The course of lectures "Startup". Peter Thiel. Stanford 2012. Lesson 2

This spring, Peter Thiel ( by Peter Thiel ), one of the founders of PayPal and the first investor FaceBook, held a course at Stanford - "Start-up". Before starting, Thiel said: “If I do my job correctly, this will be the last subject that you will have to study.”

One of the students of the lecture recorded and posted the transcript . In this habratopika, I am translating the second lesson.

Lesson 1: Challenging the Future
Lesson 2: Again, Like in 1999?
Session 3: Value Systems
Session 4: Advantage of the last move
Session 5: Mafia Mechanics
Session 6: The Law of Thiel
Session 7: Follow the money
Session 8: Presentation of an idea (pitch)
Session 9: Everything is ready, but will they come?
Session 10: After Web 2.0
Session 11: Secrets
Session 12: War and Peace
Session 13: You Are Not a Lottery Ticket
Session 14: Ecology as a Worldview
Session 15: Back to the Future
Session 16: Understanding Yourself
Session 17: Deep Thoughts
Session 18: Founder - Victim or God.
Occupation 19: Stagnation or Singularity?

Lesson 2: Again as in 1999?

I. The party has already passed

History is created by people, generation after generation. We are all born at a certain time in a certain cultural environment. This cultural setting can be likened to a conversation at dinner; many people say, someone is calm, someone is angry, someone is loud, someone is whispering. To the best of our abilities, we listen, trying to understand what this conversation is about. What makes people happy or upset? Sometimes it’s hard to understand.

Take someone born in the late 1960s. From a cultural point of view, time was turbulent. But the child, by the end of the 60s, despite the fact that he had lived through all this, essentially missed all disputes about civil rights, Vietnam, and could not have an accurate idea of ​​the United States of that time. For a child more or less excluded from the table, later it would be difficult to understand what those conversations were about.

There is a direct analogy between the cultural revitalization of the 60s and the rapid development of technology in the 90s. Today's students and graduates, like the child of 1969, may have been too young to internally experience what happened in 1999. Not to be an outcast in conversation at dinner, to be able to think and talk about businesses and startups today in 2012 - we must plunge back into the history of the 90s. I doubt that startups can be understood without knowing, say, Webvan or the mascots of Pets.com.

History is a strange thing, it often differs from what people who really survived think of it. Even the businessmen of the 90s might have trouble putting together the events of that decade. Looking back now, it’s hard to understand why it all happened this way, and not otherwise. It is indisputable only that it is the events of the 90s that form the current landscape, so it is necessary to extract the maximum from them.

II. A Brief History of the 90s

Most of the 1990s had nothing to do with the dot-com crisis. In fact, what could be called insanity began in September 1998, and lasted only 18 months. The rest of the decade was a somewhat more chaotic picture.

The nineties began in November 89 when the Berlin Wall collapsed. This was followed by 2 months of rather great euphoria. But the euphoria did not last long. By the beginning of 1990, the US economy was in recession. The first decline after the second world war. Although this was not a particularly deep recession, and technically it ended in March 91 - recovery was relatively slow. Production never fully recovered, and the transition to a service economy was long.

Thus, from 1992 until the end of 1994, there was still a feeling that the US was mired in recession. Culturally, Nirvana, grunge and heroin reflected a sense of hopelessness and a lack of faith in the future. Concerns about the NAFTA and America's competitiveness against China and Mexico have become almost ubiquitous. Strong pessimistic undercurrents led to the relative success of Ross Perot, the third-party presidential candidate. Over the past thirty years, George W. Bush has become the only one-term president. Everything seemed to fall out of hand.

Of course, technological progress continued in Silicon Valley, but this was not very noticeable. Unlike today, the Stanford campus in the late 1980s was quite divorced from the technologies developing in the valley. Japan seemed to win the semiconductor war. The Internet was just about to shoot. Technology has been the subject of special attention. The industry felt small.

The internet was supposed to change all that. Netscape, with its client-server model, is probably more than anyone else responsible for starting the Internet. This was not the first company that thought about 2-way interaction between all the computers in the network - this honor belongs to the company Xanadu, which developed its model back in 1963. The problem of Xanadu was that it required a simultaneous transition of the entire network to a new circuit, but they could not achieve this. In the future, this became some kind of obsession; despite the fact that it did not bring any money, it continued to attract venture financing for about 29 years, and finally died in 1992, when investors simply did not have the patience.

