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Strategic Small Monopolies [Startups
Posted on February 23, 2015 @ 06:54:00 AM by Paul Meagher

In his 2014 book Zero to One (which I reviewed last week), Paypal co-founder Peter Thiel argues that a startup business needs to aim first at becoming a small monopoly.

By small, I mean that the type of customer a startup business seeks to serve is identified as belonging to some unique class that no-one else is specifically serving, or there is very little competition for. In the case of PayPal, it became servicing the payment needs of Ebay users, specifically, the top sellers in the Ebay market. At the time, no financial services company was specifically catering to their needs. PayPal targeted a small monopoly consisting of Ebay PowerSellers that it would base its early growth upon.

For many companies, serving a small monopoly may be its ultimate goal. It is a good place to start a company and it could be a good niche to continue to operate your company in if you have a good subscription model figured out.

For some startups, such a PayPal, they select the small monopoly very strategically so that they can grow as fast as possible from that base. By targeting Ebay PowerSellers, PayPal found a way to increase usage of its services by an influential nucleus of users that could help it grow. The PayPal service depended on network effects, the more people using it the more people would want to use it. PayPal knew that for it to become ubiquitous they had to enlist users as fast as they could to their service. The starting point would be Ebay users and after that they would even resort to paying users $10 for enrolling to their service (this was a good inducement). They felt that over the lifetime of the user they could recoup the offer cost. This, incidentally, is an example of a crazy business model (pay your customers to join) prevalent during the dot.com days that worked out.

For PayPal to grow as it did it needed to be strategic in which market it tackled first, which market it would try to become dominant in first. Had it failed in the attempt to dominate the Ebay financial marketspace, it would probably not be here today. Ebay could have come out with it's own payment gateway for its users, but PayPal may have had too much of a lead by then or the service was so in demand that any wait for Ebay to deliver a service would have been too much delay. There is no guarantee that you will achieve your small monopoly once you set out to attain it. You may also come to realize that your small monopoly might not be so distinct as you think it is as you discover significant competition for the same customer. Perhaps your delination of the ideal customer is too broad, and narrowing it further in some way might help to better identify a small monopoly that might work better to begin with. Thiel sometimes uses a Venn diagram, and other times, unions and intersection symbols, to illustrate how to segment your customer. As an example, here is how the universe of big data customers might be delineated. This would still be too big (maybe a further breakdown by preferred software) but it illustrates how Venn diagrams can be used to identify a set of customer segments and the one you might want to initially target.

Perceived competition can be a signal telling you that you have not delineated the scope of your monopoly properly. When properly delineated, you should feel like you don't have any significant competition for your type of customer and that the customer actually exists in sufficient quantities to be worthwhile and would be interested in your product or service. When all these things come together you have the basis for starting a company. Thiel comes out strongly against the idea of "competing" as the basis of starting up a company. He does not think a company should consciously try to disrupt a large marketplace because this strategy is likely to fail. Better to start by cooperating and find your niche than competing against established businesses in a bigger market.

When starting your small monopoly it is can be very rewarding if your market is also a growing market (the Ebay marketplace) so that ongoing growth is assured. Paypal was able to say that they had 30% of the PowerSeller market enrolled after 3 months. They knew who they were targetting and could measure how much of the target market they were enlisting. They could also measure the growth rate of their market to verify that it was a potentially durable market.

In chapters 3 to 6, Peter Thiel has alot of interesting things to say about monopolies as good for business and competition as bad for business. The idea that startups can be viewed as strategic small monopolies comes from these chapters. I have also written about the importance of finding your niche but used a different set of arguments to arrive at similiar conclusions regarding the importance of avoiding competition.

I want to leave the last word with Peter on why starting small and monopolizing is important (p. 53):

Every startup is small at the start. Every monopoly dominates a large share of its 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.

On an unrelated note, Christina Martin has a new record out. You probably don't know who she is but I got to see her 4 months ago (at a Music Week festival) so was interested in hearing some of her new stuff. The record is called "It'll Be Alright" and this is a song by the same name. They are touring Europe for the next few months.

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