Part I: Zenefits and The Effects of Innovation

Zenefits discovered a real problem for small businesses, created a real solution, and developed a revenue model to fuel profitable growth. But, this isn’t enough. Sustaining innovation requires managing the effects through thoughtful operations. Zenefits is the latest to learn this lesson, very publicly. Unfortunately, it won’t be the last.

Educational Enrichment Systems (EES) is a nonprofit that employs 170 and provides early childhood education in 22 locations across San Diego County. Its entire on-boarding process is completed manually on paper. As CFO of the organization, I wanted a more efficient internal process and to improve our ability to see trends in our staff, such as turnover by position, by site, and teacher experience and education.1

In May 2015 I began exploring possible options to solve some of our HR problems and discovered Zenefits. I liked Zenefits’ software and would have been willing to pay for it, because it solved all of our pain points. But, Zenefits doesn’t sell software. Zenefits generates revenue from commissions by becoming the insurance broker and facilitates managing employees’ insurance through the software. My company had been with the same insurance broker for over twenty years and was reluctant to change but would be willing to switch providers to get better service. I reached out to a friend and former colleague who serves as Director of Human Capital at a non-profit in Washington DC. She told me in an email: “I think they have a lot of junior brokers. They say they have people with 10 years experience, but they are growing so quickly I don’t know how they could be recruiting away so many experienced brokers. But you have to give them authority to be your broker in order to use their software.” This was a risk that my company couldn’t take, so we did not pursue Zenefits further.

Software

Zenefits’ software seemed to strike a chord with small businesses. In 2014 its investors called Zenefits “the fastest growing SaaS business in history.”2 The software solved a pain for businesses across the country and no doubt for the tech startups in Silicon Valley itself. Many payroll providers’ process revolves around a HR professional. Small companies rarely can justify a HR professional on staff, so Zenefits allows them to decentralize this process, improving efficiency and avoiding costs.

Revenue Model

The revenue model was what really accelerated Zenefits growth. Zenefits acts as the broker of record for any insurance brought in through the software, earning 2%–10% in commissions paid by the insurance carriers. This arrangement earns Zenefits around $450 per customer employee, per year without charging the user of the software directly. Insurance brokers are not well positioned to develop software and software companies are not well positioned to deliver insurance. Within 2 years of launching, Zenefits raised $500 million on a $4.5 billion valuation.

Governance

In a market that richly rewarded Zenefits’ revenue growth, Zenefits’s leaders’ operated under the mantra “ready, fire, aim”. In fact, that was literally the company’s internal motto. Investors, the board of directors, and the executive team all wanted growth. When state regulators were concerned and began to react to what other insurance brokers saw as Zenefits’ unfair business practices, founder and CEO Parker Conrad said “In the end, I believe these regulatory issues will be few and far between, because this is the United States, the country that understands the need for a free market and innovation. Ultimately, I think we will prevail.” 3

Culture

This idea of “ready, fire, aim” and the cavalier belief that regulators and the United States will “understand” permeated throughout the culture of the organization. Parker Conrad had previously co-founded SigFig, a startup that struggled to raise money and was constantly two or three months away from not making payroll.4 But Zenefits was different. Customers came easily. Revenue came easily. Venture capital money came easily. This created a sense of being in control of their environment.

A company whose culture suggests that it is in control of the environment will become overconfident because it relies on their actions dictating events. For example, an entrepreneur who feels in control of the industry niche in which she operates will react with conviction when faced with conflict and resistance, even from customers. They see this as a strength because they are imposing a better way on the environment.

Another problem with Zenefits’ culture was that Zenefits’ concept of time began to warp how its leaders saw the world. There was no evidence of the past. Zenefits lacked institutional knowledge because the company was young, all employees were new with a mandate to move quickly, and the company faced significant financial incentives based in the future. Valuing a company at $4.5 billion with less than $100 million in revenue means most of the valuation is coming from projected future growth. As a result, the company barely lived in the present- everyone was just driving the company to the future.

Matt Epstein, Zenefits VP/Marketing told company employees “If you’re happy with a campaign you worked on, you almost definitely spent way too much time on it”.5

Core Process

Zenefits’ core business was eventually compromised by a culture focused on the future and too assured that regulators would bend to Zenefits’ will. Insurance brokering was Zenefits’ main revenue source, but compliance with state regulations impeded its growth.

What would be revealed later, according to an internal email “the California Department of Insurance has begun an investigation of licensing issues at Zenefits”. To obtain a insurance broker’s license, California requires a licensing exam and a minimum of 52 hours of instruction. In order to facilitate the training, Zenefits had created a tool to track the 52 hours of instruction. In reality all the tool did was track 52 hours. The same internal email acknowledged that training videos were played on a software user’s screen, whether or not the user was watching the screen and enabled “a person to spend less than the 52 hours of required time in the prelicensing course.” 6

California wasn’t the only state with problems. Buzzfeed News reported and investigated that “The insurance commissioner in Washington state, is currently examining whether Zenefits operated there without licenses” 7Buzzfeed News reporters compared 132 unique insurance polices sold by Zenefits from November 2013 through August 2015 to a public Washington state database of licensed salespeople. They discovered 83% of the policies were sold by employees who did not have a Washington license at the time of the sale.8

  1. Buhr, Sarah. “Zenefits Launches Zenefits For Managers And Zenefits Business Intelligence.” TechCrunch. AOL, 20 May 2015. Web. 15 Mar. 2016. http://techcrunch.com/2015/05/20/zenefits-launches-zenefits-for-mangers-and-zenefits-business-intelligence. ↩︎
  2. Carney, Michael. “Labeled the.” Pando. N.p., 03 June 2014. Web. 15 Mar. 2016. https://pando.com/2014/06/03/labeled-the-fastest-growing-saas-company-ever-zenefits-raises-a-66m-series-b-just-five-months-post-series-a. ↩︎
  3. Welch, Liz. “How Zenefits Disrupted Human Resources.” Inc.com. N.p., 09 Mar. 2015. Web. 15 Mar. 2016.http://www.inc.com/magazine/201503/liz-welch/hr-technology-with-benefits.html. ↩︎
  4. Bort, Julie. “How a Series of Humiliating Events Led to One of the Fastest-growing Startups EVER.” Business Insider. Business Insider, Inc, 22 Feb. 2015. Web. 15 Mar. 2016. http://www.businessinsider.com/the-incredible-story-of-zenefits-founder-parker-conrad-2015-2. ↩︎
  5. “Zenefits Hints at Marketing’s Future.” Warc.com. N.p., 17 Sept. 2015. Web. 15 Mar. 2016.http://www.warc.com/LatestNews/News/Zenefits_hints_at_marketings_future.news?ID=35403. ↩︎
  6. Alden, William. “Zenefits Software Helped Brokers Cheat On Licensing Process.” BuzzFeed. N.p., 11 Feb. 2016. Web. 15 Mar. 2016.http://www.buzzfeed.com/williamalden/zenefits-program-let-insurance-brokers-fake-training. ↩︎
  7. Alden, William. “Startup Zenefits Under Scrutiny For Flouting Insurance Laws.” BuzzFeed. N.p., 25 Nov. 2015. Web. 15 Mar. 2016.http://www.buzzfeed.com/williamalden/zenefits-under-scrutiny-for-flouting-insurance-laws. ↩︎
  8. Alden, William. “80% Of Zenefits Deals In Washington State Done By Unlicensed Brokers.” BuzzFeed. N.p., 5 Feb. 2016. Web. 15 Mar. 2016.http://www.buzzfeed.com/williamalden/80-of-zenefits-deals-in-washington-state-done-by-unlicensed. ↩︎
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