How a culture of secrecy set Theranos up for failure

Investors valued the medical testing startup Theranos at $9 billion last year. But a bombshell Wall Street Journal investigation published last week has thrown the company into crisis by raising questions about whether its technology works as advertised.

Theranos was founded by a Stanford dropout and is based in Silicon Valley, so people have naturally drawn comparisons to tech industry legends — especially Apple co-founder Steve Jobs. But founder Elizabeth Holmes ignored a crucial piece of Silicon Valley conventional wisdom, and it may prove her undoing.

The idea is that young startups should create a product and get it in front of customers as quickly as possible. Sure, the first product will have flaws and limitations, the argument goes, but there's nothing like real-world feedback to help drive improvement. Mark Zuckerberg, for example, began working on Facebook in January 2004, and had a working website operating across multiple campuses by March. The site's rapid growth helped him raise $500,000 from investor Peter Thiel a few months later.

Theranos worked in secret for a decade

Theranos was started around the same time as Facebook — indeed, Holmes and Zuckerberg are the same age. But Theranos stayed in "stealth mode" — not talking to the media or the public about what it was doing, to say nothing of releasing a working product — for a decade.

That meant that by the time customers began using its blood test services in 2013, it had already raised more than $100 million from investors. The danger with this strategy is that if your original innovation has unexpected problems — and most innovations have unexpected problems — you don't find out about it until after you've wasted tens of millions of dollars. That seems to be the problem Theranos is facing today. And at this point, it may prove to be a really hard problem to solve.

Theranos made big claims it can't back up

Theranos customers have to endure conventional veinous blood draws after all. (Tappasan Phurisamrit/Shutterstock)

When Theranos first emerged from stealth mode in 2013, it made some ambitious claim for its product. As a glowing 2013 profile put it, Theranos was supposed to have "devices that automate and miniaturize more than 1,000 laboratory tests, from routine blood work to advanced genetic analyses. Theranos's processes are faster, cheaper and more accurate than the conventional methods and require only microscopic blood volumes, not vial after vial of the stuff."

But in the past couple of weeks, many of these claims have been called into question. The company has admitted that right now only one Theranos test actually works with just a few drops of blood (others are currently being evaluated by regulators); dozens of others are conducted using the same "vials after vial of the stuff" that others labs use.

The Journal notes that while it was reporting its big scoop on Theranos's technology, the company deleted a claim on its website that "many of our tests require only a few drops of blood," replacing it with the much less impressive boast that it collects less blood from patients than competitors.

Theranos's proprietary technology doesn't live up to the hype

According to the Journal, Theranos was using its proprietary testing technology for only 15 tests at the end of 2014. The other 60 tests the company offered at the time were done using conventional laboratory equipment. (Theranos disputes these specific numbers, but it doesn't deny that it's been using conventional laboratory equipment for many of its tests, and has refused to say how many.)

The company's culture of secrecy has likely cost its investors dearly

The Journal's recent reporting also calls into question the accuracy of the Theranos tests. A big reason competing labs draw so much blood is that the machines they use often require it. But if Theranos is using the same conventional machines, it should need the same volume of blood as other testing companies — and one of Theranos's selling points is that its tests collect less blood than competitors. The Journal alleges that Theranos has dealt with this problem by diluting its samples, a process that can degrade the accuracy of the tests.

Others have raised similar concerns. Jean-Louis Gassée, a prominent former Apple executive, says he tried Theranos for a test he has to take regularly. He found that the results from the Theranos tests fluctuated a lot more than tests from a conventional lab.

A culture of secrecy set Theranos up for failure

Theranos has refused to provide details on how its testing regime works, so we can't be sure what's going on here. It's possible that the problems identified in recent reporting can be fixed, and that Theranos's new technology will eventually disrupt the medical testing industry.

But the company's culture of secrecy has likely cost its investors dearly. If Theranos had taken a more open approach, it might have been able to start testing its technology — and opening it up to scientific peer review — years ago. That might have allowed the company to identify and fix problems while it was much smaller and less well-known, avoiding the massive public relations crisis it's suffering right now.

On the other hand, if Theranos's technology can't be made to work as advertised, everyone involved would have benefited from discovering that a lot earlier. Holmes might have been able to "pivot" to a new technology or business model. And if not, investors could have avoided sinking tens of millions of dollars into a flawed technology.

Most Silicon Valley startups aren't like Theranos

Former Secretaries of State Henry Kissinger (left) and George Shultz are among the elderly former government officials on the Theranos board. (JIM WATSON/AFP/Getty Images)

The fact that Holmes was producing a medical product rather than a software one likely gave her extra leeway to keep her technology under wraps for a decade. Medical technology has life-or-death implications, so it requires more rigorous testing than a social media website. Of course, that's exactly why the medical profession has a culture of rigorous, open peer review of new medical technology — a process Theranos has largely refused to participate in.

Also, the Theranos board is conspicuously light on people who have experience with either biotechnology or startups. It contains a who's who of the military-industrial complex. Theranos's independent board members include former Secretaries of State George Shultz and Henry Kissinger, former Sens. Bill Frist and Sam Nunn, former Defense Secretary William Perry, retired Gen. James N. Mattis, and retired Adm. Gary Roughead.

This is obviously a distinguished group, but it's not necessarily a great board for a biotechnology startup. In the world of defense contracting, it's not unusual to have secretive projects that cost tens of millions of dollars and take a decade to complete. But there was apparently no one on the board to point out that this approach doesn't work very well for technology startups.

Most technology startups — and especially most technology startups that grow to be worth billions of dollars — do not stay in stealth mode for very long. We don't have to speculate on whether Uber, Airbnb, or other big, venture-funded technology companies have products that work. Their products have been in the market, and subject to intense scrutiny, for many years.

There are some exceptions. For example, a company called Magic Leap has raised more than $500 million from investors for its virtual reality technology, which has yet to be publicly unveiled. Its leading competitor, Oculus VR, was acquired by Facebook for $2 billion in 2014 — it also has yet to release its product to the public. Creating a new category of consumer products is harder than creating a new website, so it's not surprising that it's taken these companies more than a few months to bring their products to market.

But neither company has been in stealth mode for nearly as long as Theranos was — Magic Leap was founded in 2010, and Oculus VR has only been around since 2012. If these companies are still struggling to get their technology to work in 2020, their investors should be worried.

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