What Went Wrong at Jawbone

May was a triumphant month for Jawbone, an otherwise embattled maker of fitness-tracking bracelets and other gadgets. For more than 12 months, it had been looking for badly-needed investment capital, after having spent heavily on product development, new employees and dealing with complaints about defective products. But that month it raised $300 million in funding from private equity firm BlackRock and hired a Google executive Sameer Samat to serve as its president.

The funding and executive appointment opens a new chapter for a company that since its founding in 1999 has had plenty of ups and downs, including frequent glitches with products requiring, in at least one case, embarrassing refunds. Yet Jawbone is one of the few private Silicon Valley firms that has built a well-known consumer electronics brand in an era in which software companies have dominated. It is also a classic case of a company led by a co-founder who has kept his hand firmly on the tiller despite major setbacks.

For the first time, CEO Hosain Rahman addressed some of these issues in interviews with The Information. For instance, Jawbone blames its most recent struggles on a funding round gone wrong. Private equity firm Rizvi Traverse was in line to put $175 million into the company, Jawbone says, but abruptly halted its investment after the first $25 million payment.

But in dozens of interviews with former engineers and executives, other causes of Jawbone’s troubles emerged.

The Takeaway
In one of the most turbulent examples of the challenges of building a multi-billion dollar startup, Jawbone CEO Hosain Rahman has faced a number of setbacks, including previously unreported complaints about his management and tensions with an investor.

From its early Bluetooth headsets to its latest fitness bands, Jawbone ran into costly manufacturing problems by taking risks in order to make its products look aesthetically pleasing. In some circumstances, Jawbone engineers warned higher ups at the company that the products might not meet their expectations or would be expensive to produce.

Having to offer customer refunds on troubled products or scrap large numbers of products in its factories have hurt the company’s bottom line, people who have worked at the company say. Moreover, its decision to focus on premium products and to expand into new markets has kept the company from being consistently profitable.

Jawbone doesn’t “make money on the products because they’re not designed really for profit. They have a beautiful design, but they’re expensive to manufacture,” said one former executive. “They can’t get out of this cycle of products that are beautiful that don’t make money,” this person said.

Meanwhile, Jawbone’s biggest competitor, Fitbit, has gone from strength to strength. Ben Arnold, an industry analyst for market research firm NPD Group, said Fitbit’s market share has been growing while Jawbone’s has been declining. In the first quarter of 2014, Jawbone’s market share in the “connected activity tracker” market, defined as “digital fitness wristbands and multi-location devices that connect to other devices,” was 20 percent, compared to Fitbit’s 70 percent, NPD estimates. In the first quarter of 2015, Jawbone had dropped to 5 percent and Fitbit grew to 85 percent.  

Fitbit went public earlier this year, and has turned a profit starting in 2014. Fitbit now has a market capitalization of more than $7 billion, more than Jawbone’s most recent valuation of roughly $2.5 billion. Jawbone is suing Fitbit for patent infringement and theft of trade secrets, allegations Fitbit denies.

In an interview with The Information, Mr. Rahman acknowledged having made mistakes in product design but stressed that he’s doing something more ambitious than his competitors: building cutting edge consumer gadgetry that doubles as fashion accessories. Jawbone’s profitability has been affected by its heavy spending on research and development, he said, which at times has accounted for as much as half its operating expenses.

“I have the definitive portfolio in sensors and wearable technology,” Mr. Rahman said. “If you think about Fitbit as sort of the Nokia to Blackberry transition in phones, we think we have the technology base that’s equivalent to iOS and Android.” Mr. Rahman said the company is also sitting on wireless speaker technology that is “the next step of where that whole category goes.”

Employee Doubts

While Mr. Rahman’s zeal for Jawbone’s future is unwavering, the company’s roughly 430 employees haven’t always been convinced. Internal frustration with Mr. Rahman’s management style has surfaced in complaints from employees, both former and current. In the summer of 2014, for instance, a survey of Jawbone’s workforce found deep discontent among some employees with the company’s management and pointed criticism of Mr. Rahman and other top leadership at the company, according to employees who worked there at the time. Among the issues: People felt detached from the management and that the company wasn’t pursuing a clear direction.

Mr. Rahman said the complaints partly reflected his frequent absences during a particularly difficult fundraising round that strained the company’s resources. The company has been implementing changes to its management, he said.

