Monday, March 19, 2018

Theranos: Knives Out, Razors In


The knives are out for Elizabeth Holmes.  If my social media feeds are any indication, the young entrepreneur, who recently settled charges of massive fraud by the SEC, should already be in jail.  It’s a kind of crowd-sourced Schadenfreude directed at the one-time, youngest-in-the-world, self-made female billionaire whose company is today one secured-loan away from bankruptcy.

In the world of virtual knives, it’s a Twitter melee.  And in the world of razors, the SEC action suggests Holmes and her company are best described by Occam’s advice: The simplest explanation is usually the best.  In other words, Theranos was nothing less than one giant scam.

But there’s another razor, Hanlon’s, that shaves in a different direction, advising never to ascribe to maliciousness what can be explained by ineptitude.  In other words, assume stupidity before assuming evil.  This explanation doesn’t excuse fraud, and Holmes (despite not admitting wrongdoing in her SEC settlement) probably won’t ever squirm off that hook.  But there’s a reading of the Theranos saga that might be more satisfying if we couple charges of massive fraud with an equally massive dose of incompetence.  And not just by Holmes, but by the entire entrepreneurial ecosystem that’s designed to support and protect young entrepreneurs whom we encourage to be bold, take chances, and put a dent in the universe.

In Outliers, Malcolm Gladwell describes a typical plane crash as the result not of a single, catastrophic event, but of seven factors, most of them small and benign in themselves: slightly poor weather, the plane being a bit behind schedule, a pilot being tired, two pilots never having flown together, and the like.  The conventional commercial jetliner, Gladwell writes, “is about as dependable as a toaster.  Plane crashes are much more likely to be the result of an accumulation of minor difficulties and seemingly trivial malfunctions.”[1]

So let’s tell the tale of Theranos with Hanlon and Gladwell in mind.


What Could Possibly Go Wrong?

A 19-year-old college drop-out with no start-up experience, no management experience, and only a rudimentary science background founds a company providing life-and-death diagnostic services for consumers.  In the interest of competitive secrecy, she naively crafts the company’s development process so that it bypasses FDA and peer-review checkpoints, and she constructs a business model that excludes doctors from the decision to test patients and interpret their test results—thereby pitting herself against much of the medical establishment.  The fledgling CEO hires as her COO—presumably with her board’s consent—a computer scientist without a work history in blood diagnostics, a science or medical background, or a strong record of operating and scaling businesses.[2] 
The novice CEO relies on a board of directors (Shultz, Mattis, Kissinger, Frist, Boies) capable of running a government or pleading a case before the Supreme Court, but largely incapable of, or perhaps disinterested in, assessing complex medical technology.  The company’s funding comes from venture capitalists with little biotech experience, who continue to pump-up insider valuations to unicorn levels.  This fragile organization is egged on by a technology press less interested in hard-edged reporting than in uncovering dramatic stories of innovation and—as Holmes was anointed by Marc Andreesen—"the next Steve Jobs.”

What could possibly go wrong?

The evidence to support Hanlon’s Razor is abundant.  When undergraduate Holmes originally pitched her idea, she was told by Stanford professor of medicine Phyllis Gardner that it was impossible to get a precise result for many medical tests from a finger prick because the blood was full of debris, and because a drop or two just wasn’t enough.[3]  This caution might have inspired another student to undertake further research before launching a company to solve a problem based as much on human physiology as technology.  Instead, Holmes appeared to embrace Silicon Valley entrepreneur Reid Hoffman’s famous, if sometimes tragic, claim that “the entrepreneurial journey starts with jumping off a cliff and assembling an airplane on the way down.”[4] 

The revolutionary nature of Holmes’s idea is also in question.  “The ability to measure numerous things on a tiny amount of blood is not rare,” says Dr. Norman Paradis, a professor at Dartmouth’s Geisel School of Medicine.  “MIT alone has three or four groups that can do that.”[5]  And many blood tests are already cheap to perform.  “Why on earth would you start a business,” Paradis asks, “in a super-low-margin commodity space dominated by two main players who have a built-in brick-and-mortar distribution system out there?”[6]  In other words, Holmes picked a fight which may have excited the technology press for its daring, but might not have survived a standard business-school market and competitive analysis. 

