Theranos and the Power of Psychological Denial

The rise and fall of Elizabeth Holmes and Theranos could easily fill a 500-page book. At one point, supposedly sophisticated investors assigned a valuation of $9 billion to this company. Today, however, according to Forbes the valuation stands a precisely $0. This blog post examines how it could possibly be that so many intelligent people could be so easily fooled by what now appears to be a virtual hoax of a company. Surely something must have gone haywire in the brains of those who invested $400 million in Theranos in 2015, as well as the multitudes of tech executives and journalists who sang Holmes' praises until she was exposed. We conclude that the circumstances surrounding Holmes' rise and fall were made possible by what Munger refers to as 'simple psychological denial', which took root among a large swathe of the tech community, including those with real capital at risk in the venture.

On the surface, Elizabeth Holmes seemed to be the Saviour and the Chosen One for denizens of Silicon Valley who, as everyone knows, lean to the left of the political spectrum. There have been a number of self-made tech billionaires over the years--Jobs of Apple and Pixar, Bill Gates and Paul Allen of Microsoft, Larry Ellison of Oracle, Elon Musk of Tesla and SpaceX, Jeff Bezos of Amazon, Mark Zuckerberg of Facebook, Larry Page and Sergey Brin of Google, and the list goes on. The glaring omission is that there is no woman on this roll call. Yes, one could point to Sheryl Sandberg, Safra Catz or Meg Whitman as examples of powerful women in tech, but they were not founders; they were merely executives who rose through the corporate ranks, often owing their privileged positions to the powerful men who appointed them. How could it be that in Silicon Valley, possibly the wealthiest and most liberal enclave in the country, there was no female billionaire founder?

Enter Holmes, a founder and, hence, a visionary. She dropped out of Stanford at 19 to pursue her dream, much like Gates and Zuckerberg dropped out of Harvard and Jobs dropped out of Reed College. She was young and photogenic, great for magazine covers. She had an inspirational genesis story [she founded Theranos because she was personally afraid of needles and wanted to empower everyone to take control of their personal health destinies]. But, most critically, she was a woman who could finally break through the Silicon Valley Self-Made Billionaire Glass Ceiling. When Holmes appeared on the scene, one could practically hear a collective 'Eureka, We Have Found It' emanate from the Bay Area [which cry quickly spread to the East Coast, thanks to the media who leapt to spread the Gospel of Theranos]. At long last, we had discovered THE FEMALE STEVE JOBS...

The story was indeed mana from heaven, except for one minor detail--it was all a lie, as exposed by the Wall Street Journal [see coverage here]. So how could so many seemingly smart people fall for such a colossal hoax? Simple psychological denial. One starts with a premise, namely that if we are truly to achieve gender equality, especially in Silicon Valley, there must be a female version of Steve Jobs. If there isn't one, then we [meaning Silicon Valley collectively] have failed to live up to our ideals--and hence, Silicon Valley is a collection of hypocrites, saying one thing unanimously [we demand gender equality] but doing something completely different in practice. And this simply could not be psychologically tolerated.

Thus, when Holmes appeared on the scene, the multitudes in the tech world immediately grasped on to her story and company like a drowning person latches on to a life preserver. Because of the psychological fixation on the preferred outcome [Theranos must succeed or we are collectively a fraud with respect to gender equality], evidence that may have led to the conclusion that Holmes and Theranos were not as they seemed was simply ignored. For example, Theranos bizarrely had a board of directors stocked not with medical or high-tech professionals, but rather with octogenarian and nonagenarian politicos such as ex-Secretaries of State George Schultz and Henry Kissinger. What in the world could such folks possibly contribute to a fledgling tech company? Moreover, the company was highly secretive, which should have raised red flags. After all, if Theranos had truly invented [and presumably thoroughly protected via patents] a revolutionary diagnostic technology, why wouldn't they want to share the details of their miraculous triumph with the world? Even the most basic due diligence by those putting real money into the company was overlooked. The exception proves the rule--one VC investor that was asked to invest in Theranos actually decided to take a blood test at a Theranos Wellness Center. The result? The test required much more blood to be drawn than Theranos promised in its marketing materials and, hence, this particular investor declined the investment opportunity [source here]. Many others, wanting to believe, failed to do even such basic due diligence.

All of the red flags were basically ignored for the simple fact that investors and journalists simply wanted Holmes's story to be true too badly, and if one wants something to be true badly enough, one will ignore a mountain of contrary evidence. Munger explains the phenomenon as follows...

[The power of psychological denial] first really hit me between the eyes when a friend of our family had a super-athlete, super-student son who flew off a carrier in the North Atlantic and never came back, and his mother, who was a very sane woman, just never believed that he was dead. And, of course, if you turn on the television, you’ll find the mothers of the most obvious criminals that man could ever diagnose, and they all think their sons are innocent. That’s simple psychological denial. The reality is too painful to bear, so you just distort it until it’s bearable. We all do that to some extent, and it’s a common psychological misjudgment that causes terrible problems.

Another of Munger's psychological misjudgment tendencies may also have been at work in the Theranos debacle, namely Bias From Liking Distortion, including the tendency to especially like oneself, one’s own kind and one’s own idea structures, and the tendency to be especially susceptible to being misled by someone liked. This bias is further explained as follows [source here]...

We ignore the faults of other people, products or companies that we admire. According to Charlie Munger, a newly arrived human is born to like and love, and the strongest inborn tendency to love is that of a mother for its child. Liking/Loving tendency makes the liker or lover tend:

1. To ignore the faults of, and comply with wishes of the object of its affection;

2. To favor people, products and actions merely associated with the object of his affection; and

3. To distort other facts to facilitate love.

Note that, among the tech community and press [again, generally believed to be extremely left-leaning], Elizabeth Holmes was one of them, the best possible version of what Silicon Valley should be and could be--in a sense, she was loved as if she had been their collective child, born with a halo around her head. Because of what she represented [and because of the glowing thoughts and ideas others projected onto her], those who admired her were thus susceptible to being misled by her--which is exactly what apparently happened.

In sum, in our view what Elizabeth Holmes and Theranos represent is a clear example of the fact that the psychological biases inherent in the human mind can easily lead an investor astray. Well-meaning and intelligent people put $400 million of their capital into a worthless company for no good reason. They did this because their minds were playing tricks on them--yet they did not realize this reality. Only when the Wall Street Journal ran an in-depth expose on Theranos did the scales finally seem to fall from people's eyes. Thus, as an investor one must be constantly vigilant against falling into such psychological traps. One must endlessly question and stress-test one's own preferred world beliefs and conclusions, as well as the super-structures one builds up in one's mind regarding any particular investment, to determine whether they are true or a fiction. Finding out that one has been misled or is deluded about an investment is never psychologically easy to bear--it hurts to be wrong. Facts and circumstances change; what was true today may be false tomorrow. The truth or falsity of any investment thesis will emerge eventually, whether one likes the fact or not [as seen with the Theranos investors], and it is vastly preferable that this happens sooner rather than later so that, if it turns out that one has been completely deluded, capital can be preserved and redeployed into better opportunities.