From 0 to 1 and from 1 to N - Transcripts from a Tea Session - Reflections on Investment

The tea session will focus on two questions that have emerged from reading "Zero to One": how to define the boundaries of a company and how to define the space in which a company operates.

Robert：

"Zero to One" discusses the desire for monopolistic companies as both investors and entrepreneurs, emphasizing the significance of the first third of the book. Particularly, a key statement on page 33 states, "But the history of progress is a history of better monopoly businesses replacing incumbents." Monopolistic companies obtain their dominant status by providing 10x innovations that previous market players couldn't offer.

Classic examples include the largest tech companies today, such as Google, Intel, and Microsoft. Once a company achieves a monopoly status, it can continue to innovate without the need for intense competition, which requires substantial capital expenditure. These companies can allocate funds to more meaningful projects, such as Google's X division or Microsoft's Office product suite. While intense competition offers consumers value through inexpensive products, a monopoly landscape provides consumers with richer products and sustaining innovations.

Cong：

Does the first Big Picture discussed in the book "Zero to One" provide any practical help for our investment and thinking?

Robert：

The best approach in investment is to identify companies with monopoly capabilities.

Cong：

The insights derived from the book's Big Picture I lead to a broader reflection. It is not just about seeking companies with monopoly capabilities. The book highlights an important point that there is a significant difference between monopoly and non-monopoly companies. However, in reality, competitive companies are more common, while monopolistic or near-monopolistic companies are rare. Moreover, the former often deliberately emphasize their uniqueness, differentiation, and advantages, attempting to masquerade as "monopolistic" companies, while the latter try to downplay this aspect.

Robert：

I noticed that, but I didn't consider it a focal point. Isn't it relatively easy to identify whether a company has a strong competitive advantage or a monopoly by looking at its market share?

Tracy：

It's actually not that easy to identify, as there can be traps when calculating market share. Monopoly companies often portray their market scope as broad. For example, Google wouldn't position itself solely as an internet search company; instead, they would claim to be an advertising or technology company, making their market share appear less dominant. On the other hand, companies facing intense competition tend to define their market scope too narrowly. For instance, a restaurant may claim to be the only one on a particular street offering a specific cuisine.

Cong：

Monopoly companies indeed have a tendency to conceal their monopoly status. In addition to defining themselves within broader market categories, they may also hide their profitability. For example, they may include certain expenses that can be capitalized or adjusted and deduct them as costs in the current period, making their profits appear less significant.

Tracy：

Defining the market scope of a company is indeed crucial, but it is not a simple task. Apart from deliberate concealment by the company itself, there are cognitive biases that can lead to misdefinitions. These cognitive errors can arise from a lack of understanding of the company's competitive advantage or from a narrow focus on a single dimension without considering cross-domain competition from other dimensions.

Take Apple as an example. At the end of 2018 and the beginning of 2019, there was a prevalent belief in the market that Apple would be the next Motorola, leading to the perception that despite its relatively low price-to-earnings ratio (around 10x) and a market value of only around $600 billion, it would be less valuable in the future. Looking at its smartphone business, the market evaluated Apple's iPhone based on the overall smartphone market, considering its market share to be less than 15% and expecting diminishing differentiation among competitors. Consequently, it was believed that maintaining market share, pricing power, and profitability would be challenging for Apple.

However, a deeper analysis of Apple would reveal that the market in which the iPhone operates is the mid-to-high-end segment of the smartphone market, where it holds a very stable and dominant position with over 50% market share. Additionally, Apple has established strong user stickiness through other products, software, and content services, boasting a user base of over 1 billion with low churn rates. This ability sets Apple apart from other smartphone manufacturers.

Another example is Yahoo, a web portal. If one were to define its market solely as a web portal and failed to consider the rise of Google, which disrupted the way online information was accessed, they would still perceive Yahoo's competitive advantage as strong and stable, making the mistake of defining the market too narrowly.

In summary, defining the market scope of a company requires a comprehensive understanding of its competitive advantage and the ability to consider multiple dimensions of competition. It is essential to avoid cognitive biases and conduct in-depth research to gain a more accurate assessment of the company's market position.

Cong：

Yes, there are indeed many misconceptions. The monopoly status of Google was not as certain as it appears in hindsight. It faced many doubts and challenges at that time, such as the fear of being disrupted by Facebook. Now, Facebook itself is facing the question of whether it will be disrupted by companies like TikTok, and how to define its boundaries.

Robert：

Big Picture II emphasizes the importance of distinguishing between vision and goals, and understanding the significance of timing and positioning. The book repeatedly emphasizes the importance of first conquering a niche market. If you want to conquer or liberate the entire continent of Europe, you must first set your sights on the five beaches of Normandy. The example of Amazon mentioned by Thiel perfectly illustrates this concept: Bezos' vision was to dominate all online retail, but he deliberately started with selling books. He provided a disruptive product: Amazon offered competitive prices, a selection of books ten times larger than physical bookstores, and eliminated the overhead costs of physical inventory.

Cong：

I agree with your thoughts on Amazon and the potential misconception investors may have had regarding its valuation. Many people at the time, including those at Harvard and conversations with investors, believed that Amazon was overpriced because they defined it solely as an online bookstore. However, Bezos had a much bigger vision in mind – to create "the Everything Store." Successful disruptive innovators often find a strategic entry point to establish core advantages and capabilities, and then replicate those advantages in broader markets. When considering the potential of these disruptive innovators from an investment perspective, if we only see their initial entry point and niche market as the extent of their capabilities, we greatly underestimate their potential and may perceive their valuation as too high, thus missing out on great investment opportunities.