Quest Diagnostics employed 45,000 people, operated eight regional labs and 150 satellite labs, and ran 2,200 patient service centers.  The company was profitable and more than capable of defending its turf.  Writer Ken Auletta noted after a visit to Quest’s lab in New Jersey that their traditional business was more advanced than the picture painted by Theranos’s managers.  Quest was running six-hundred million tests annually—six hundred times Theranos’ goal for 2015—across thirty labs with four thousand vehicles, using automation and mass spectrometry.  In the last ten years, Quest said, the amount of blood needed for testing a patient had decreased from two full vials to one-fifth of a vial.[7]

Holmes was a management neophyte, having never apprenticed in a successful technology company or trained under a top-notch mentor.  Her choice for COO, Sonny Balwani, had sold his company, CommerceBid, to Commerce One in 2002; at the time, CommerceBid had thirty employees and “three customers testing its product, which is geared toward the business auction needs of Fortune 500 companies.”[8]  This history implies that Balwani’s start-up experience extended to a relatively small team of technologists, and never involved the building of a bricks-and-mortar enterprise, nor the release of a consumer product, much less a medical device. 
Meanwhile, Holmes admitted to personally interviewing all eight hundred employees[9] that Theranos had at its peak—a kind of micromanagement that may have robbed her focus from other, CEO-level issues.  In fact, Holmes seemed to have micromanaged many decisions, “from the number of American flags framed in the company’s hallway . . . to the compensation of each new hire.”[10]  In discouraging employees to speak with one another about their work, she copied Steve Jobs’s “silo management.” But the practice left Holmes and Balwani the only people with broad enough perspective to make strategic decisions—difficult for any managers, much less fledgling managers.
Naiveté and ineptitude haunt the entire Theranos narrative.  Some processes at the company were never robust enough to deliver a safe, working product.  One engineer who worked on Theranos devices from January 2013 to November 2014 says, “The time was not taken to develop anything properly.”[11]  In 2016, Holmes admitted to CNN that, “At the highest level, we didn’t have the right leadership in the laboratory and we didn’t have the implementation of the quality system in terms of procedures and the associated documentation.”[12]  Likewise, Holmes managed to raise money from a variety of investors apparently without any of them determining if, or at least how well, the company’s technology actually worked.[13] 

Walgreens admitted that their 2013 investment in Wellness Centers came as a result of competitive pressure—not wanting to lose Theranos—but without adequate explanation of the science nor inspection of the lab in Newark, California.[14]  Court depositions also showed that two Theranos directors, former U.S. Navy Adm. Gary Roughead and former U.S. Secretary of State George Shultz, did not follow up on public allegations that Theranos was using standard blood-testing equipment instead of its Edison machines.  Neither questioned Holmes about it.  “It didn’t occur to me,” Shultz said.  “Since I didn’t know, I didn’t have anything to look into.”[15] 

That’s an explanation that might not pass muster with a second-grade teacher.

Nothing Here to See, Move Along

In the period between the October 2015 Wall Street Journal article and the implosion of the company, talented people who presumably had an inside look at the business continued to defend Theranos.  In December 2015, the company’s senior technical advisor, Robertson Channing, denied that Theranos’s tests might be inaccurate.  Precision and accuracy are “our holy grail,” Channing said.  “We would have to be certifiable, you know, to go out and put out a product that people’s lives are going to depend on.  That’s not who we are.”[16]  And yet, an early 2015 test for a hormone related to testosterone levels failed a quality-control check 87 percent of the time, one for the hormone Prolactin failed 47 percent of the time, and one to help detect prostate cancer failed 22 percent of the time.[17]  “Based on the data,” says Stephen Master, a pathology professor at Weill Cornell Medical College, “it’s hard for me to believe they went with this [Edison] instrument and tested patient specimens on it.”[18]

