The Real Cost of Disruption
The old adage that it is better to ask forgiveness than permission is not always correct, particularly when it comes to technology.
The spaces that innovators seek to disrupt are often the same ones that are most tightly regulated and for the same reason — — lots of people use them.
22 year old, Aktarer Zaman, learned this lesson the hard way last year, when he was sued by travel giants, United Airlines and Orbitz, because of his website, Skiplagged’s, use of “hidden city” ticketing to book flights. The legality of the “hidden city” ticketing strategy is debateable. United and Orbitz argue that Skiplagged’s practices constitute unfair competition, while encouraging “strictly prohibited” travel. Zaman settled with Orbitz last week, but its case with United is still ongoing.
Though Zaman claims his website did not make any money (in fact the website had not yet been incorporated when he was notified of the suit), he paid a high price for disrupting a heavily regulated market.
When a company emerges as a provider of a public accommodation (or seeks to supplant the provider of public accommodation) in a previously uncontested, tightly regulated space where there are historically vested economic interests; they face significant scrutiny and most likely backlash. The experience of the ride-sharing sector epitomizes this phenomenon. In California, alone, in addition to lawsuits related to wrongful death and rape, Uber currently is fighting a consumer protection lawsuit filed by two different counties for their background check policies. Lyft settled a similar lawsuit in December; and Sidecar is also under investigation. All of these companies face lawsuits in other states and outright bans on their services. They are hardly alone, from human resources to home rental to healthcare technology, start-ups are being forced to deal with thorny regulation.
Traditionally, companies choose from one of three paths when it comes to policy: ignore it, temper their behaviour because of it, or get active in making it. Too often, innovators chose to follow the first path, resent the second, and dismiss the third. This betrays a flawed cost-benefit analysis — that first mover status and captured market-share trump the costs of pre-emptively navigating regulation. That may not necessarily be the case, and companies should be realistic about how much the policy of ignoring policy really stands to cost them.
Ideological Costs
Despite all assertions to the contrary, ignoring regulation can actually discourage innovation. Attempts to skirt policy ignore a critical feedback loop — that business strategy pushes regulatory policy which pushes back on business strategy, threatening the innovative power and profitability of new products. Companies which choose to ignore regulation also choose to have their business strategy dictated by regulators, some of whom will be more interested in maintaining the status quo than improving marketplace conditions. Ultimately such an approach is counterintuitive and antithetical to the innovative ethos which should drive technological advancement.
Ignoring policy can also mean ignoring opportunity. That’s because policy doesn’t just regulate businesses. It is also used to curtail the harmful attitudes of those engaged in business transactions — like discrimination or exploitation. An examination of the policy environment in which a business seeks to operate can point to the people failed by industry; the ways in which they are overlooked; and, correspondingly, opportunities to expand a business’s customer base. Take Uber. Black riders like Uber, because it means the drivers that they need will actually pick them up. Women in India, where public transportation has been historically a risky option, might have also welcomed Uber. The service could have positioned itself as the safe-riding alternative that they were looking for. Uber knows about these opportunities now, but could have anticipated and capitalized on them much earlier during the product development or business expansion processes.
Aside from the ideological impact, companies that find themselves on the wrong side of policy must also deal with very real-world costs, which can get extremely high.
Real World Financial Costs
Typically, a startup can spend up to $90K on legal costs just to get through Series A financing. While alternative fee structures exist and some firms will allow a startup to defer or accept an equity share; the price tag is still daunting. Understandably, founders could be tempted to believe that such expenditure also covers them where matters of policy, regulation, and the public interest are concerned. They would be wrong.
Lawyers are great (most of the time) and firms should keep hiring them (because they have to). But the scope of their expertise is limited. Generally lawyers are not big picture folk. Where matters of public policy are at stake, they may not be equipped or interested in fully meeting a firm’s needs.
It also must be said, that in the increasingly common scenario, where shit does hit the regulatory fan, law firms stand to make A LOT of money. Businesses stand to lose much more. The information on how much exactly is surprisingly hard to come by.
That’s because there are a lot of vested interests in maintaining a lack of transparency when it comes assumption of risk and resulting legally-related expenditures.
But, for the purposes of refining the regulatory cost-benefit analysis, let’s at least attempt to break these costs down.
Say a company has been hit with a private action by either a group of pissed off stakeholders in the market that they currently seek to ‘disrupt’ or an angry customer who believes that the company did not take appropriate precautions prior to providing them with a service. In this case, the company might be blindsided. Though there would be a shorter timetable for litigation, due dates would be immediate. And so, the unlucky company that we are talking about would want to pay top dollar. Top dollar means….
Preliminary Action(responding to court docs, interrogatory responses, fighting discovery starts): 10 partner hours (@ 900 per hour) and 50 associate hours (@500 per hour) = estimated $34,000
Discovery: 10 partner hours (@ 900 per hour), 30 senior associate hours (@500 per hour), 250 junior associate hours (@400 per hour) per month for at least 3 months + e-discovery production ($1.8 million on avg) = estimated $2,172,000
Trial (per week): 20 partner hours (@900 per hour) and 72 senior associate hours per week (@ 500 per hour) = estimated $216,000 for four weeks of trial.
TOTAL: $2,422,000
Of course, those are just the barebones legal costs. In the shit hitting the regulatory fan scenario, a beleaguered company would also want to pay for…
A lobbying firm (so they don’t get regulated out of current and future markets): at least 10K per month retainer cost = $120 K for a year-long contract plus expenses
A PR firm (so people stop hating them): $50K per month retainer for a large national firm = $300K for a 6 month contract plus expenses
Employee recruitment and retention (to reduce the aforementioned outside costs): General Counsel (180 K), Public Policy/ Government Relations Manager (130K), Legal Associate (100K), Compliance Officer (90K), Strategic Communications Manager (110K) = 520K per year + equity
Not including settlements or penalties, appeals, the pieces of the company that have been given away to handle this crisis, or the expenses incurred by the people doing the handling; this company is now looking at a bill of at least
$3,362,000.
All told, the bill will probably be more like $4 to 5 million. For one crisis.
Obviously, this one worst case scenario. Expenses will be higher for a government action or where lots of money is at stake. But, as it stands, they are hardly negligible. Considering that the average successful startup raises $41 million before exiting, that one crisis could constitute a significant drain — making a company less attractive to the potential investors or acquirers willing to take notice.
Beyond the scope of crisis-management, disruptive companies in the public accommodation space should expect to have to navigate some of the same policy issues as their predecessors. Discrimination, data privacy, competitive practices, and consumer protection will all eventually emerge as concerns for most services.
In the age of multi-billion dollar valuations, some businesses may see themselves as invincible or convince themselves that they are willing to handle high litigation costs in exchange for innovation and market share. But, these companies should also note that markets are only willing to tolerate so much risk. The longer a company stays bogged down in legal and regulatory fights, the longer that company is likely to wait to go public and the shyer investors might get. Today, more and more members of the billion dollar club are waking up to the reality of lower than expected public valuations.
Currently, tech companies are crippled by the short-term view that policy is an impediment to progress. This ignores the fact that they are uniquely positioned to innovate within the realms of policy, just as they have in other sectors. It also ignores the real cost of wilful ignorance. Rather than waiting for the law to catch up with them, innovators should face policy issues head on.
