not it fits into a diversified hedging strategy, venture investing starts to look a lot like buying lottery tickets. And once you think that you’re playing the lottery, you’ve already psychologically prepared yourself to lose.
Power Law:
To understand this view, one must acknowledge the idea of a power law. A power law speaks towards the relationship between two quantities, such that one is proportional to a fixed power of the other.
When it comes to equities – put simply: a small handful of companies will radically outperform all the others.
Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers. But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all.
Investing returns don’t follow a normal distribution overall. Rather, they follow a power law: a small handful of companies radically outperform all others.
If you focus on diversification instead of single-minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place.
The bottom line remains, via mass diversification this innately sets you up to fail. Buying a basket of stocks is a bad idea, says’ Peter, because it is analogous to buying a lottery ticket.
Common Features Of 10X Companies:
The conventional schooling system teaches that of mass diversification. For example, it is impossible to get into Oxford or Harvard university via solely specialising within one skill.
Instead, the undergraduate system favours average knowledge within a range of domains. This risk adverse philosophy is indoctrinated within individuals throughout their childhood, and therefore trickles into the financial sector too.
The uncertainty of the future causes individuals to spread their investments and time over a range of skills and topics, in an attempt to hedge against uncertainty. However, as mentioned this indeterministic and chance-based approach to the future leads to very average results.
The truth is, the future is deterministic. Individuals can change and shape the future, if they act within the most effective manner. And, individuals can predict trends and identify patterns among highly successful companies.
Whilst it is logical to state that there is no one formulation for a successful investment, there is a common set of traits within these successful companies that can give us an indication of future success.
Firstly, the technology within the company must be 10X better. Proprietary technology is the best advantage a company must have because it can make a product impossible or difficult to replicate. Within the case of Google & their algorithms, it seems clear that Google has a 10X better piece of technology, in comparison to Bing or Yahoo.
For Google, the autocorrect, & load times are incredibly fast, yet also very hard to copy.
If the improvement is only deemed as marginal, this will make the product hard to sell, and thus especially within a competitive landscape, very hard to win.
Interlinked with this previous philosophy is the idea of network effects. Network effects looks at the network becoming more useful over time, as more nodes join the select network.
Within the case of a social platform, the network effects are very strong. As more people join Facebook, the perceived disconnectedness and isolation felt is very disconcerting.
Thus, one is incentivised to join the social network.
Network effects lead to a flywheel of utility improvements.
Economies of scale is a common trait too.
Idealistically, a good business should be a company that has a zero marginal cost associated with replication of the product or service.
Code is a great example of how replication can occur at scale with zero marginal cost.
On the other hand, a yoga studio clearly will never be able to scale infinitely. This is because, the studio needs renting, there is a limit in terms of how many people can fit in the studio at a give time, and therefore replication at scale is by no means easy.
“A good start-up 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.”
Branding is fundamental too, however alone this can not great a monopolistic 10X company. “A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful
way to claim a monopoly.
Today’s strongest tech brand is Apple: the attractive looks and carefully chosen materials of products like the iPhone and MacBook, the Apple Stores’ sleek minimalist design and close control over the consumer experience, the omnipresent advertising campaigns, the price positioning as a maker of premium goods, and the lingering nimbus of Steve Jobs’s personal charisma all contribute to a perception that Apple offers products so good as to constitute a category of their own”
“Beginning with brand rather than substance is dangerous. Ever since Marissa Mayer became CEO
of Yahoo! in mid-2012, she has worked to revive the once-popular internet giant by making it cool
again. In a single tweet, Yahoo! summarized Mayer’s plan as a chain reaction of “people then
products then traffic then revenue.”
The people are supposed to come for the coolness: Yahoo! demonstrated design awareness by overhauling its logo, it asserted youthful relevance by acquiring hot startups like Tumblr, and it has gained media attention for Mayer’s own star power. But the big question is what products Yahoo! will actually create. When Steve Jobs returned to Apple, he didn’t just make Apple a cool place to work; he slashed product lines to focus on the handful of opportunities for 10x improvements. No technology company can be built on branding alone.”