And there has been no truer friend to the company than venture capital investor Tim Draper, himself a Silicon Valley institution, who made the initial one-million-dollar investment in Theranos. He argued that Theranos was facing the usual resistance which all true disruptors must battle.  In June 2016, with the company unravelling, Draper noted, “nothing’s gone wrong with Theranos.”  The company “is being attacked by the powers that be in big phrama,” the way Uber and Bitcoin are being attacked in their industries.  Draper believed that consumers “love” Theranos and implied that Wall Street Journal reporter John Carreyrou should be fired for his coverage of the company.[19] In January 2017, amidst company layoffs, lawsuits, and an agreement with CMS forbidding Holmes to be in the lab business for two years, Draper doubled down and found that Theranos’s troubles were the result of a vast conspiracy: “Elizabeth is the victim of a witch hunt," and reporter John Carreyrou has “some strange vendetta” against her.   “It's the press creating a series of events that negatively impact technology, progress and our economy,” Draper explained. “Those [federal] regulators were compelled to go in there and find something because of the Journal,” he argued.[20] 

In other words, Theranos fits squarely into the modern entrepreneurial ecosystem, a disruptive economic force like Uber and Bitcoin, fated to battle regulatory meddling, hostile incumbents, and a skeptical established press.  This is what Silicon Valley and its unicorns are designed to do—and bloody noses are just part of the game.  In October 2016, venture capitalist Steve Jurvetson, Draper’s co-partner, said that he had not visited the company or discussed its management.  Elizabeth Holmes had “been off doing her own thing . . . [and] ran into all kinds of troubles,” he noted.  “At the end of the day there is not much we can do when they fail.”[21]

If Elizabeth Holmes and her investors were seeking a model of failure that might encourage them through hard times, they needed to look no further than entrepreneur sensation Elon Musk.  He founded SpaceX in 2002 to revolutionize space technology and enable multiplanetary human existence—the biggest and boldest of ideas.  Since then, the company has successfully launched a privately funded reusable launch system program, landed a rocket after orbital spaceflight, and begun a program to colonize Mars.  But before this success, the company’s first three launches failed spectacularly.  It was only the fourth, a last gasp coming as the company’s cash ran out, that finally succeeded.  If the fourth launch had failed, Musk says, “That would have been it for Space X.”[22]  Musk was willing to push through failure to the end of his money, believing he could be successful.  And his story had a certain uncomfortable parallel with Theranos, reflected in Musk’s admission, “We started off with just a few people who really didn’t know how to make rockets.”[23]

When You're Pitching, The Right Answer Is "Absolutely"

Did Holmes lie?  Of course.  Most entrepreneurs let their promises get ahead of reality.  Kevin Ryan, founder or chairman of DoubleClick, Gilt, and MongoDB, is credited with raising $750 million in venture capital.  His advice to aspiring entrepreneurs on how to raise funds for their start-ups emphasizes playing into what he calls the natural biases of technology investors.  One of these biases is “toward founders who exude confidence in every interaction.”[24]  Ryan relates a story about one fundraising meeting he attended where the venture capitalist asked the CEO how she felt about meeting their next year’s budget.
The CEO gave the answer I’d like to hear in a board meeting, but not the answer I’d want to hear in a pitch . . . She said, ‘Look, it’s not easy.  It’s hard.  A couple of things have to come together, but I think if they do, we’ll be in a position to make the budget.’ That’s a very honest answer.  But it’s not the answer to give in this situation. 
When you’re pitching, he says, the right answer is: “Absolutely.  In fact, I actually think we’re going to do a little bit better, but I don’t like to over-promise. There are a couple things that are not in there that we think we can hit.  We are absolutely going to make those numbers.[25]
Steve Jobs’s historic demonstration in 2007 of an iPhone that did not yet work points to Ryan’s advice that you “fake the confidence that you can and will deliver.”  This “fake it till you make it” ruse is an imperative, a way of surviving in a game where product performance can lag promises, but promises must be made to secure funding.  Fundraising is a world where “a very honest answer” is “not the answer to give in this situation.”  The month after the Wall Street Journal’s October 2015 takedown of Theranos, entrepreneur Micah Rosenbloom endorsed Theranos’s “misleading story” because “start-ups by definition should evangelize a future vision.”   Rosenbloom concluded that nobody had been hurt, except the media, adding that he’d rather have the Theranos and the Ubers of the world seeking breakthroughs, “even if we stub our toes, or prick our fingers, in the process.”[26]
The advantage of this “fake it till you make it” attitude, Ryan tells entrepreneurs, is that if you practice it long enough, “You basically start to believe your own bullshit . . . and that’s a good thing.”[27]  Or, as it turned out at Theranos, maybe not. 

