Recently, the idea of “first principle thinking” came up quite a few times in my readings of various articles. If you have a doctoral degree or if you are a scientist, you may already be familiar with it. Unfortunately, I am neither and hopelessly ignorant. At first, I didn’t pay much attention – the idea seemed self-explanatory. But it turned out that I actually knew nothing about it. The more I heard about it, the more curious I became about it. And the more I know about it, the more I am fascinated by it. Now I think the idea of “first principle thinking” should be added to everyone’s mental model list. This article is an attempt to explain why.
First of all, what the heck is “first thinking principle?” Well, according to Wikipedia:
“A first principle is a basic, foundational, self-evident proposition or assumption that cannot be deduced from any other proposition or assumption. In philosophy, first principles are taught by Aristotelians and a nuanced version of first principles are referred to as postulates by Kantians.In mathematics, first principles are referred to as axioms or postulates. In physics and other sciences, theoretical work is said to be from first principles, or ab initio, if it starts directly at the level of established science and does not make assumptions such as empirical model and parameter fitting.”
The idea of “first principle thinking” was believed to be first introduced by Aristotle more than 2,000 years ago. Aristotle's viewed first principles as "the first basis from which a thing is known" and “seeking first principles is the key to doing any sort of systemic inquiry.”
As you can imagine, “first principle thinking” is widely applicable in science and philosophy. As a value investor, I’m naturally inclined to seek the application of the idea in investing. So I did a little bit more research on the topic.
Not surprisingly, the most effective “first principle business thinker” is Elon Musk. It is well-known that Musk dropped out of Stanford’s Ph.D. program in physics, but perhaps less well-known is the fact that studying physics trained him well in “first principle thinking,” which laid the foundation for his later success with SpaceX.
In an interview with Kevin Rose, Musk said the following: "I think it's important to reason from first principles rather than by analogy. The normal way we conduct our lives is we reason by analogy. We are doing this because it's like something else that was done, or it is like what other people are doing. But with first principles, you boil things down to the most fundamental truths and then reason up from there."
Musk then explained how he applied “first principle thinking” in tackling the batter cost of Tesla’s electric cars:
“Someone could, and people do, say battery packs are really expensive and that's just the way they will always be because that's the way they have been in the past. They would say it's going to cost $600 per kilowatt-hour. It's not going to be much better than that in the future. But what are the material constituents of the batteries? What is the spot market value of the material constituents? It has carbon, nickel, aluminum, and some polymers for separation, and a steel can. Break that down on a materials basis, if we bought that on a London Metal Exchange, what would each of these things cost? Oh jeez, it's $80 per kilowatt-hour. Clearly, you need to think of clever ways to take those materials and combine them into the shape of a battery cell, and you can have batteries that are much cheaper than anyone realizes.”
In this wonderful article, the author gave another example of how Elon Musk applied “first principle thinking” with SpaceX.
“When Musk was estimating the cost of building the first SpaceX rockets, he could have simply used comparable products on the market as a benchmark. Making decisions using common knowledge is the antithesis of first principles thinking. Instead, his team analyzed the necessary parts of a rocket, then researched the prices of the raw materials of parts firsthand. As a result, the SpaceX team was surprised to learn that they could build a rocket that cost around two percent of the typical price.”
Or take the radical idea of the Hyperloop. If I were to build a transportation system between high traffic city pairs like Los Angeles and San Francisco, I’d probably choose high speed railway and I’d start with the status quo and study the high-speed railway system in Japan, China and Germany and see how I can apply the best technology. Most people will likely take a similar approach. But not Elon Musk. He wrote a 57-page paper on Hyperloop, which is extremely interesting. You should read it.
Again, he gets to the most fundamental truths - a transportation system between high traffic city pairs like Los Angeles and San Francisco is still a system that gets people from Los Angeles to San Francisco. Nobody has said that it has to use cars, railroads, boats or airplanes – the four status quo transportation systems. Musk then listed the features of the ideal system: Safer, faster, lower cost, more convenient, immune to weather, sustainably self-powering, resistant to earthquakes, not disruptive to those along the route. And the result: hyperloop. It’s so radically different from the current system that some people find it insane, just like when most people heard about Tesla (TSLA, Financial) and SpaceX the first time.
We can argue that Steve Jobs, Jeff Bezos, Warren Buffett (Trades, Portfolio), Sergey Brin and Larry Page also applied “first principle thinking” with Apple (AAPL, Financial), Amazon (AMZN, Financial), Berkshire Hathaway (BRK.B, Financial) and Google (GOOGL, Financial). The recent health care tie-up between Amazon (AMZN, Financial), Berkshire (BRK.B, Financial) and JPMorgan (JPM, Financial) will most likely result in something spectacular for America’s health care system and I assume Warren Buffett (Trades, Portfolio), Jeff Bezos and Jamie Dimon will also apply the “first principle thinking.”
As I wrote in the beginning of the article, the more I learn about the idea of “first principle thinking,” the more I am fascinated by it. In the future, I expect to write more on this subject. Meanwhile, it would be great if readers can share some useful insight or resources on the subject in the comment section.