Zero to One: Notes on Start Ups, or How to Build the Future
Authors: Masters, Blake; Thiel, Peter
Notes by: Jacopo Perfetti.
About the Book
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The next Bill Gates will not build an operating system. The next Larry Page or Sergey Brin won’t make a search engine. If you are copying these guys, you aren’t learning from them.
Preface: Zero to One
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Technology is miraculous because it allows us to do more with less, ratcheting up our fundamental capabilities to a higher level.
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invent new things and better ways of making them.
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the single most powerful pattern I have noticed is that successful people find value in unexpected places, and they do this by thinking about business from first principles instead of formulas.
1 The Challenge of the Future
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When we think about the future, we hope for a future of progress. That progress can take one of two forms. Horizontal or extensive progress means copying things that work—going from 1 to n. Horizontal progress is easy to imagine because we already
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know what it looks like. Vertical or intensive progress means doing new things—going from 0 to 1. Vertical progress is harder to imagine because it requires doing something nobody else has ever done. If you take one typewriter and build 100, you have made horizontal progress. If you have a typewriter and build a word processor, you have made vertical progress.
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it’s hard to develop new things in big organizations, and it’s even harder to do it by yourself.
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In the most dysfunctional organizations, signaling that work is being done becomes a better strategy for career advancement than actually doing work (if this describes your company, you should quit now).
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Startups operate on the principle that you need to work with other people to get stuff done, but you also need to stay small enough so that you actually can.
2 Party Like It’s 1999
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“Madness is rare in individuals—but in groups, parties, nations, and ages it is the rule,” Nietzsche
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The internet craze of the ’90s was the biggest bubble since the crash of 1929,
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Everybody should have known that the mania was unsustainable; the most “successful” companies seemed to embrace a sort of anti-business model where they lost money as they grew. But it’s hard to blame people for dancing when the music was playing;
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In this kind of environment, acting sanely began to seem eccentric.
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But we didn’t have enough customers, growth was slow, and expenses mounted. For PayPal to work, we needed to attract a critical mass of at least a million users. Advertising was too ineffective to justify the cost. Prospective deals with big banks kept falling through. So we decided to pay people to sign up. We gave new customers $ 10 for joining, and we gave them $ 10 more every time they referred a friend.
1. Make incremental advances
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Stay lean and flexible All companies must be “lean,” which is code for “unplanned.” You should not know what your business will do; planning is arrogant and inflexible. Instead you should try things out, “iterate,” and treat entrepreneurship as agnostic experimentation.
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4. Focus on product, not sales If your product requires advertising or salespeople to sell it, it’s not good enough: technology is primarily about product development, not distribution. Bubble-era advertising was obviously
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wasteful, so the only sustainable growth is viral growth.
3 All Happy Companies Are Different
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Creating value is not enough—you also need to capture some of the value you create.
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Compare them to Google, which creates less value but captures far more. Google brought in $ 50 billion in 2012 (versus $ 160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry’s profit margin that year. Google makes so much money
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that it’s now worth three times more than every U.S. airline combined.
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“Perfect competition” is considered both the ideal and the default state in Economics 101. So-called perfectly competitive markets achieve equilibrium when producer supply meets consumer demand. Every firm in a competitive market is undifferentiated and sells the same homogeneous products. Since no firm has any market power, they must all sell at whatever price the market determines. If there is money to be made, new firms will enter the market,
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increase supply, drive prices down, and thereby eliminate the profits that attracted them in the first place. If too many firms enter the market, they’ll suffer losses, some will fold, and prices will rise back to sustainable levels. Under perfect competition, in the long run no company makes an economic profit.
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The opposite of perfect competition is monopoly.
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95% of Google’s revenue comes from search advertising;
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(French chef and winner of three Michelin stars Bernard Loiseau was quoted as saying, “If I lose a star, I will commit suicide.” Michelin maintained his rating, but Loiseau killed himself anyway in 2003 when a competing French dining guide downgraded his restaurant.)
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In business, money is either an important thing or it is everything.
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All happy companies are different: each one earns a monopoly by solving a unique problem.
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All failed companies are the same: they failed to escape competition.
4 The Ideology of Competition
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CREATIVE MONOPOLY MEANS new products that benefit everybody and sustainable profits for the creator. Competition means no profits for anybody, no meaningful differentiation, and a struggle for survival.
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Why do people compete with each other?
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According to Marx, people fight because they are different. The proletariat fights the bourgeoisie because they have completely
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To Shakespeare, by contrast, all combatants look more or less alike. It’s not at all clear why they should be fighting, since they have nothing to fight about.
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Competition can make people hallucinate opportunities where none exist. The crazy ’90s version of this was the fierce battle for the online pet store market. It was Pets.com vs. PetStore.com vs. Petopia.com vs. what seemed like dozens of others. Each company was obsessed with defeating its rivals,
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When Pets.com folded after the dot-com crash, $ 300 million of investment capital disappeared with it.
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So Ellison was probably thrilled when in 1996 a small database company called Informix put up a billboard near Oracle’s Redwood Shores headquarters that read: CAUTION: DINOSAUR CROSSING.
