#13: On Competition and Monopolies; Feynman on Genius; Steve Jobs's insights from the mid-90s
Oct 5 - Nov 7, 2021
On Competition and Monopolies
Peter Thiel: Competition is for losers
One of Peter Thiel’s surprising claims in his uncomfortably insightful book, Zero To One, was that “Monopolies are good”.
Thiel does narrow his claim to monopolies of “the type of company that is so good at what it does that no other firm can offer a close substitute”; specifically, he excludes monopolies created via illegal tactics or regulatory capture.
This WSJ article($) is a good summary of Thiel’s view:
Under “perfect competition” with undifferentiated, fungible products, profits will drop towards zero, and in order to just survive, companies will trend towards lower wages, lesser R&D and innovation, and reduced product quality.
Since [a monopoly] doesn't have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world/environment.
In a static world, a monopolist is just a rent collector. But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices, and make the world better, by adding entirely new categories of abundance to the world.
The promise of monopoly profits provides a powerful incentive to innovate. Thus monopolies can keep innovating because their outsized profits enable them to make long-term plans and to finance ambitious research projects.
Thiel modifies Tolstoy’s famous lines: Business is the opposite [to families]. All happy companies are different: Each one earns a monopoly by solving a unique problem. All failed companies are the same: They failed to escape competition.
Separately, Thiel also offers that real monopolies can be easily identified because they are the only ones that vigorously deny any suggestion that they are a monopoly.
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Philo: The Cartel Theory of Everything
Philo describes some of the biggest monopolies (created by cartels), which have the surprising characteristic of being able to hide in plain sight.
If 10 widget makers sell a million widgets apiece at a profit margin of 10%, they’ll make $10 million in combined profit. If they collude as a cartel (or merge) and raise prices to $13, then even at 30% lower sales, they will triple their profits to $28 million. But 3 million people can no longer afford widgets now. And the rest are paying a $3 surcharge which is a transfer of wealth to the shareholders, which typically skew towards the rich, thus increasing inequality.
Competition may be for losers, but competition does play a role in maximizing economic output, spurring innovation, and creating a more equal distribution of wealth.
Economic theory would suggest that cartels are inherently unstable; there is a high temptation for individual members to cheat. A competitive equilibrium is more stable equilibrium.
David Brooks (NYT) and Marc Andreessen see cartels as the single biggest culprit behind the major challenges facing the American economy today. Brooks cites economist Jonathan Rockwell that the top one percent of earners in America are disproportionately composed of members of professions that have convinced legislators to allow them to collude to restrict supply and pass laws that shield existing members from competition. In other words, legalized cartels.
His chief example is the medical profession. In America, the number of medical school and residency slots is capped, and other medical professionals such as nurse practitioners are legally limited in what they can do. As a result, doctors and surgeons in the US get paid over double what doctors and surgeons get paid in Western Europe even relative to the average worker in their countries. He also points out that there are eight times as many software developers as there are dentists in America, but there are about as many dentists as there are software developers in the top one percent of earners, the result of restricted entry to the dental profession. Andreessen argues that this issue extends to higher education, that there is a college cartel that controls accreditation and thus controls access to critical federal student loan funds, so that no innovative alternative can ever break through.
Both Brooks and Andreessen identify housing as possibly the biggest cartel of them all; existing homeowners in a city frequently enact policies to restrict or prohibit the construction of new housing, resulting in artificially high rents and housing prices. If we compare San Francisco and Boston, two markets that restrict building, to Chicago and Atlanta, major cities which are economically healthy but also allow construction — housing prices in the former have tripled since the turn of the century, while housing prices have not even doubled in the latter, evidence of the impact of barriers to entry erected by cartels.
The secret to a successful cartel is to recruit the government to your side. The government can make anything legal. The government also will solve the other typical cartel problem, the temptation for members to cheat and undermine the whole enterprise. If violating a quota is actually illegal, enforcing compliance becomes much easier.
How do you convince the government that a cartel is actually in the public interest?
You can say that cartels are simply more stable; firms that are insulated from competition are unlikely to go out of business. eg: Banks, and airlines before deregulation.
You can argue that it is necessary for public safety. eg: Doctors, dentists, lawyers.
You can argue that the cartel is necessary to maintain the integrity of the product; homeowners argue that residents prefer to live in places with limited density (even though the highest rents are frequently found in the densest parts of the densest cities, like SF or NYC). Any plausible sounding argument is usually enough to at least distract people from the real issue.
One potential strategy is to quietly migrate from legitimate cooperation to rules that limit competition and increase member profits. Complex regulation benefits the incumbents.
The most successful cartels do not look like cartels at all - doctors, dentists, lawyers, homeowners in coastal cities. Most cartel members today are scarcely aware they are part of a cartel at all.
How do these unorganized cartels sustain?
One tactic is to allocate a portion of your monopoly profits to public relations and advertising to improve public opinion toward your cartel. eg: NCAA, NFL. A smart cartel will also lobby and buy off key special interest groups whose support they will need.
It is a good idea to also publicly support strategic exemptions to cartel pricing for those who cannot afford it. Such strategic discounts (eg: patient assistance in pharma, financial aid in colleges) enable monopolies to extract maximum revenue, while also reducing the risk of exclusion to undermine the monopoly.