So, in 93, Netscape enters the scene, and away we go. In August 1995, Netscape came out with an IPO, just in the middle of the decade - this event attracted all the attention to the Internet. It was an unusual IPO, since Netscape was not profitable at that time. The initial estimate was $ 14 / share, then it was doubled. On the first day of trading, stock prices doubled again. Within 5 months, Netscape shares soared to $ 160 / share - an absolutely unprecedented growth for a non-profit company.

Netscape's story recalls Greek tragedy: the visionary founder, great vision, pride and epic fall. Regarding pride, there was, for example, the following case: they arrived on the Redmond campus and triumphantly pasted Netscape posters everywhere. They played with fire - Bill Gates immediately ordered Microsoft to drop everything they did and start work on the Internet. IE soon came out and Netscape began to quickly lose market share. Netscape’s latest graceful step was to contact the antitrust committee - probably the only reason the company, which never made a profit, was sold to AOL for more than a billion dollars.

The first 3 years after the Netscape IPO were relatively calm; by the end of 1998, the NASDAQ was about 1,400 - only 400 points higher than in August 95. Yahoo entered the public market at 96 and was valued at $ 350 million, after which it became public Amazon at 97 with an estimate of $ 460 million Skepticism was in the air. People continued to pay attention to profitability and believe that these companies cannot be very valuable and will never be successful.

Pessimism was probably sober, but directed in the wrong direction. Things were not going particularly well in the rest of the world. Alan Greenspan delivered his famous speech “Irrational Abundance” in 1996 - 3 years before the dot-com bubble, when the real craziness began. But even if it were not for this 96-year speech, the United States could hardly have changed anything then. In 1997, a series of East Asian financial crises swept through, in which a combination of huge debts and clan capitalism brought the economies of Thailand, Indonesia, South Korea, and Taiwan to their knees (the list is not complete - there are only a few). China managed to avoid a major blow with tough state control over capital. But in 1998, the ruble collapsed in Russia. The case was unique in that, usually, the banking system either collapses or the currency depreciates. Here we saw both. Money costs nothing, and banks do not have money. Zero multiplied by zero will be zero.

On the heels of the Russian crisis came the crisis of the hedge fund Long-Term Capital Management; LTCM, trading in huge borrowed funds, eventually exploded, and if it weren’t for multi-billion dollar loans from the Federal Bank of New York, it would be ready, it would seem, to take away the entire US economy with itself. In Europe, things were not going much better. The euro was put into circulation in January 1999, but the optimism surrounding it was rather the exception. Strong skepticism was the norm. Immediately after the launch, the Euro began to lose in value.

One explanation for the technical boom from March 1998 to September 2000 comes from the understanding that everything else was insanely wrong at the time. The technology bubble was indirect evidence of this; the economy did not work, because we could no longer compete with Mexico or China. The financial markets of developing countries have failed, wallowing in clannishness and inept leadership. Europe did not give much hope. And no one wanted to make risky investments after the LTCM crisis. Thus, by the end of the 90s there was only one area where you could invest money - technology.

Of course, proof from the contrary is a dangerous way to draw conclusions, but the world is not always logical. If A, B, C, and D are not true, the truth of E does not necessarily follow from this. The set may be somewhat wider. But it is probably worth noting that indirect evidence has a certain psychological strength. Indeed, technology worked, unlike everything else.

III. Crazy: September 1998 - March 2000

A. In general

Madness began in September 98. Probably the best way to convey how this craziness happened was to tell a few stories. Any high-tech entrepreneur of that time must have a lot of tales about all this. Most of them have a common feature - time was party and just saturated with communication. People were extremely generous. It felt like money was everywhere ... probably because it was. And there was no shortage of very suspicious people hanging around the valley.

Admittedly, all these stories quite superficially reflect what is happening. But because of this, we should not be skeptical of them - often the external manifestations of things are the essence of things. In short, all these tales, reflecting the fleeting spirit of the “bubble”, besides being just funny and unusual, are worth considering.