5 Last Mover Advantage
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Compare the value of the New York Times Company with Twitter. Each employs a few thousand people, and each gives millions of people a way to get news. But when Twitter went
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public in 2013, it was valued at $ 24 billion—more than 12 times the Times’s market capitalization—even though the Times earned $ 133 million in 2012 while Twitter lost money. What explains the huge premium for Twitter? The answer is cash flow.
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This sounds bizarre at first, since the Times was profitable while Twitter wasn’t. 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. Simply stated, the value of a business today is the sum of all the money it will make in the future.
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Most of a tech company’s value will come at least 10 to 15 years in the future.
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In March 2001, PayPal had yet to make a profit but our revenues were growing 100% year-over-year. When I projected our future cash flows, I found that 75% of the company’s present value would come from profits generated in 2011 and beyond—hard to believe for a company that had been in business for only 27 months. But even that turned out to be an underestimation. Today, PayPal continues to grow at about 15% annually, and the discount rate is lower than a decade ago.
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LinkedIn is another good example of a company whose value exists in the far future. As of early 2014, its market capitalization was $ 24.5 billion—very high for a company with less than $ 1 billion in revenue and only $ 21.6 million in net income for 2012. You might look at these numbers and conclude that investors have gone insane. But this valuation makes sense when you consider LinkedIn’s projected future cash flows.
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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.
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Every monopoly is unique, but they usually share some combination of the following characteristics: proprietary technology, network effects, economies of scale, and branding.
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Proprietary technology is the most substantive advantage a company can have because it makes your product difficult or impossible to replicate.
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invent something completely new.
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Network effects make a product more useful as more people use it. For example, if all your friends are on Facebook, it makes
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sense for you to join Facebook, too. Unilaterally choosing a different social network would only make you an eccentric.
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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.
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A monopoly business gets stronger as it gets
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bigger:
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the fixed costs of creating a product (engineering, management, office space) can be spread out over ever greater quantities of sales.
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marginal cost of producing another copy of the product is close to zero.
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A good startup should have the potential for great scale built into its first design.
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A company has a monopoly on its own brand by definition, so creating a strong brand is a powerful way to claim a monopoly.
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Beginning with brand rather than substance is dangerous.
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No technology company can be built on branding alone.
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Every startup is small at the start. Every monopoly dominates a large share of its
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market. Therefore, every startup should start with a very small market. Always err on the side of starting too small. The reason is simple: 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.
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The perfect target market for a startup is a small group of particular people concentrated together and served by few or no competitors.
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Scaling Up Once you create and dominate a niche market, then you should gradually expand into related and slightly broader markets.
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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.
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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
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Silicon Valley has become obsessed with “disruption.” Originally, “disruption” was a term of art to describe how a firm can use new technology to introduce a low-end product at low prices, improve the product over time, and eventually overtake even the premium products offered by incumbent companies using older technology.
However, disruption has recently transmogrified into a self-congratulatory buzzword for anything posing as trendy and new.
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The concept was coined to describe threats to incumbent companies, so startups’ obsession with disruption means they see themselves through older firms’ eyes.
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PayPal could be seen as disruptive, but we didn’t try to directly challenge any large competitor. It’s true that we took some business away from Visa when we popularized internet payments: you might use PayPal to buy something online instead of using your Visa card to buy it in a store. But since we expanded the market for payments overall, we gave Visa far more business than we took.
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THE LAST WILL BE FIRST You’ve probably heard about “first mover advantage”: if you’re the first entrant into a market, you can capture significant market share while competitors scramble to get started. 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.
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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
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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.
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Grandmaster José Raúl Capablanca put it well: to succeed, “you must study the endgame before everything else.”
6 You Are Not a Lottery Ticket
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Jeff Bezos attributes Amazon’s success to an “incredible planetary alignment” and jokes that it was “half luck, half good timing, and the rest brains.”
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You can also expect the future to be either better or worse than the present. Optimists welcome the future; pessimists fear it. Combining these possibilities yields four views:
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An indefinite pessimist
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looks out onto a bleak future, but he has no idea what to do about it.
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A definite pessimist believes the future can be known, but since it will be bleak, he must prepare for it.
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To a definite optimist, the future will be better
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than the present if he plans and works to make it better.
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big plans for the future have become archaic curiosities.
Diluita innovare
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To an indefinite optimist, the future will be better, but he doesn’t know how exactly, so he won’t make any specific plans. He expects to profit from the future but sees no reason to design it concretely.
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Instead of working for years to build a new product, indefinite optimists rearrange already-invented ones.
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While a definitely optimistic future would need engineers to design underwater cities and settlements in space, an indefinitely
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optimistic future calls for more bankers and lawyers.
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Finance epitomizes indefinite thinking because it’s the only way to make money when you have no idea how to create wealth.
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Only in a definite future is money a means to an end, not the end itself.
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indefinite optimists: they didn’t have any specific vision of the future.
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In 1928, Scottish scientist Alexander Fleming found that a mysterious antibacterial fungus had grown on a petri dish he’d forgotten to cover in his laboratory: he discovered penicillin by accident.
