Column: Silicon Valley’s D-word: These breakdowns show that ‘disruption’ is sometimes just hype

Sometimes “disruption” isn’t all it’s cracked up to be.

The D-word is much beloved by Silicon Valley venture investors and gurus. It signifies the arrival of new technologies that expose long-accepted business practices as nothing but cobwebbed old habits, while pointing the way toward nirvana for consumers, workers and, yes, shareholders. The promise of a disruptive business model can be worth billions of dollars in putative investment valuation.

But the term also can mask a vacuum at the heart of the business model, a substitution of hype for content. That may be what underlies the developing fall of Theranos, the Silicon Valley purveyor of an ostensibly “disruptive” blood testing technology that has turned out to be inefficient and inaccurate.

Theranos boasted a private-market valuation of $9 billion last October when it came under the scrutiny of the Wall Street Journal, which reported that the firm had struggled to show that its technology works and suggested that it may have been misleading the public, and possibly government regulators, about the effectiveness and accuracy of its blood tests. On Wednesday, the Journal reported that Theranos has voided or issued corrections of tens of thousands of blood-test results it produced over the last two years, including many from its ostensibly revolutionary technology and some that became the basis of treatment decisions by doctors and patients. Theranos hasn’t commented.

Theranos is not alone as a Silicon Valley high-flier brought low by realities on the ground. This year, Zenefits, an electronic health insurance broker for businesses, has allegedly run afoul of state insurance regulators nationwide by allowing employees to sell insurance without being licensed, while the building managers of its San Francisco office have complained about discarded alcohol containers and used condoms.

In an extended defense via Twitter, Zenefits CEO David Sacks says the company’s licensing problems are “are historical issues, not current ones” and that “today we are operating in compliance.” In a post on the corporate blog dated May 9, he wrote that since he replaced co-founder Parker Conrad on Feb. 8, he has moved to remake Zenefits as “the Compliance Company,” though “this transformation is still underway and there is still some work to do.”

LendingClub, a publicly traded Uber-like loan broker that brings small borrowers and investors together online, has suffered management turmoil and, like other online lending services, come under scrutiny from federal regulators; over the last year its market value has fallen from more than $7 billion to about $1.4 billion.

Then there’s Uber itself, the ride-hailing service that still reigns among Silicon Valley “unicorns” (companies valued at more than $1 billion) with a private market valuation north of $60 billion. Uber’s business model depends on flouting price and safety regulations developed for the taxi industry, lowering prices and increasing convenience for customers, often at the expense of drivers. But it’s facing intensifying pushback: Voters in Austin, Texas, recently upheld that city’s mandate on background checks for Uber drivers, and drivers themselves have moved toward unionizing to combat alleged exploitation of their status as independent contractors.

Many such companies share features treasured by Silicon Valley investors: dynamic founders spinning a future-is-now vision; the targeting of mature, complacent industries; and business plans promising steady revenues with low fixed costs, equaling high margins.

But real life doesn’t always allow easy transitions to “disruptive” new models. Zenefits crowed that its software app would revolutionize benefits management and human resources record-keeping for small businesses that couldn’t afford HR departments of their own. But it turned out that most insurance contracts are still done on paper, with email the most advanced technology that small businesses and insurance brokers can handle.

LendingClub’s business model, which matches investor/lenders and borrowers online and employs automated algorithms to judge borrower credit, may have looked superficially like an innovative breakthrough. But when the Treasury Department looked under the surface, it found that the fancy new systems added risk even while traditional risks still applied.

According to a Treasury report this month, these include the “potential for disparate impact and fair lending violations, predatory lending and targeting of vulnerable borrower segments, and the use of data contrary to consumer expectations (e.g., using social media in underwriting).” The online marketplace, moreover, has developed entirely during an economic expansion and loose credit and remains “untested through a credit downturn.”

Companies promoting disruptive technological models can still attract hundreds of millions of dollars in venture investments and multibillion-dollar private valuations for two reasons. One is that expectations for a new technology naturally are at their highest before they’re actually tested in practice. Bill Gurley, one of Silicon Valley’s more skeptical investors, observed at an investment conference last September that although only four e-commerce start-ups had actually succeeded in justifying billion-dollar-plus valuations, “the number of companies that are attempting to be successful in e-commerce is maybe two orders of magnitude above that number ... and the number of e-commerce unicorns is probably 20 instead of four.”

The other is that, in recent years, Silicon Valley has been fixated on growth -- start-ups can be forgiven years of financial losses as long as their customer base appears to be expanding. “Investors have been favoring growth over profitability at a level that I think has reached somewhat absurd proportions,” Gurley said. That leads to lack of discipline. “You avoid putting constraints on your organization and you make less-good decisions.”

Until its exposure last year, Theranos had created a closed universe that heightened investor expectations and kept skeptics at bay. It revealed very few details about the technology it asserted would allow panels of blood tests to be conducted on tiny volumes of blood drawn from a fingertip. This innovation, according to Elizabeth Holmes, its charismatic young founder, would make blood testing almost painless and dirt-cheap.

Theranos recruited a board of eminent directors, including former Secretary of State George Shultz, former Sen. Bill Frist and Henry Kissinger. Walgreens and Safeway agreed to open Theranos testing clinics in their stores, which added to the impression that blood-testing was about to become an everyday, self-empowering consumer product.

Skeptical voices were drowned out by the secretive company’s allure, fawning news coverage, and Holmes’ spellbinding speech at a TEDMED talk about how “when people have access to information about their own bodies, they can change outcomes.” Few noticed that, unlike other biomedical companies, Theranos’ board lacked directors with real experience in the field. (Frist, a heart surgeon, hadn’t practiced in decades.)

Nor did investors pay much attention to medical experts questioning the core premise of Theranos -- that more blood testing was good for you.

“The notion of patients and healthy people being repeatedly tested in supermarkets and pharmacies, or eventually in cafeterias or at home, sounds revolutionary,” observes John P.A. Ioannidis of Stanford Medical School in the Journal of the American Medical Assn. But “even if the tests [are] accurate, when they are performed in massive scale and multiple times, the possibility of causing substantial harm from widespread testing is very real, as errors accumulate with multiple testing.” Excessive testing, especially when unprescribed by doctors, can lead to “overdiagnosis, false-positive findings,” and costly and “overly zealous” treatment, Ioannidis had warned in an earlier article.

Laboratory expert Eleftherios P. Diamandis of the University of Toronto observed, meanwhile, that the company’s pitch was based on exaggerated claims for its own technology. “History teaches us,” he warned presciently, “that there are numerous examples of seemingly disruptive technologies in healthcare ... developed by high-profile scientists, including Nobel laureates, which later collapsed due to their inability to deliver the promised goods.”

Where Theranos really deserved credit for “spectacular success,” he concluded, wasn’t for its technology, but for “fund-raising, for attracting high-profile individuals on their Board ... and with widespread exposure to the public media.”

But as Theranos appears to be teaching us, those successes can be skin-deep, and “disruption” can cut both ways.

Keep up to date with Michael Hiltzik. Follow @hiltzikm on Twitter, see his Facebook page, or email michael.hiltzik@latimes.com.

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UPDATES:

3:55 p.m., May 20: This post has been updated with remarks by Zenefits CEO David Sacks.