There are plenty of stories. For example, there were 40-year-old Stanford graduates who tried to found dozens of stupid companies at the same time. Now, usually, if you graduate at the age of more than 40, it means that you are kind of crazy, but the desire to open several companies at once is considered unreasonable. But at the end of 1998, many people considered this a winning move.

There were breakfasts at Bucks and Il Fornario dinners. There were billionaires from Idaho arriving and giving money to anyone who had any idea with a beautiful presentation. There were entrepreneurs who were penniless for their souls, having dinners of several thousand dollars and trying to pay off the shares of their company, and sometimes it even succeeded. Looking back, you can see a lot of absurdities. But all this was nothing worthless nonsense: much was done in a social context. Holding parties has become so important that someone even created a mailing list, with their schedule and ranking.

People began to discuss and do crazy things. There are such business models in which, the more you made or sold, the more money you lost. It was like a SNL parody: a client deposits $ 100 with one-cent coins and the bank loses money, because processing and maintenance cost more than the deposit itself. But before the bank understands all this and stops, the Dotkomites come and say without irony: “Everything is OK, all this will soon grow in value.” Irrationality became rationality, and simply adding ".com" to the name of your company doubled its cost per day.

Yahoo has grown to replace Netscape on Olympus as the most arrogant hi-tech company. In 97, it was the largest Internet company in Silicon Valley. Yahoo contributed to the fact that PayPal in 2000 thought well about who to sell the company to, because when selling "shares for shares", you need to be sure that the buyer is a reliable and stable company. Yahoo imagined itself to be an attractive buyer because it bought for its shares, which, in their words, "always only grow in value."

Huge fortunes were made in those 18 months. Many were lost. In 1997, Larry Augustin was thinking about whether to close the VA Linux project. Decided not to close. In 1999, VA Linux came out with an IPO for $ 30 / share. The price soared quickly to $ 300 / share, marking in history as the coolest rise in stock prices on the first day of trading. Augustine owned a 10% stake, which by the end of the day was worth about a billion dollars. People began to say that sometimes lightning strikes twice in the same place, because Augustine had earlier rejected the offer to become the third Yahoo employee, which would certainly make him a billionaire. But there was a sharp turn in the story with VA Linux: 6 months later, after a downturn, stocks lost 90% of their value. And those who did not sell their shares by another 6 months later lost another 90%.

All these stories with parties, money and a successful IPO gave rise to many dubious companies. These companies were founded by dubious selling entrepreneurs and were funded by dubious venture capitalists. Due to the fact that everyone around expressed pretty crazy ideas, it has become increasingly difficult to distinguish between normal companies and crooks. In order not to be deceived by clever traders, Max Levchin developed what he called the “aura test” - you listen to someone for 15 seconds and decide if he has a good aura. If yes - you continue to listen, if not - you just leave. It is not difficult to assume that companies that used something like the “aura test” were more likely to survive the dotcom crisis than everyone else.

B. PayPal Mania

Since PayPal appeared only in December 1998, when the high-tech boom was already in full swing, one of the problems that we had to deal with was the high probability of hiring scammers who multiplied at an incredible speed. The founders decided that they could not afford to hire such people, and simply hired their friends.

PayPal's original idea was to transfer money between Palm Pilot s. According to the polls, this was one of the 10 worst business ideas of 1999, and that says a lot. The initial business model was hardly better: it was supposed that PayPal should make money, then earn more money, and then we’ll decide what to do with all this money. Oddly enough, with such a model it was quite possible to attract investment: one typical investor, while serving Chinese food at Town & Country in Palo Alto, was completely indifferent to what PayPal was doing, he was only interested in one question: who else was investing? At the end of the conversation, when a “cookie with a surprise” was served (approx. Transl. Dry cookies of two halves, inside which a message is hidden: a strip of paper with a proverb, a funny saying or a prediction of fate. An indispensable attribute of Chinese restaurants in the United States; served at the very end of the meal, often along with the bill), he got fortunate on it, and the cookie told him to invest.

