Navigating Regulation

By David Miller

Our recent case discussion on Plastiq highlights issues surrounding lean startups in ambiguous regulatory environments.  Plastiq enables consumers to use a credit card to make large purchases from merchants who otherwise do not accepted credit cards.  Though not violating the letter of the law, Plastiq operates in a regulatory grey area because they charge consumers a fee to use a credit card, which previously has been prohibited.

The case of Plastiq raises the question, what are best practices for startups in unclear regulatory environments?  Laws are backward-looking by nature and therefore new business models inevitably create the need for new regulations.  How best can a cash-strapped startup ensure that it will end up on the right side of the law?

In thinking about this problem, I propose four tactics that startups can use to improve their odds of a positive regulatory outcome.  I then evaluate how well the tactics fit with the lean startup methodology.

1.       Be a “must have” product – Coursera is an organization that partners with universities to offer courses online for free.  This past October, the state of Minnesota banned residents from using Coursera because of an old law that said degree granting universities much register with the Minnesota Office of Higher Education and pay a fee.  The decision went viral online and after receiving numerous complaints, Minnesota reversed its position the next day.  Sean Ellis, describes this type of support as essential for a B2C startup to succeed and defines benchmarks that entrepreneurs can use to see if their product is a “must have.”

2.       Avoid confronting incumbents – When laws are ambiguous, a startup can easily be crushed by a wealthy incumbent willing to go to court.  Plastiq enlisted incumbent support by working with card issuers, for whom the Plastiq business model represents new revenue.  Another approach, particularly for businesses with network effects, is to utilize “safe harbors” during the early scaling period.  For example, Paypal initially worked to sign up a specific group of customers–eBay power users–before branching out to other payment transactions that would compete head on with Visa and MasterCard.

3.       Serve politically popular causes – In 2012, California was approaching a legal cap on the amount of electricity that homeowners could sell back to the grid from their rooftop solar panels.  Such a cap would have crushed solar startups such SolarCity.  Fortunately for SolarCity, regulators raised the cap, ensuring the survival of the solar industry in California.  Because solar power is a politically popular issue in California, solar startups could gain broad political support, even from non-customers, and counter the well-funded incumbents lobbying against them on the cap issue.

4.       Diversify your offerings – When Craigslist drew scrutiny for its adult services listings, Craigslist argued that it did more than other sites to report abuses to the police.  That argument was rejected and Craigslist had to eliminate the category, one of the few categories in which it charged a fee.  However, eliminating adult listings did not affect other profitable sections of the site such as apartment listings, and Craigslist survived the legal troubles.

How does lean startup methodology impact a venture’s ability to achieve the aforementioned tactics?  I would argue that lean startup methodology works well with tactic 1, because startups can set up falsifiable tests to see if consumers consider their product a “must have.”  Tactic 2 can also work well with lean startups because safe harbors are useful places to test for product-market fit prior to scaling.  Lean startups are less well suited to pursue tactics 3 and 4.  A lean startup may initially promote a politically popular cause, but if the startup fails to validate an initial hypothesis, it may have to pivot to a less politically popular business model.  Likewise, tactic 4 is more difficult for a lean startup because diversification draws precious resources away from the core product, which should be the focus of falsifiable tests.

In evaluating Plastiq, I believe the founders have done a good job with tactic #2, but not a good enough job with the other tactics.  In particular, I would recommend that the founders of Plastiq focus on becoming a “must have” product.  I worry that if Plastiq goes away, its users will resign themselves to using another form of payment rather than protesting to government officials.