Early last week, reports surfaced that the Center for Medicare and Medicaid Services (CMS) had threatened to sanction Theranos Inc., an early-stage diagnostics company, by banning founder and CEO Elizabeth Holmes from participating in any laboratory business for at least two years. Later in the week, the matter took a turn for the worse when it was revealed that the company was under a federal, criminal investigation.
Allegations started just six months ago when a Wall Street Journal article raised questions regarding the validity of Theranos’ proprietary technology. If sanctioned, the collapse of this entrepreneurial superstar of Silicon Valley would be all but certain. After all, even if the worst could be avoided, the company would still have to recover from damages of lost credibility. Which begs the question: What drove the $9 billion poster child of disruption into such a rapid descent?
Some of early post-mortems have suggested that Theranos failed to bring a “low-end” disruptive innovation to the market. This type of innovation provides a low-cost product or service with “good enough” performance to the market, targeting customers who do not need expensive, high-end products. Instead, the diagnostics company insisted that its technology was superior to conventional blood tests, since it required only a small drop of blood from the finger tips. Critics argued that with such a bold claim, Theranos’ downfall began when the technology couldn’t live up to these high expectations. Others wondered if Holmes could have avoided this crisis with better advisers and more experience. We doubt it.
Hardly unique, the reason for Theranos’ fall from the top can be found elsewhere. In Greek mythology, the god Dionysus grants King Midas’ wish to turn everything he touches into gold. But, as we all know, this “gift” came at a price, since his touch ultimately turned his beautiful daughter into a lifeless gold statue. Similarly, once Silicon Valley’s golden touch drove hundreds of millions of dollars into Theranos, the company’s life was snuffed out of it altogether.
The theory of disruptive innovation requires three key ingredients for both low-end and new-market disruptions. First, is the enabling technology. An enabling technology allows a product (or a service) to perform certain functions in a simpler way. The simplicity might initially limit the breadth of functionality, but for those functions that the technology can perform, there is little to no performance drop-off from established solutions.
The second element is an innovative business model. A business model is a way in which the enabling technology can turn into a sustainable business. Without an innovative business model, an enabling technology cannot be disruptive.
Finally, a disruptive innovation needs a value network that can not only support the long-term adoption of the disruptive product but also create opportunities for new disruptions to occur within the network.
In the April 2015 issue of the Journal of Clinical Chemistry, I argued that Theranos could be a potential disruptor, as long as the technology could be validated. Indeed, Theranos was on the path towards disrupting the diagnostics industry, but its roadblock was in the technology. It turned out that Theranos’ diagnostic device, Edison, which claimed to perform numerous diagnostics from just a drop of blood, was not yet capable of supporting a sustainable business model. Edison had not been good enough to be a low-end alternative to conventional diagnostics. Without an enabling technology, there is neither disruption nor transformation.
Although questions have been raised about whether the company inflated its claims regarding Edison’s performance, their decision to go with the CLIA-lab model, which allows unproven diagnostics products to be analyzed under a controlled lab environment, tells us that they were aware of the technology hurdle. The CLIA-lab model was Theranos’ very public admission that Edison had a ways to go before it could prove that its basic functionalities are comparable to existing FDA-approved diagnostics.
Theranos needed to demonstrate that its technology worked on a single test before more tests could be added to the menu. Just as retail clinics significantly expanded their service menus once their model was proven to work, Edison could also add more tests once it was validated. Although the media had raised concerns that Edison was still performing just a single test even as late as the last month, this was consistent with a new technology in the validation phase. But, investors had very high expectations for the growth of the company. So, a technology that had yet to be proven—even for something as simple as a cholesterol test—had to be thrown into primetime action.
On top of that, Theranos signed up with Walgreens’ retail clinics to provide a long list of diagnostics at a significantly lower price than conventional labs would charge. Walgreens was hoping for revenue growth from Theranos’ technology, and Theranos needed Walgreens to pump up its valuation even more, but the diagnostics company was still too early to deliver such impact. Some may argue that Holmes and Theranos’ leadership should have resisted the Walgreens partnership, but it is understandably difficult to resist a billion dollar embrace. The fact that Walgreens is still not severing its relationship with Theranos despite serious allegations might suggest that the story is more complicated than it appears.
A low-end disruption is not achieved by inferior performance. Instead it offers a limited menu of functionalities without compromising performance quality. For example, when Japanese auto manufactures came to America, their cars met all the minimum regulatory requirements of the industry. They were just inexpensive cars without the frills of the American cars. Naturally, consumers who wanted functioning, inexpensive cars rapidly gravitated to these new products. Over time, however, these simple cars would prove to be “superior” to many of their more expensive American counterparts. In the same way, Theranos had all the ingredients to shift the paradigm of diagnostics industry.
Instead, the short-term expectations of traditional investors and industry partners seem to have driven Theranos into an untenable position. Pushing for growth too early and too fast, before the disruptive model could become sustainable, has led to the massive thud of a nine billion dollar mammoth. Although the company seemed to have correctly positioned itself to be the latest disruptive force, the hype, the influence, and the incessant pressure from the financial and healthcare industries might have been too strong to overcome.
If Theranos’ technology is real, it will eventually come back. There is no question that the hyped technology could transform the 75 billion dollar global diagnostics market. But, next time, let’s be very cautious of the Midas Touch. Exploding valuations and hundreds of millions in investments before a company is ready can turn a perfectly fine unicorn into a crumbling golden pillar.