First Principle of Business?

Oct 15, 2023 9:31 pm

First-principle thinking can make you a billionaire. At least, it helped Elon Musk become one.

First principle thinking is about breaking down a problem or an area into its most fundamental truth or breaking it down to the most basic part, where you cannot break it down further.

Example

Some principles of health can be summarized as follows: Eat healthy, exercise, sleep well, and don't use drugs. But these are not first principles. The first principle of eating healthy, for example, is: What is healthy, and how much?

It turns out that first principles can be quite tricky to arrive at.

In the case of health, it turns out we need not search for new knowledge; instead, we have to observe what works. It makes a lot of sense to eat what your great-grandparents ate. They ate pure, unprocessed food and may have lived long, healthy lives. They lived very active lives due to the lack of technology and other modern comforts. Do less when it comes to health and do what your grandparents did.

We are looking for knowledge that stands on its own. It does not need to be defined by something else. When we start reasoning from this point forward, it's easier to solve problems and build something new.

First Principles of Business

(Feel free to disagree and reply with your thoughts at any point.)

Here are a few statements that are true for good businesses (from Charlie Munger, Peter Drucker, Clayton Christensen, Warren Buffet, and many others):

A business creates value.
The value is a solution to a problem that people are willing to pay to get.
There should be enough people who are willing to pay (financial sustainability).
The people who pay are customers. And a business creates a customer with the value it offers.
The amount a customer pays should be higher than it costs to create the value (generating profits).
The operations that a business does to create value should become more efficient over time.
The value the business creates with the operations should be better than the competitors.
Customers should be constantly reminded that the value they get from the business is better than the competitors (Marketing).
The business should continuously improve its offerings to delight the customers (innovation).
The teams that work in the business should be excited to work, innovate, and improve (employee growth and retention).
The business should operate within the boundaries of the law and ethics.
The business should build and maintain good relations with all stakeholders.

We can arrive at a couple of first principles from these:

Continuously create value that solves customer problems for a large number of customers (they will be willing to pay for it).
Keep the cost of creating value lower than the price the customer pays.

That is it.

Those are the two fundamental principles of a business.

Everything else derives from these two principles.

Let's try to analyze this.

Marketing: When you are creating value for customers, you have to understand the following: Who is the customer? How to understand their problem? And how to communicate to them that you have a solution? The last part is marketing.

Ethical and legal: The cost of creating value goes up if you do something illegal and get sued, violating the second principle.

Finance: May be needed to create value and to differentiate from the competition.

Team: Again, the cost of operations goes up if the team is unhappy or inefficient (this includes operations).

There are only two fundamental principles to run a business. It is not easy to run one, but by focusing on customers, their problems, and internal efficiencies, you can create one without overthinking about everything else.