Robinhood is a case study in the ‘success trap’, in which explosive growth can derail your business’ mission. Here’s what founders can learn.
  • A “success trap” is when a company exploits the most profitable aspect of its business to the detriment of its core mission.
  • Michigan Ross School of Business professor Erik Gordon told Business Insider investing platform Robinhood may have done just that by focusing on the gamification of day-trading at the expense of protecting customers.
  • Robinhood is now at the center of a firestorm about the way its platform encourages users to place outsized bets that have resulted in devastating losses.
  • As a meltdown appears to follow the boom, Gordon says founders could learn from Robinhood and perform a monthly audit to ensure their startup’s success is aligned with their actual mission.

Anti-ballistic glass has reportedly been installed at the Menlo Park, California, headquarters of investing app Robinhood, presumably to protect employees from angry customers seeking retribution against the company.

The platform’s popularity has soared during the pandemic — but so have accounts of amateur traders losing thousands of dollars through high volume day trades in a volatile stock market. In one case last month, a user died by suicide after apparently seeing massive negative account balance in what turned out to be a design flaw in the app.

Co-founders Vladimir Tenev and Baiju Bhatt announced new changes to the platform in response to the tragedy, including “additional criteria and education for customers” seeking higher levels of activity, but declined to specify a timeline.

When Tenev and Bhatt launched Robinhood in 2013, they promised a new way of investing — one that was “friendly, approachable, and understandable for newcomers and experts alike,” per the mission statement on the company’s website.

Today, the company is riding high with more than 13 million users (3 million added this year alone) and an $8.6 billion post-Series F valuation led by Sequoia Capital. And while the company has accomplished the first part of its mission, tales of staggering fortunes gained and quickly lost suggest it’s falling short on what finance experts would describe as a sound education in investing.

Dr. César Albarrán-Torres, a senior lecturer in media and communication at Swinburne University of Technology in Australia, previously told Markets Insider that “the casualization of trading,” like in Robinhood, “makes money more ethereal, like a token in a video game, so users tend to treat it as a game credit rather than actual cash.” 

In response to a request for comment on these issues, a Robinhood spokesperson told Business Insider the company “enables a diverse range of investing strategies that reflect thoughtful participation in the market. We’re committed to providing customers with both access to the markets and the resources they need to get and stay informed.”

How success and failure can be linked

Business Insider spoke with Erik Gordon, a professor of entrepreneurship at the University of  Michigan’s Ross School of Business, to find out why Robinhood is in its current situation, and how founders can avoid what Gordon described as a “success-failure” trap.

A success-failure, Gordon says, “can turn an innovation that was born in social value into one that lives in social dysfunction.”

Robinhood appears to be in just such a predicament. Its award-winning design vaulted it to extraordinary levels of popularity, but its addictiveness could undermine its stated goal of helping, rather than harming, its retail investor customers if the startup stays its current course.

Indeed the company walks an extremely fine line between opening up new doors to the market and sucking inexperienced users into the gears of a complex machine, as in the case of their rollout of fractional stock trading.

“I think the user that we’re particularly excited about is the first-time investor that wants to get started and maybe has a couple of dollars,” one Robinhood product manager previously told us

Here’s what Gordon suggests founders can learn from this case study.

Top-notch user experience plus a risky product is a dangerous package

By all accounts, Robinhood accomplished its goal of creating an approachable platform for novices to get started with investing. The problem, according to NYU Professor Scott Galloway is that it’s so approachable that it’s addictive.

“Robinhood management and investors have taken cues from big tech, and made a conscious decision to disregard the well-being of our youth for personal enrichment,” he wrote.

That’s fine if your primary objective is to get as rich as possible without regard for other considerations, but it is at odds with the revolutionary ethos that Bhatt and Tenev claim as their inspiration.

The cues that Galloway is referring to are a suite of psychological tricks used by app developers and casino designers alike to keep users engaged and hunting for their next jolt of dopamine. Researchers have identified “variable rewards”, like whether cherries or sevens come up on a slot machine, as one of the main drivers of the addictiveness of gambling — and software design.

“Robinhood has tapped into the quick-action, online gaming culture of many of its customers,” said Gordon. “Robinhood encourages rapid trading, which is a very good way for inexperienced people to lose money.”

At odds with its mission

Gordon said Robinhood’s decision to include risky trades like options and margin accounts into their ultra-convenient interface is like allowing casino gamblers to take cash advances on their credit cards to use at the poker table.

“It’s like that, except multiplied,” he said. “Robinhood on the downside for inexperienced people can be very dangerous.”

The company also makes most of its money in a way that arguably puts it at odds with a thoughtful understanding of financial instruments. 

Robinhood helped popularize zero-commission trading — and in doing so set off a price war among discount brokers that saw many of its incumbent competitors slash commissions on US stock and ETF trades to zero last year. But apart from commissions, there are also implicit costs to trading that are less transparent to users. 

In order to offer free trades to users, Robinhood relies on a common (but somewhat controversial) practice called “payment for order flow”, which means it makes money on the number of trades it sends to be executed by firms like Citadel Securities, G1X, and Two Sigma.

Many brokerages use this technique, but few rely on it so heavily. Such a reliance could create an incentive for companies to encourage users to make more frequent trades, which research has shown leads to worse financial returns.

‘A perfect ugly storm’

Prior research has shown that people are more likely to gamble when the economy is bad, and the economy is indeed bad right now. The stock market, as you’ll recall, is not the economy.

“There is a perfectly ugly storm that contributed mightily to Robinhood’s success so far,” Gordon said, citing lockdown boredom during the pandemic and the market’s extreme volatility in recent months.

Economy-stabilizing measures taken by the Fed have also contributed to an artificially low-risk market environment, prompting hyperbolic claims that “stocks only go up” from gamblers like Barstool’s Dave Portnoy.

It’s easy to see how an engaging platform like Robinhood might appeal to users with few alternatives to channel their restlessness or anxiety as a global pandemic rages on, especially when it seems like everyone else is getting rich while you’re missing out.

How to avoid a success-failure trap

Entrepreneurship is in many ways characterized by failure. Fail fast and learn is practically the innovator’s gospel, but what do you learn when everything seems to be going right?

“Sometimes success can be tougher because you don’t stop and try it again and do it better,” Gordon said. “You just keep doing more and more of what you think is success until it’s taken over and you burn out.”

To avoid this fate, he recommends making a regular monthly audit of how everything about your business is aligning with your core mission.

“You look at all of these metrics,” like revenues and active users, he said, “but what about the metrics of ‘how did we do this month in terms of staying true to our mission?'”

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