Are you innovative enough?

OPINION

I’ve been reading Peter Thiel’s excellent and short book Zero to One. It’s resonating with a lot of people at the moment, and justifiably so. It reminds me a lot of Peter Drucker’s  Innovation and Entrepreneurship, published originally in 1984 and with very similar messages.

My own take is that the art of business is easy but the way we talk about it keeps changing, at least superficially. I do recommend reading both of these books.

Thiel differentiates between companies making incremental changes, such as those who create new products in a category or new markets for a product, and companies creating entire new markets. Drucker did as well, saying that entrepreneurs search and take advantage of changes, and “create something new, something different; they change or transmute values."

All this this is aligned with design thinking, which, as we did at Better by Design, preaches that the goal is to capture a global niche – something Thiel also pushes. While Thiel puts end-user centred design in the incremental change bucket, and we can argue either way about that, we can all agree that nobody knows they need a product in a category that does not yet exist. The Walkman used to be the classic example of this – a product created by the strong will of Sony Co-Chairman Masaru Ibuka, while more recently Steve Jobs was famous for doing similarly at Apple.

While Thiel is not enamoured with incremental companies, that’s not to say there are not great returns possible for founders and investors in those companies. Trade Me shareholders were, no doubt, happy with their status as “the eBay (and other sites) of New Zealand,” even as they outperformed eBay on all the vital per capita metrics.

But the outsized gains for founders and investors, the billions and tens of billions, are reserved for really disruptive companies like Amazon, Microsoft, Thiel’s Paypal, Elon Musk’s Tesla, and Apple. Here in New Zealand we have Xero [NZX: XRO] and Vend, each of which attracted investment from Thiel’s vehicle here – Valar. All of these companies changed or are changing the way business is done, and once they establish a foothold the relentless adoption curve takes over.

All of these companies delivered or will deliver outsized returns to investors, and they all required leaps of faith by founders and investors both. Succeeding isn’t certain, as the acquirers of Paypal (eBay) eventually found but PayPal still delivered years of outsized growth despite not delivering on the true promise of PayPal. And sometimes investment can be in a product that just isn’t going to take – it’s fair to say the jury is firmly out on Valar’s investment in Booktrack but nobody can accuse Booktrack of being unambitious.

Thiel tells the dirty little secret that we all know – the ultimate business aim should be to create a sustainable global monopoly but never to call it that for fear of being regulated. Monopolies can extract economic rent (high margins and profits) while they dominate, and that’s where the huge valuations come from. Don’t expect, for example, Xero’s average revenue per customer to stay as low as it is forever, and be wary of Xero moving horizontally into related products once they do dominate.

Thiel suggests that we can pick the great companies as the ones that can  answer the series of questions below:

1. The Engineering Question: Can you create breakthrough technology instead of incremental improvements?
2. The Timing Question: Is now the right time to start your particular business?
3. The Monopoly Question: Are you starting with a big share of a small market?
4. The People Question: Do you have the right team? (real technologists wear T-Shirts not suits)
5. The Distribution Question: Do you have a way to not just create but deliver your product?
6. The Durability Question: Will your market position be defensible 10 and 20 years into the future?
7. The Secret Question: Have you identified a unique opportunity that others don’t see?

Let’s put these into my preferred way of looking at companies, which I use for Better by Capital, Punakaiki Fund and consulting work:

End User: Timing, Durability, Secret. Is the target end user well defined and is the product delivering something distinctive and delightful that changes their life? Is the product in a long-term defensible position, and is there a (generally obvious) future development path?  I’m not so sure that Thiel has covered this fully in his questions but I would hope it is taken as a given – the product or service has to be great for its chosen niche.

Customer: Monopoly, Distribution: How do you get money for the product or service? How do you expand sales rapidly and sustainably?  How do you capture a global niche market?

Company: Engineering, People: Do you have the founders, staff and governance to deliver? Do you have the internal knowledge and IP, and a track record of shipping?

Investor: Do you have all of the above, and does the investment get you to the next stage of sustainability? Do the numbers work?

For me there seems to be good overlap, and I generally do cover the points raised in the questions in my own work. But the exact form of the model we use to look at businesses does not really matter – just whether it works for you and the business. I’ll certainly be adding Thiel's questions to my arsenal but not to replace my own model. I do commend them for people starting on new businesses or developing products.

Lance Wiggs is an independent consultant providing management, strategy, growth and valuation consulting to industrial, media and internet based businesses. Lance holds shares in Apple, Vend and Xero. He blogs at Lancewiggs.com