As I wrote in my 1998 book, “Unleashing the Killer App,” middlemen needed to adapt, and quickly. In a chapter titled “Death of a Middleman,” I offered survival tips for travel agents, insurance brokers and other service providers facing imminent disaggregation: “Middlemen need to wrap information around the products they handle, adding measurable value in the process. As one client puts it, ‘Add value or adios.’ ”
But nearly 20 years later, even as physical retailers and others fell like dominos, the ranks of the middlemen have swelled.
In retrospect, they had a secret weapon I hadn’t begun to appreciate — powerful professional organizations and long-standing regulations that successfully excluded the new entrants. Including those that had invested in technologies that made business transactions both better and cheaper.
To paraphrase Mark Twain, reports of the death of middlemen had been greatly exaggerated.
But in what my co-author Paul Nunes and I see as a dramatic new wave of digital transformation we call “Big Bang Disruption,” middlemen are once again under extreme pressure.
And this time, it’s personal.
Armed with a potent combination of big data, cloud computing and ubiquitous mobile platforms, entrepreneurs are suddenly challenging staid incumbents in transportation and travel (Uber, Airbnb), professional services (TaskRabbit), journalism (Reddit), financing (Kickstarter) and wholesaling (Etsy).
Once again, the first line of defense for the incumbents is to sic the regulators on their new competitors, demanding that rules designed for a pre-digital society by applied with equal force to innovations that consumers clearly prefer.
The goal, in many cases, is to stop the catastrophic success of the start-ups, if not permanently than at least long enough for the incumbents to regroup and figure out how the hell they can compete.
The latest front in this expanding war has now opened in the placid world of human resources and benefits management, where a start-up known as Zenefits has achieved remarkable success and scale in just under two years of operation.
The company has already signed up over 2,000 companies, representing more than 50,000 employees. Investors, who include Netscape founder Marc Andreessen, claim it is the fastest growing cloud-based software company in history, going from 15 to over 400 employees in 2014 with plans to hire another 1,300 over the next three years. Its most recent round of funding was considered one of the hottest deals in Silicon Valley, valuing the company at half a billion dollars.
Oh, and it’s even earning revenues.
“We have found this giant dead beast lying in middle of the Sahara desert — the employee benefits and insurance brokerage industry,” CEO Parker Conrad told Bloomberg last week. “In 5 to 10 years that entire industry will turn over — no way companies will be doing this all by fax machine. We are first to come across this opportunity and the really big risk is in not growing as quickly as we can.”
The company’s initial success can be attributed to a unique business model. Conrad, a serial entrepreneur, developed software that knits together a range of human resource applications, including payroll, taxes, benefits and insurance, and “on-boarding.” Following the playbook of many digital disruptors, that valuable product is simply given away, saving small and mid-sized businesses thousands of dollars in computing costs.
To make money, Zenefits eschews the typical advertising model in favor of brokerage fees. Users are encouraged (though in most states are not required) to use Zenefits to shop for health insurance providers for their employees. The company then acts as a licensed broker, collecting commissions from the insurers, just as a traditional insurer broker would do. (The company is licensed in all 50 states.)
Unlike a traditional broker, however, Zenefits offers a powerful incentive for its users to choose the company as its broker, in the form of the free software. They have, in effect, followed the advice I gave middlemen back in 1998, differentiating a traditional commodity activity (insurance brokerage) in valuable information (integrated human resource software).
Complacent brokers in the trillion dollar insurance industry are understandably panicked by this radical new approach. So, right on cue, they have responded by encouraging regulators to throw the book at Zenefits.
Earlier this month, the state of Utah sent a violation letter to the company, characterizing the free software as an illegal rebate to users of the commission Zenefits collects from the insurer — a kickback, in other words.
Utah Insurance Commissioner Todd Kiser, who spent his earlier career building and running a traditional insurance brokerage firm, threatened to fine Zenefits $100,000 and take further action if it didn’t stop making human resources simultaneously better and cheaper for its customers.
Indeed, the letter points out, simply charging a nominal fee for the software wouldn’t bring Zenefits in line with Utah law. Customers must be charged a fair maker value, which the state estimates to be tens of thousands of dollar a year.
It’s hard to see how anyone benefits from Utah’s interpretation of its rebate rule, other than incumbent brokers who didn’t have the initiative or imagination to invest the millions Zenefits has to develop a compelling new set of products and services. The ruling twists the law to punish innovation, with no corresponding public benefit.
If Utah’s hard line holds and other states follow suit, it’s the end of the line for Zenefits’s unique approach to solving the human resource needs of small businesses. Current and future customers and their employees, needless to say, are the real losers. Thanks, Commissioner Kiser.
The company has fended off similar attacks in other states, though the Utah law is more explicit and may be harder to overcome. Facing understandable backlash from Zenefits customers in his state, Governor Gary Herbert quickly issued a statement seeking a compromise. “While we have to uphold the law on the books,” he wrote, “there are times our laws must adapt to changes in the marketplace.”
While the company has stopped taking new clients in Utah, the action has done little to slow down Zenefits’s momentum. Last week, the company scored a major coup when Yammer and PayPal co-founder David Sacks not only invested in the company but joined its management team as chief operating officer.
For its parts, Zenefits and its venture investors remains defiant. “This whole thing is kind of [expletive],” Conrad told a Fortune reporter (along with even more colorful language).
Will Zenefits survive the legal blowback? Probably. Our research suggests that if start-ups can achieve a critical mass of customers before incumbents manage to wake up sleepy regulatory giants, users can often be rallied to offer an effective counterweight to the imposition of old and largely inapt rules on the start-ups. (Again, see the latest ups and downs of companies such as Aereo, Uber and Airbnb.)
Middlemen need more than just a legal strategy if they want to survive. Once their customers see the potential of new technologies to improve existing interactions, they’re not likely to settle for older, inferior and unimaginative alternatives. One way or the other, technology finds a way.
As with so many disruptive innovations, the transformation of human resources may move quickly from gradual to sudden. Time is not on the side of the incumbents.
Twenty years after their obituaries were first published, the death of middlemen may not be exaggerated any more.
Larry Downes is co-author with Paul Nunes of “Big Bang Disruption: Strategy in the Age of Devastating Innovation” (Portfolio 2014). He is a project director at the Georgetown Center for Business and Public Policy.