Elizabeth Holmes followed the rules in an entrepreneurial ecosystem that rewards boldness and confidence, and even encourages lies.  But when she pushed the envelope, the ecosystem let her down.  The first scent of fraud should have been the last scent of fraud.  Just one engaged and insistent friend or mentor could have made all the difference.



[1] Malcolm Gladwell, Outliers: The Story of Success, New York: Little, Brown and Company, 2008, 184.
[2] John Carreyrou, “At Theranos, Many Strategies and Snags,” Wall Street Journal, December 27, 2015, Web December 5, 2017, https://www.wsj.com/articles/at-theranos-many-strategies-and-snags-1451259629.
[3] Nick Bilton, “Exclusive: How Elizabeth Holmes’s House of Cards Came Tumbling Down,” Vanity Fair, October 2016, Web November 28, 2017, https://www.vanityfair.com/news/2016/09/elizabeth-holmes-theranos-exclusive.
[4] Gabriella Cacciotti and James C. Hayton, “Fear of Failure and Entrepreneurship: A Review and Direction for Future Research,” Enterprise Research Centre, ERC Research Paper No. 24, August 2014, Web December 4, 2017, https://www.enterpriseresearch.ac.uk/wp-content/uploads/2014/09/Formated-Fear-of-Failure-res-p-Cacciotti-Hayton.pdf, 5.
[5] Lev Grossman, “The Fall of Theranos and the Future of Science in Silicon Valley,” Time Inc., May 5, 2016, Web December 6, 2017, http://time.com/4319110/the-fall-of-theranos-and-the-future-of-science-in-silicon-valley/.
[6] Lev Grossman, “The Fall of Theranos and the Future of Science in Silicon Valley,” Time Inc., May 5, 2016, Web December 6, 2017, http://time.com/4319110/the-fall-of-theranos-and-the-future-of-science-in-silicon-valley/.
[7] Ken Auletta, “Blood, Simpler,” The New Yorker, December 15, 2014, Web November 22, 2017, https://www.newyorker.com/magazine/2014/12/15/blood-simpler.
[8] Kim Girard, “Commerce One to buy CommerceBid,” CNET, Janurary 2, 2002, Web December 13, 2017, https://www.cnet.com/news/commerce-one-to-buy-commercebid/.
[9] Ron Leuty, “Why is Elizabeth Holmes Still Leading Theranos?”, San Francisco Business Times, November 18, 2016, Web December 5, 2017, https://www.bizjournals.com/sanfrancisco/news/2016/11/18/theranos-elizabeth-holmes-james-mattis-trump.html.
[10] Nick Bilton, “Exclusive: How Elizabeth Holmes’s House of Cards Came Tumbling Down,” Vanity Fair, October 2016, Web November 28, 2017, https://www.vanityfair.com/news/2016/09/elizabeth-holmes-theranos-exclusive.
[11] John Carreyrou, “At Theranos, Many Strategies and Snags,” Wall Street Journal, December 27, 2015, Web December 5, 2017, https://www.wsj.com/articles/at-theranos-many-strategies-and-snags-1451259629.
[12] Ron Leuty, “Why is Elizabeth Holmes Still Leading Theranos?”, San Francisco Business Times, November 18, 2016, Web December 5, 2017, https://www.bizjournals.com/sanfrancisco/news/2016/11/18/theranos-elizabeth-holmes-james-mattis-trump.html.
[13] Nick Bilton, “Exclusive: How Elizabeth Holmes’s House of Cards Came Tumbling Down,” Vanity Fair, October 2016, Web November 28, 2017, https://www.vanityfair.com/news/2016/09/elizabeth-holmes-theranos-exclusive.
[14] Meghana Keshavan and Neil Versel, “Theranos Doomsday Clock: A Full Timeline of Its Rise and Fall (Updated), MedCity News, February 5, 2016 (updated December 2016), Web November 28, 2017, https://medcitynews.com/2016/02/theranos-doomsday-clock-full-timeline-rise-fall/.