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chance ever since. Modern drug discovery aims to amplify Fleming’s serendipitous circumstances a millionfold: pharmaceutical companies search through combinations of molecular compounds at random, hoping to find a hit.
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Even in engineering-driven Silicon Valley, the buzzwords of the moment call for building a “lean startup” that can “adapt” and “evolve” to an ever-changing environment. Would-be entrepreneurs are told that nothing can be known in advance: we’re supposed to listen to what customers say they want, make nothing more than a “minimum viable product,” and iterate our way to success.
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But leanness is a methodology, not a goal. Making small changes to things that already exist might lead you to a local maximum, but it won’t help you find the global maximum. You could build the best version of an app that lets people order toilet paper from their iPhone. But iteration without a
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bold plan won’t take you from 0 to 1. A company is the strangest place of all for an indefinite optimist: why should you expect your own business to succeed without a plan to make it happen? Darwinism may be a fine theory in other contexts, but in startups, intelligent design works best.
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Forget “minimum viable products”—ever since he started Apple in 1976, Jobs saw that you can change the world through careful planning, not by listening to focus group feedback or copying others’ successes.
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founders only sell when they have no more concrete visions for the company, in which case the acquirer probably overpaid; definite founders with robust plans don’t sell, which means the offer wasn’t high enough. When Yahoo! offered to buy Facebook for $ 1 billion in July 2006, I thought we should at least consider it. But Mark Zuckerberg walked into the board meeting and announced: “Okay, guys, this is just a formality, it shouldn’t take more than 10 minutes. We’re obviously not going to sell here.” Mark saw where he could take the company, and Yahoo! didn’t.
7 Follow the Money
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In 1906, economist Vilfredo Pareto discovered what became the “Pareto principle,” or the 80-20 rule, when he noticed that 20% of the people owned 80% of the land in Italy—a phenomenon that he found just as natural as the fact that 20% of the peapods in his garden produced 80% of the peas. This extraordinarily stark pattern, in which a small few radically outstrip all rivals, surrounds us everywhere in the natural and social world.
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Venture capitalists aim to identify, fund, and profit from promising early-stage companies. They raise money from institutions and wealthy people, pool it into a fund, and invest in technology companies that they believe will become more valuable. If they turn out to be right, they take a cut of the returns—usually 20%.
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But most venture-backed companies don’t IPO or get acquired; most fail, usually soon after they start.
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The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.
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only invest in companies that have the potential to return the value of the entire fund.
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Andreessen Horowitz invested $ 250,000 in Instagram in 2010. When Facebook bought Instagram just two years later for $ 1 billion, Andreessen netted $ 78 million—a 312x return in less than two years.
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But in a weird way it’s not nearly enough, because Andreessen Horowitz has a $ 1.5 billion fund: if they only wrote $ 250,000 checks, they would need to find 19 Instagrams just to break even.
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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.
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But life is not a portfolio: not for a startup founder, and not for any individual. An entrepreneur cannot “diversify” herself: you cannot run dozens of companies at the same time and then hope that one of them works out well.
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Less obvious but just as important, an individual cannot diversify his own life by keeping dozens of equally possible careers in ready reserve.
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You could have 100% of the equity if you fully fund your own venture, but if it fails you’ll have 100% of nothing.
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Kaczynski argued that modern people are depressed because all the world’s hard problems have already been solved. What’s left to do is either easy or impossible, and pursuing those tasks is deeply unsatisfying. What you can do, even a child can do; what you can’t do, even Einstein couldn’t have done. So Kaczynski’s idea was to destroy existing institutions, get rid of all technology, and let people start over and work on hard problems anew.
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Having abandoned the search for technological secrets, HP obsessed over gossip. As a result, by late 2012 HP was worth just $ 23 billion—not much more than it was worth in 1990, adjusting for inflation.
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competition and capitalism are opposites.
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The best place to look for secrets is where no one else is looking. Most people think only in terms of what they’ve been taught; schooling itself aims to impart conventional wisdom. So you might ask: are there any fields that matter but haven’t been standardized and institutionalized?
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Faust tells Wagner:
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The few who knew what might be learned, Foolish enough to put their whole heart on show, And reveal their feelings to the crowd below, Mankind has always crucified and burned.
9 Foundations
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“Thiel’s law”: a startup messed up at its foundation cannot be fixed.
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Bad decisions made early on—if you choose the wrong partners or hire the wrong people, for example—are very hard to correct after they are made.
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As a founder, your first job is to get the first things right, because you cannot build a great company on a flawed foundation.
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Now when I consider investing in a startup, I study the founding teams. Technical abilities and complementary skill sets matter, but how well the founders know each other and how well they work together matter just as much. Founders should share a prehistory before they start a company together—otherwise they’re just rolling dice.
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In the boardroom, less is more. The smaller the board, the easier it is for the directors to communicate, to reach consensus, and to exercise effective oversight.
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A board of three is ideal. Your board should never exceed five people, unless your company is publicly held.
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As a general rule, everyone you involve with your company should be involved full-time.
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That’s why hiring consultants doesn’t work. Part-time employees don’t work.
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If you’re deciding whether to bring someone on board, the decision is binary. Ken Kesey was right: you’re either on the bus or off the bus.