One of the first turning points was the attraction of 4.5 mil. dollars from Nokia. The problem, however, was that the mobile Internet was not working at that time. There is still life to live for good interfaces, and connecting a headset seemed to take forever. To Nokia’s surprise, PayPal introduced the prototype at the first post-investment board meeting. The new idea was simple: an account-based system where you could send money to anyone with an email address. It was a good idea, but everything seemed too simple. In addition, enormous competition was foreseen. So in 1999, the tension grew and grew, everyone understood, or we are moving forward quickly or failure.

PayPal's biggest problem was attracting new customers. Tried to advertise - too expensive. We tried to conclude BD-deals (Business Development) with large banks. Only the triumph of the bureaucracy followed. The turning point was when Luke Nosek made a meeting with the chairman and top managers of HSBC Bank in London. Several old-school bankers crammed into a large conference-paneled conference room. They had no idea what to do with these California startup guys who were repeating something about the Internet. They were so embarrassed and stunned that they could easily pass for extras, absolutely not knowing anything about payments and technologies. Luke, despite being on a diet, found Häagen-Dazs. And behind the ice cream, the PayPal team came up with an important decision: BD does not work. We needed organic viral growth. It was necessary to give people money.

So that’s what they did. Each new client received $ 10 at registration, as well as $ 10 received by the user for the recommendation. Exponential growth began, which cost PayPal $ 20 for each new customer. Everything looked as if it was working and not working at the same time: 7-10% growth daily and 100 million users is good. Lack of profit and exponential increase in costs - of course not. The instability of the situation was felt. PayPal had to shine on every corner in order to attract additional capital and continue what was started. (Ultimately, it worked, but that doesn’t mean that it was the best way to create a company. I think it didn’t.)

February 16, 2000 was a good day for PayPal. The Wall Street Journal published a laudatory article highlighting the company's exponential growth and valuing the company at $ 500 million. The following month, in the next round of financing, the main investor accepted the WSJ rating, considering it quite authoritative.

March was just crazy. One South Korean company that wanted to invest in PayPal called PayPal lawyers and asked where to transfer the money. After that, they immediately transferred $ 5 million without any agreements or signatures. The Koreans completely refused to tell PayPal how to get the money back. They had a very simple position: "No, no, you have to take them." On March 31, PayPal closed the next round of financing at $ 100 million. It happened at a very good time, it was a turning point - the dot-com crisis hit further. So, PayPal had everything necessary to create a real, working business.

The transition from 1999 to 2000 was very similar to what Prince predicted in his 1999 song ("Cause they say 2,000 zero zero party over, oops! Out of time! So tonight I'm gonna party like it's 1999!" - "They say: 2000 zero, zero - the end of the party, what a bummer! Time is up! And I'm going to break away, as for the last time, as if it was still 1999!"). He was right, although he was mistaken in the reasons. Probably it is not necessary to pay too much attention to this, but the song turned out to be prophetic. The oncoming wave of collapse dealt a blow: in the first half of 2000, e-commerce companies fell in the second B2B company. They were followed in 2001 by the telecommunications industry. If you had to choose a sector of the economy that was the lowest in March 2000, it would probably be the military industry. NASDAQ soared. No one believed that there would ever be another war. But everything turned upside down. The military industry grew almost all the next decade.

IV. Pride and gloating

After 2001 and 2002, a huge amount of pride of some turned into the gloating of others. People said: “We knew that!” Cultural and social depression came.

PayPal would survive this period, but it was clear that this was a completely new world. In 2001, the company broke even, was able to deal with several frauds and customer service problems. When PayPal registered for an IPO at the end of September 2001, it was the first after the events of September 11th. This time, 20 months after the first laudatory article of WSJ, the second came out. It started like this:

What would you do with a 3-year-old company that never made a profit, is about to lose a quarter of a billion dollars, and according to the results of its last inspection, the Securities Commission (SEC) warns that its services can be used for money laundering and financial fraud?

If you were PayPal-a managers or venture investors, you would try to sell it to the public. This is what they are going to do for $ 80 million, trying to check the limits of tolerance of investors and credulity of financial markets.

Then it’s not much better: “USA”, according to the publication, “needs it [PayPal] as well as an anthrax epidemic”.