[15] Christopher Weaver, “Court Documents Shed Light on Theranos Board’s Response to Crisis,” Wall Street Journal, May 30, 2017, Web December 6, 2017, https://www.wsj.com/articles/court-documents-shed-light-on-theranos-boards-response-to-crisis-1496136600.
[16] Sheelah Kolhatkar and Caroline Chan, “Can Elizabeth Holmes Save Her Unicorn?,” Bloomberg, December 10, 2015, Web November 27, 2017, https://www.bloomberg.com/news/articles/2015-12-10/can-theranos-ceo-elizabeth-holmes-fend-off-her-critics-.
[17] Beth Mole, “Theranos Blood Tests Wildly Wrong and May Be Shut Down By Feds,” Ars Technica, April 1, 2016, Web November 29, 2017, https://arstechnica.com/science/2016/04/theranos-blood-tests-often-wildly-wrong-and-may-be-shut-down-by-feds/.
[18] Beth Mole, “Theranos Blood Tests Wildly Wrong and May Be Shut Down By Feds,” Ars Technica, April 1, 2016, Web November 29, 2017, https://arstechnica.com/science/2016/04/theranos-blood-tests-often-wildly-wrong-and-may-be-shut-down-by-feds/.
[19] Beth Mole, “’Nothing’s Gone Wrong with Theranos . . . Consumers Love It,’ Says Investor,” Ars Technica, June 24, 2016, Web December 6, 2017, https://arstechnica.com/science/2016/06/nothings-gone-wrong-with-theranos-consumers-love-it-says-investor/.
[20] Beth Mole, “Theranos’ Downfall Due to Elaborate $4M Conspiracy, Investor Says,” Ars Technica, January 19, 2017, Web December 6, 2017, https://arstechnica.com/science/2017/01/theranos-downfall-due-to-elaborate-4m-conspiracy-investor-says/.
[21] Christopher Weaver, John Carreyrou, Michael Siconolfi, “Big Names Take Hit on Theranos,” Wall Street Journal, November 28, 2016, Web November 29, 2017, https://www.wsj.com/articles/big-names-take-hit-on-theranos-1480379536.
[22] Catherine Clifford, “9 Years Ago SpaceX Nearly Failed Itself Out of Existence: ‘It is a Pretty Emotional Day,’ Says Elon Musk,” CNBC.com, September 29, 2017, Web December 4, 2017, https://www.cnbc.com/2017/09/29/elon-musk-9-years-ago-spacex-nearly-failed-itself-out-of-existence.html.
[23] Catherine Clifford, “9 Years Ago SpaceX Nearly Failed Itself Out of Existence: ‘It is a Pretty Emotional Day,’ Says Elon Musk,” CNBC.com, September 29, 2017, Web December 4, 2017, https://www.cnbc.com/2017/09/29/elon-musk-9-years-ago-spacex-nearly-failed-itself-out-of-existence.html.
[24] “Step-by-Step Fundraising Tactics from the NYC Legend Who Raised $750M,” First Round Review, Web December 16, 2017, http://firstround.com/review/step-by-step-fundraising-tactics-from-the-nyc-legend-who-raised-750m/.
[25] “Step-by-Step Fundraising Tactics from the NYC Legend Who Raised $750M,” First Round Review, Web December 16, 2017, http://firstround.com/review/step-by-step-fundraising-tactics-from-the-nyc-legend-who-raised-750m/.
[26] Micah Rosenbloom, “In Defense of Theranos,” TechCrunch, November 21, 2015, Web December 6, 2017, https://techcrunch.com/2015/11/21/in-defense-of-theranos/.
[27] “Step-by-Step Fundraising Tactics from the NYC Legend Who Raised $750M,” First Round Review, Web December 16, 2017, http://firstround.com/review/step-by-step-fundraising-tactics-from-the-nyc-legend-who-raised-750m/.