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February 25, 2016

Move Fast and Break Things…With Integrity

Can Silicon Valley really disrupt highly regulated markets?

Silicon Valley has a problem with authority.

In many ways this is a fundamental strength. It enables entrepreneurs to think outside the box and tackle problems in completely new ways, unrestricted by convention. It’s the perspective necessary to disrupt long calcified industries and have the courage to take on multibillion dollar corporate behemoths.

It can also be a liability, particularly as Silicon Valley shifts its attention to disrupting highly regulated markets like insurance, healthcare, and financial services. That is a lesson that’s Zenefits and its investors learned the hard way.

Earlier this month, the founder and CEO of Zenefits, a startup disrupting the health insurance industry, resigned abruptly in the wake of allegations of widespread regulatory compliance violations. Since then, it’s been revealed that the company created a secret tool to help brokers cheat on the licensing process in California, California has opened an official investigation into company, and Washington state is looking into allegations that Zenefits was operating without a license in the state.

Zenefits COO David Sacks, who has taken the helm of this compromised ship, largely admitted the problems with his open letter to employees, “Our culture and tone have been inappropriate for a highly regulated company.” He also moved to change the company’s motto to one more likely to please regulators: “Operate with integrity.”

The Zenefits debacle combined with recent allegations about Theranos have some questioning whether Silicon Valley is even capable of tackling highly-regulated markets. Obviously, that’s a bit of an over reaction.

First of all, the tech industry has long bristled under the eye of regulators and political power. When Microsoft was on top of the world, Bill Gates also questioned who had more power:

A close friend of Gates’ recalls a dinner with him and his then-fiancée (now wife) Melinda French back in 1993. “We were talking about Clinton, who’d just been elected, and Bill was saying blah, blah, blah about whatever the issue was,” this friend remembers. “Then Bill stopped and said, ‘Of course, I have as much power as the president has.’ And Melinda’s eyes got wide, and she kicked him under the table, so then he tried to play it off as a joke.

Second, these highly regulated markets NEED Silicon Valley style disruption. Massive industrial ecosystems are filled with middlemen with no real value, choked by red tape, and are built to generally resist innovation. These are the kind of markets where information technology and creative thinking can restructure the entire ecosystem with lower costs and creating better services and outcomes for consumers.

The challenge with more highly-regulated markets is that startups can’t simply “move fast and break EVERYTHING.” Unlike tricky consumer policy issues like privacy, the regulatory systems and schema that have evolved around markets like insurance are usually very clear and well-tested. The rules are the rules, and there are whole industries established to enforce them. While many of them are outdated, over-burdensome, or outright gifts to prop up existing players, others clearly protect the public interest. More importantly, these regulations are the law of the land and can’t simply be ignored.

The challenge with more highly-regulated markets is that startups can’t simply “move fast and break everything.”

Startups can, however, think innovatively about how to comply more effectively and efficiently with those regulations. They can structure their services to avoid some of the ridiculous rules, and they can work to change others through the law or politics. For example, in the same month as Zenefits self-immolated, another health insurance startup, Oscar Health, raised a new $400 million from Fidelity investments. This is the same large investor that previously invested in Zenefits and controversially wrote down that investment late last year. As Brian Singerman of Founders Fund explained:

“The Oscar team has had amazing execution in a business that is highly complex, regulated, and competitive and capital intensive. This isn’t a ‘move fast and break things business,’ people’s lives are at stake.”

There is a path for Silicon Valley to disrupt even the most regulated markets, but it requires a different approach. Startups must understand the existing laws and regulations and create a strategy to comply with the rules, work around them, or change them if necessary. The only thing they can’t do is pretend like the rules don’t exist. In that scenario, they will give the disrupted all the ammunition they need to protect their turf.

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