V. Lessons learned

A. Mir

A key lesson for most people was that the technical boom of the late 90s was a bubble. A return to the real economy was a must. If the slogan of the 90s was “bricks to clicks” (from bricks to clicks), then the 2000s demanded a return from clicks to bricks. People have gone into real estate and emerging markets. Serious investors such as Warren Buffet have shunned high-tech companies in favor of the old economy markets. They began to evaluate business only by profit. Technology has faded into the background, globalization has come to the fore. In general, Dotcom taught us that the future is very uncertain, and all the prophets are false prophets. We should not take people’s word for it.

The only problem with all these lessons is that all of them are probably wrong. They are based on complex reactionary emotions. They come from pride, envy and resentment about the 90s in general. When emotions enter the scene, the analysis becomes unreliable.

The reality is that people were right about the bill a lot in the 90s. The indirect evidence that declared technology the queen has not lost its strength due to all these future events. There were problems with the Euro, with the war, clan capitalism and excessive regulation of the economy. Technologies have never been perfect, and since they did not have a vaccine against the bubble, they can be justified.
But be that as it may, March 2000 was not only the apogee of madness, in some important aspects - it was a moment of truth.

B. Silicon Valley

In Silicon Valley, it became clear that now everything needs to be done differently in order to survive in the world of gloating. First, you must believe and practice incrementalism. Seers are no longer held in high esteem.

Secondly, your startup should be "lean". In fact, this means that you do not need to know exactly what you end up with. You must constantly experiment, getting closer to understanding over and over again.

Thirdly, you should not have advertising at all. If the growth is not viral - this is a fake.

Fourth, it must be borne in mind that the new society is anti-social. People would like to go into some kind of antisocial modality. Google is a typical example; it is a product for people who are more willing to interact with computers than with people.

Fifth, the product needs to be promoted, bypassing "Business Development". In 1999, nimble "non-engineers" resorted to BD, in 2001 they created the "product". In the 90s, iconic CEOs were sellers. For example, Larry Ellison. In the 2000s, iconic CEOs were "product seers." For example, Steve Jobs.

Sixth, there is a certain distrust of quick monetization. Better longer growth phase and later IPO. If your company is growing relatively fast, you need to reinvest profits in order to achieve even greater growth.

And finally, you should not discuss the future. You are not that you would look a little crazy against the general background, you just should not do this.

On the whole, the post-crisis effect was one big strategic retreat one step back. What is right and what is not is a difficult question. But this is a question that must be answered. Of course, there were a lot of reasons for the rollback, but in many aspects, the return was nevertheless excessive. Some positions definitely make sense: for example, an early IPO, but others are clearly in doubt.
Really, really, completely refuse advertising, do not use BD, sales? Is there really no need to discuss the future? You must be open and understand that for most issues the retreats were excessive.

VI. Bubbles

As a legacy from the 90s, we got a big question: are we in a high tech bubble now?

Many say yes. Richter Scales video “Another Bubble Coming!”, Shot in October 2007, but perfectly illustrates how people think today.





Now back to the conversation over dinner. There are many good questions to discuss, but the bubble / not bubble issue is not one of them. Of course, you can collect various random data together, but the result will be superficial. Now much more than in 99, people are engaged in computer science, and erroneous judgments tend to accumulate over time.

Fragmented data are unlikely to prove that bubble theory is true. Moreover, there is a lot of data indicating the opposite. Bubbles arise when (1) some belief is widespread, (2) it is not true. In our society, no one else believes in anything, and without the widespread mistaken faith, it is impossible to create a bubble. The incredible hi-tech bubble story comes from people who need a bubble. This is more a residual response to 90s pain than the result of the analysis.

The theory of the absence of a bubble is probably more true. In other words, it is probably better to assume that everything works and buy houses and shares of hi-tech companies, instead of claiming that now is another hi-tech bubble. But we must resist it, too. The theories of bubble and anti-bubble are wrong because they are rooted in opinions and have social roots. If the majority does not want to think, then even if you are against the majority, there is no particular sense.

To understand the businesses and startups of 2012, you need to do the exact opposite - you need to think for yourself. The question of the value of something is much more important than the question of the bubble. The value question becomes more specific when we ask: what is the value of company X? Why? How can we understand this? These are the questions we should ask, and in the next lesson we will see how to approach them.

From the translator:
I ask for translation errors and spelling in PM. I also remind you that this text is a translation, its content is copyright, and the author's opinion may not coincide with mine.