In October 2020, the Robinhood trading app was seven years old. It had 13 million users and was valued north of eight billion dollars. The sky was the limit – or seemed to be, until the company’s glaring weakness was exposed: it had grown faster than its infrastructure could support. Its goal to “democratize Wall Street” worked too well when a large number of customers used the app to create stock market volatility. Robinhood was forced to halt trades of volatile stocks until it raised a billion dollars in backstop capitalization.
In less than seven days in January, Robinhood went from being the sweetheart of Main Street retail investors to facing a class-action lawsuit from over one thousand customers. CEO Vlad Tenev appeared before Congress today. And the company has been treated to millions of dollars in negative publicity.
Cracks turn to chasms
Opinions about Robinhood’s mistakes are everywhere. Billionaire venture capitalist Mark Cuban and millionaire entrepreneur Lee Rashkin, however, hold two of the most important. They both told our founder in a recent Forbes.com article that Robinhood had failed to “stress-test” whether it had enough money to withstand volatility. In other words, the company grew faster than it was prepared for, and the cracks in its model suddenly turned into chasms.
No company can outgrow its infrastructure and expect to succeed. Marketing and staffing must grow together or there will be more business than can be serviced or more outlays than are affordable. Offices and warehouses that are too large will waste money, but buildings that are too small will create barriers to growth. Too little product on-hand may mean you can’t handle growth, while too much may mean you’re wasting valuable space and money.
It’s easy to see the impact of outgrowing infrastructure when you’re a start-up retailer who is has to go from making the product yourself to mass-producing it because Walmart or Target picked you up. It’s easy to see it when your growing business requires investments in warehousing, vehicles, and new staff. But, sometimes, infrastructure weaknesses are hard to see when you’re growing fast and your star is on the rise.
Robinhood’s two big infrastructure failures
Robinhood became a major industry player when it gained seven million new users after the COVID-19 pandemic shut down the nation. Its democratization, no-commission model seemed to be working…until its under-capitalization was exposed by customer decisions to engage in highly speculative, volatile trades. Raising a billion dollars to back-stop its risk solved the immediate problem – Robinhood opened all trades within a few days – but the dam had been opened to criticism and potentially significant action from customers, politicians, and federal regulators.
Robinhood’s capitalization mistake also exposed its poor crisis communications infrastructure. Its January 28 decision to freeze trades on volatile stocks was announced after the decision was made – giving customers no more ability to react than the wider market. Its blog was suddenly very busy, explaining its decisions as Tenev went on an interview spree to protect the company’s brand. But even its explanation of “What happened this week” exposed its lack of capitalization preparedness (emphasis ours):
The amount required by clearinghouses to cover the settlement period of some securities rose tremendously this week. How much? To put it in perspective, this week alone, our clearinghouse-mandated deposit requirements related to equities increased ten-fold. And that’s what led us to put temporary buying restrictions in place on a small number of securities that the clearinghouses had raised their deposit requirements on.
In other words, the company admitted to the public that it wasn’t ready for extreme market volatility. But instead of finding out when they signed the dotted line, many customers claim they only found out when it was too late to matter, and they were losing money.
Robinhood’s infrastructure weakness was evident to Rashkin long before Robinhood’s volatility hit the press. “I was concerned that Robinhood was under-capitalized and hadn’t shown it survived tough times,” Rashkin, a retail investor, said in Forbes. “Robinhood should have stress-tested their systems” and told customers that it was “not financially equipped to handle extremely volatile market conditions.” Of course, Rashkin also acknowledged that transparency might have cost Robinhood customers – perhaps the same customers who are now suing it for breach of contract.
The long road ahead
Robinhood may be able to recover from its infrastructure weaknesses; it raised several billion dollars in a few days from investors, and it may stave off both court battles and regulatory burdens. But scrambling to recover is a far more difficult and expensive prospect than being prepared in advance. Robinhood’s long recovery road ahead should be a good lesson for small businesses and non-profits to focus on building a strong infrastructure – from finances to staffing to logistics to marketing – to meet their unique challenges before those challenges turn into obstacles, and the obstacles turn into mountains.