To maintain the cartel, members typically have production quotas that restrict supply. Your quota has value as long as the cartel remains in place and demand exceeds the combined quota.
Cartels can die due to exogenous factors when supply increases (eg: airline deregulation, Uber vs taxi medallions) or demand falls (eg: Covid).
Often the biggest risk to a cartel is not opposition from its direct victims (suppliers and consumers), who are diffuse and frequently unaware of the existence of the cartel, but rather discontent from some of its own members. Even if the whole cartel prospers, members only care about their own individual outcome, and cartels frequently also redistribute income between members in such a way that manages to leave some members worse off than they were before. eg: 1970s airline deregulation passed due to United’s support, who felt they would capture increased market share from deregulation.
John Myers of London YIMBY proposed a new urban planning proposal in 2019 to break the housing cartel - “street by street zoning”.
Let each street (or block or other small area) decide on its own how it wants to zone commercial activity, including construction. This would allow so much room for experimentation.
Street-by-street zoning would allow neighborhoods to defect from the city-wide cartel and vote to mint medallions for themselves. Landowners in the most underdeveloped prime locations would almost certainly wish to do so.
Such a proposal would naturally split homeowners in the same way similar proposals split airlines and college football programs decades ago, and therefore some form of this proposal stands a better chance of political approval.
It is now fashionable to be concerned about the monopoly power of Big Tech; but Big Tech is very visible, and easy to track and regulate. The tech sector is actually quite small compared to housing and health care.
Cartels are effective precisely because they do not look like evil monopolies at all. Doctors and schoolteachers are the healers and educators of society, not the enemy.
Cartels only persist because voters and legislators support them and exempt them from some of the laws that govern most businesses. Cartel members make up a very small subset of voters; even in the case of housing, although the majority of American households are homeowners, only a tiny fraction are in markets that benefit from restricted supply. They rely on the support of other voters to maintain the status quo.
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My thoughts
Thiel and Philo are talking about orthogonally different types of monopolies, so I don’t see their views as contradictory.
Thiel cites Google and Apple as examples of monopolies formed due to being 10X better than the competition. Not only have they had a significant positive impact on the world with their technological innovations, they has also undertaken significant public benefit projects - such as becoming carbon neutral in their offices and data centers, or (for Google in particular) funding expensive experimental research that can advance the state of humanity, eg: self-driving cars, protein folding (AlphaFold), etc.
However, Thiel doesn’t describe the forces that keeps such creative monopolies benevolent. Especially in the past few years, Google and Apple have both lost some of their sheen. Some of this is attributable to the general backlash against Big Tech, but there’s more. Google has an uncomfortably large amount of user data, and we rely on the idealism of its engineers to continue to follow “Don’t be evil”. And Apple under Cook, while continuing to innovate on the iPhone and Airpods and M1 chips, has also clearly become a classical monopolistic rent-extractor via its App Store policies (well covered by other analysts like Ben Thompson and Ben Evans).
So creative monopolies can start well and follow Thiel’s formula for a while, but as the drive to innovate dies down (once they win), or the pressures/incentives to continue to increase profits becomes a higher priority, the temptation to take advantage of their monopolistic position keeps rising. In practice, they do this while also continuing to invest in innovation, and are thus able to continue believing that they are following their original mission, while also generating harmful externalities on the way.
Philo’s take on “cartels that hide in plain sight” is fascinating, and the problems created by housing/doctor/lawyer cartels are clearly backed by data. But given that these cartels are emergent stable states of complex adaptive systems, simple-sounding solutions won’t solve them either. As he points out, they can be weakened by taking advantage of the lack of internal cohesion between cartel members, with a divide and conquer strategy. Or alternatively, by creating regulation (or taking advantage of organic structural shifts) that can change the stable state to a more desirable situation. However, even if better laws are put in place, the stable state can take a long time to change in a complex adaptive system, so it will require incredibly patient, long-term thinking lawmakers, who really understand the system. Proposals like John Myers’ are much more promising since they can be enacted as small experiments, and can be marketed on American values of freedom and self-rule.
Feynman: How to be a Genius
Keep a dozen of your favorite problems constantly present in your mind, although by and large they will lay in a dormant state. Every time you hear or read a new trick or a new result, test it against each of your twelve problems to see whether it helps. Every once in a while there will be a hit, and people will say: "How did he do it? He must be a genius!"
Source: Ten Lessons I wish I had been Taught, by Gian-Carlo Rota
What Steve Jobs learnt after he was fired from Apple?
“Apps and platforms are where the real value lies.”
Remarkably forward-thinking given that this was in the mid-1990s, way before iOS or even the iPod.“Hardware has a 18 month replenishment cycle. But software seems to last longer, and it takes longer for customers to catch up.”
Software lock-ins don’t have an automatic expiry date; another key strategy employed extensively by iOS, and why Jobs wanted complete control of iOS from the beginning.“Without working on something for 2-3 years, without accountability for the results, you don’t learn everything” [15:00].
Perseverence + introspection + accountability triumphs genius.