What Peter Thiel taught Stanford University students about startup success

The following are edited excerpts taken from Blake Master’s notes of CS183, the class that Peter Thiel taught at Stanford in 2012, on how to identify and grow your startup’s audience. The full notes are available here.

For a company to own its market, it must have some combination of brand, scale cost advantages, network effects, or proprietary technology. Of these elements, brand is probably the hardest to pin down. One way to think about brand is as a classic code word for monopoly.

But getting more specific than that is hard. Whatever a brand is, it means that people do not see products as interchangeable and are thus willing to pay more. Take Pepsi and Coke, for example. Most people have a fairly strong preference for one or the other. Both companies generate huge cash flows because consumers, it turns out, aren’t very indifferent at all. They buy into one of the two brands.

Brand is a tricky concept for investors to understand and identify in advance. But what’s understood is that if you manage to build a brand, you build a monopoly.

Scale-cost advantages, network effects, and proprietary technology are more easily understood. Scale advantages come into play where there are high fixed costs and low marginal costs. Amazon has serious scale advantages in the online world. Wal-Mart enjoys them in the retail world. They get more efficient as they get bigger. There are all kinds of different network effects, but the gist of them is that the nature of a product locks people into a particular business.

Similarly, there are many different versions of proprietary technology, but the key theme is that it exists where, for some reason or other, no one else can use the technology you develop. Apple – probably the greatest tech monopoly today – has all these things. It has complex combination of proprietary technology. By building both the hardware and the software, it basically owns the entire value chain.

With legions of people working at Foxconn, it has serious scale-cost advantages. Countless developers building on Apple platform and millions of repeat customers interacting with the Apple ecosystem provide the network effects that lock people in. And Apple’s brand is not only some combination of all of these, but also something extra that’s hard to define. If another company made an otherwise identical product, it would have to be priced less than the Apple version. Even beyond Apple’s other advantages, the brand allows for greater monetization.

There are three steps to creating a truly valuable tech company. First, you want to find, create, or discover a new market. Second, you monopolize that market. Then you figure out how to expand that monopoly over time.

Choosing the right market

The Goldilocks principle is key in choosing the initial market; that market should not be too small or too large. It should be just right. Too small a market means no customers, which is a problem. This was the problem with PayPal’s original idea of beaming money on palm pilots. No one else was doing it, which was good. But no one really needed it done, which was bad.

Markets that are too big are bad for all the reasons discussed above; it’s hard to get a handle on them and they are usually too competitive to make money. Finding the right market is not a rhetorical exercise. We are no longer talking about tweaking words to trick ourselves or persuade investors. Creating your market has nothing to do with framing stories about intersections or unions. What is essential is to figure out the objective truth of the market.

Monopoly and scaling

If there is no compelling narrative of what the market is and how it can scale, you haven’t yet found or created the right market. A plan to scale is crucial. A classic example is the Edison Gower-Bell Telephone Company. Alexander Graham Bell developed the telephone, and with it, a new market. Initially, that market was very small; only a few people were involved in it. It was very easy to be the only one doing things in such a small, early market. They expanded. They kept expanding. The market became durable.

Network effects began to operate. It quickly became very hard for others to break in. The best kind of business is thus one where you can tell a compelling story about the future. The stories will all be different, but they take the same form: find a small target market, become the best in the world at serving it, take over immediately adjacent markets, widen the aperture of what you’re doing, and capture more and more.

Once the operation is quite large, some combination of network effects, technology, scale advantages, or even brand should make it very hard for others to follow. That is the recipe for building valuable businesses. Probably every single tech company ever has fit some version of this pattern. Of course, putting together a completely accurate narrative of your company’s future requires nothing less than figuring out the entire future of the world, which isn’t likely to happen.

Some examples