Robert：

However, in reality, Bezos may not want to draw too much attention too early and may not reveal his grand ambitions, making it difficult for others to know about his "Dream Big." In such cases, how can one determine if the current market is just a niche and if there are broader extension markets in the future? Additionally, at what stage is it appropriate to imagine the company's extension markets?

Cong：

It is necessary to study the company's core capabilities/competitive advantages and the extensibility of those advantages to different application areas. If possible, discussions with the company can provide insights, and observing the company's actual actions and results is important. Taking Amazon as an example, when they were primarily selling books, it was important to study whether they had a strong competitive advantage and had established a dominant position in the niche market. Then, it was necessary to imagine whether this advantage could be replicated in other areas. For example, Amazon disrupted the traditional retail model by offering the cheapest prices, the widest selection, and the convenience of purchasing anytime and anywhere. After establishing user stickiness and network effects, it was important to research whether this capability could be applied to selling other products like toys and assess the corresponding market space. Similarly, Tesla started in a high-end niche market, but without studying its competitive advantages, understanding the technological extensibility, cost reduction curve, and software capabilities, one would not realize that it had the potential to cover a broader mass market. Underestimating the company's potential could lead to undervaluing its market space. In reality, truly great companies often appear undervalued. Therefore, studying the underlying factors of these truly great companies and imagining the extensibility of these factors is meaningful.

Robert：

I want to know where the boundaries of this imagination lie. For example, if Netflix currently sells movies and TV shows, should we also imagine that they might sell games or even other things? And when is the right time to imagine these things? If we follow this logic, wouldn't there be too many things to imagine?

Cong：

What I want to say is a mindset and research approach, not specific to any particular company. If we only look at the surface without understanding the underlying core capabilities, some companies may appear to have scalability in their business while others may have their boundaries in their existing niche markets. Therefore, imagining scalability is based on a thorough understanding of the underlying capabilities. It may seem like two similar logics, such as LeEco and Apple both building ecosystems. LeEco talks about it but hasn't achieved it, while Apple hasn't talked about it but has actually achieved it. Clearly, LeEco's boundaries are much smaller than what they claim. The imagination of business scalability that we should do is based on the foundation of underlying competitive advantages, and it is essentially a replication from 1 to N.

Tracy：

When it comes to Apple, for example, when should we imagine the iPhone? Should we imagine it even before the iPod or iTouch was released? Similarly, for Amazon, when they were primarily selling various products online, should we have imagined them entering the cloud computing industry?

Cong：

When a company establishes a competitive advantage in a niche market, the ability to expand from 1 to 10 requires some wild guesses, and discussing the runway is crucial. Our methodology focuses on three core questions: the first is competitive advantage, the second is runway, and assessing long-term runway is one of them.

Tracy：

I completely agree. After understanding the competitive advantage, it's important to imagine the long-term runway. It's not about making accurate predictions through imagination, nor is it about immediately incorporating imagined scenarios into the company's valuation. However, the act of imagining is crucial as it fosters an open mindset to consider possibilities. Otherwise, there's a risk of focusing only on short-term, deterministic judgments due to the uncertainty of the future. Without considering qualitative changes and being fixated on quantitative changes, it's impossible to anticipate potential breakthroughs. For investors, this can lead to short-term-based investments, and for companies, it may result in short-sighted planning. This aspect is also addressed in "Zero to One." Regarding Apple's example, it was difficult to imagine the iPhone before the success of the iPod and the release of the iTouch. However, it was realistic to imagine the disruption of the portable music player industry and even the provision of music services. It would have been remarkable to imagine the iPhone when the iTouch was released, but by the time the iPhone emerged and became the leading smartphone, its competitive advantage was already evident, making it possible to envision the restructuring of the mobile phone industry based on thorough research.

Cong：

Indeed. Amazon's case, transitioning from selling goods to cloud computing, doesn't fit into the framework of the "imagination" we're discussing. It involves a significant leap and doesn't fall within our scope of research and imagination.

Robert:

Why didn't we apply the imagination we had for Amazon to other dot-com companies back then, such as pets.com?

Cong：

It still needs to be based on a clear understanding of competitive advantage. Moreover, predicting the future is inherently challenging, and while imagining, one also needs to adapt and adjust their imagination to changes. For example, it was difficult to imagine ByteDance becoming what it is today from day one. Similarly, when VCs invested in Today's Headlines, it would have been challenging to imagine the success of TikTok. However, if one recognized that Today's Headlines possessed disruptive technology for information distribution, applied specifically to news and information, it becomes easier to understand TikTok's success when it emerged with good data. This is because it leveraged the same capabilities in distributing short video content, which represents a larger market than news and information. Imagination is not a one-step process.

Robert：

I want to clarify the extent of imagination. For example, taking SpaceX as an example, what level should we imagine and how much should it be reflected in pricing? For instance, I can imagine mining resources from asteroids, where in the future, with technological advancements and cost reductions, it may become more cost-effective than mining on Earth. This might be the limit of my imagination, as thinking about Mars colonization seems too far-fetched.

Tracy：

I think for us, when it comes to something like Mars colonization, it's too distant for us to dismiss its potential, and we will continue to keep an eye on it. However, in terms of research and pricing, we would focus on studying the competitive advantage that can be established based on technology, as well as the direction and potential of technological advancements. For example, how much can costs be reduced? How advanced can interstellar transportation become? We would assess the market space and profitability behind each milestone, and pricing would be based on this research. If there are developments that go beyond the initial path, adjustments would be made to these assessments. But we wouldn't outright dismiss the possibilities from the beginning. As I mentioned earlier, the act of "imagination" is crucial.