Has Silicon Valley Met Its Waterloo in Health Care?

TechCrunch Disrupt SF 2012 event at the San Francisco Design Center Concourse in San Francisco on September 10, 2012. The nature of the health care industry discourages the underdog mentality of Silicon Valley because size and weight matter. REUTERS/Stephen Lam

Updated | In the past few years, Silicon Valley entrepreneurs, buoyed by the buzzwords of disruption and big dreams, flooded into health care and biotech industries. Now, some of the most zealous believers are reeling, with nothing to show but bruised reputations.

On Thursday, Zenefits, the beleaguered human resources software startup-turned-unicorn, took another blow after Buzzfeed News uncovered secret software that helped its health insurance brokers cheat on their legally required licensing process. Hours before Buzzfeed's story broke, the California Insurance Department announced it will investigate Zenefits over compliance issues.

Zenefits's troubles coincided with controversy surrounding Theranos, another highly praised nonpublic, health-related startup, which boasted it could gather a myriad of biometric data with just a drop of blood.

Theranos has been under scrutiny after two Wall Street Journal investigations unveiled discrepancies in its blood test science. On Wednesday, Theranos' largest retail partner Walgreens threatened to end their partnership unless Theranos fixed the problems, according to a Wall Street Journal report.

Responding to an earlier article about their relationship with Walgreens, Theranos said: "This is an issue that many other labs have faced, and we will fix it quickly and completely, working with our regulators as we always do."

It may very well be a coincidence that the two largest—and most-hyped—startups in the health-tech field are under fire. But plenty of observers, including Silicon Valley entrepreneurs, buy into the idea that "perhaps health care is where disruption meets its Waterloo."

"These are prime examples of the 'software will eat the world' ethos going overboard," Vic Gatto, founder of Jumpstart Foundry, a health care–focused innovation fund accelerator, tells Newsweek. "Silicon Valley prefers to move incredibly fast and be cavalier. It's fine for Uber. It's different when it's about monitoring people's hearts."

Compared with Uber, which jumped into the taxi industry, Zenefits and Theranos deal with a much more highly regulated, public industry. Since the rollout of Obamacare, the federal government is playing a larger role than ever in health care.

Considering that lives are at stake, governments, hospitals, health care providers and regulatory agencies move much slower and more deliberately than most industries, according to Gatto. "The FDA exists for a reason," he says.

Former Zenefits CEO Parker Conrad, who resigned on Monday after Buzzfeed's series of investigative reports on his company, was long-known as a rebel who sought the underdog role, comparing himself and his employees to the Rebel Alliance in Star Wars and calling Utah regulators and their ruling to temporarily ban Zenefits "blatant overreaching" and "Kafkaesque."

When Newsweek asked Zenefits for comment, the company forwarded a memo that new CEO David Sacks had sent to employees on Monday shortly after Conrad's resignation. "We sell insurance in a highly regulated industry," Sacks writes. "In order to do that, we must be properly licensed. For us, compliance is like oxygen. Without it, we die."

While being small and nimble in Silicon Valley works for many startups, the nature of the health care industry discourages the underdog mentality because size and weight matter.

Take, for example, Oscar Health, which may be the new big thing in health care. Oscar Health is a health insurance company that is challenging the Aetnas and Anthem Blue Crosses of the world in providing health care plans. Valued at $3 billion, Oscar Health has become a unicorn of its own.

But due to its lack of scale, the company faced serious challenges when it came to leveraging its size to negotiate better prices from hospitals and doctors and being more proactive about offsetting patient costs, according to venture capitalist Bob Kocher in a Fast Company feature on Oscar Health.

"Health insurance is a business where scale matters," says Kocher. "For smaller insurers, the cost margin can put you in the same bracket as a newspaper."

It is almost inevitable that another bright-eyed entrepreneur will jump into health care to uproot the industry. It remains a bloated, multitrillion-dollar industry that still runs on "horse-and-buggy" technology—the type of environment Silicon Valley lusts after. But Gatto says preaches a message of transition rather than revolution for health care to the new generations of startups.

"Health care is different because people live and die because of it," Gatto says. "But that doesn't mean we have to lose our entrepreneurial spirit. We just can do everything 20 percent less quickly."

Correction: An earlier version of this article said Theranos' statement was from February 8. It was from January 28 and referred to an earlier article about its relationship with Walgreens.