Some employee complaints were more serious. In 2009, Jawbone’s former CFO, Patrick Chiang, alleged Mr. Rahman was misappropriating company funds for personal use and misleading investors and board members about the finances of the company. Mr. Chiang submitted a lengthy report to the board detailing his allegations, which were investigated by Jawbone board members Gregory Turnbull and Roelof Botha, along with the company’s outside auditor Ernst and Young.

According to a person briefed on the investigation, Mr. Rahman offered an alternative explanation for every allegation in Mr. Chiang’s report. A person familiar with the thinking of the Jawbone board said the investigators went through Mr. Rahman’s expenses line by line and found no wrongdoing. This person also said the investigators concluded that Mr. Rahman did not mislead investors or board members about Jawbone’s finances. But the board suggested Mr. Rahman make changes to the way he fill out expense reports, said several people with knowledge of the situation.

Other employees have complained about the company’s manufacturing practices, which have led to frequent product problems. That first became apparent with Jawbone’s line of Bluetooth headsets. Designed by industrial designer Yves Behar, the first version of the headset released in 2006 was a hit with gadget reviewers for its good looks. Its rugged-chic exterior was perforated with tiny holes, giving it a metal grate aesthetic.

The device proved popular and sold well. But in subsequent versions of the device, Jawbone tweaked the design to make it smaller and simpler-looking, with the buttons hidden beneath a smooth piece of plastic on the underbelly of the device. Those versions ended up causing manufacturing difficulties, however, according to former employees.

Manufacturing Troubles

The second version of the headset, for instance, released in May 2008, had  “serious production problems [which] caused the company to miss margin estimates in 2008 and led to very high product return rates,”  according to allegations made in a 2009 lawsuit by Elizabeth Bastiaanse, who was director of marketing between 2007 and late 2008, when she was terminated.  

The allegations were made in a countersuit she filed after Jawbone sued her, claiming she took confidential documents with her when she left. The litigation was later settled.

The third version of the headset, released in April 2009, and called the Jawbone Prime, had buttons that sometimes weren’t positioned correctly underneath the plastic, which meant consumers weren’t always sure if they’d pressed the buttons correctly or could press the buttons by accident, according to Sandy Williamson, Jawbone’s director of program management from October 2008 to June 2009.  

Mr. Williamson estimated that roughly 10 percent of all earpieces manufactured came out defective at one point because the buttons did not work properly. He said he and other engineers at the company notified higher-ups about the problem. But when the product was released, the problem hadn’t been fixed, he said. “There were things we should have done design-wise to make a more substantial product that were never considered,” said Mr. Williamson, a veteran of companies like Apple, Microsoft, Bose and Hewlett Packard.

In an interview, Mr. Rahman said this episode reflected Jawbone’s “design-driven” culture. “When you push the envelope, sometimes you fall down,” he said. “I don’t make commodity products,” he said.

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Richard Drysdale, who heads manufacturing at Jawbone, said the number of defective products coming off the assembly line, also known as “yield,” got better over time. But he argued that in product manufacturing generally, yields aren’t an issue “if the product is strategic in the marketplace and accomplishes what it wants to, the yields don’t matter as long as you catch the failures in the factory.”

In this case, he said that despite the manufacturing difficulties, the device was a huge success and helped the company forge ahead with new products.

Manufacturing experts say factory yields are one of the most important factors that determine whether a consumer electronics company is profitable. When a device comes off the assembly line defective, the company still has to pay for the parts and labor. Lower yields, experts say, also lead to higher returns, because companies never catch every defective product on the assembly line. Boxing and shipping a defective product can prove even more costly. “Saying it doesn’t matter, that’s crazy, or someone who doesn’t know what they’re talking about,” says Ben Einstein, a partner at Bolt, a venture capital fund for early stage hardware startups. “There are companies that spend millions and millions of dollars a month to optimize the yield rate.”

Even as Jawbone was struggling with defective units, the Bluetooth market was getting more competitive as new entrants offering cut-price products entered. With Jawbone’s market share in decline, the company began looking at new product categories.

One answer came on the evening of Dec. 1, 2009, when inventor Philippe Kahn visited Mr. Rahman’s San Francisco home carrying a box of multi-colored fitness bands, a category of consumer electronics that barely existed at the time. The bands could track a person’s steps, monitor their sleep and sync up with a mobile app. Mr. Kahn, who runs a wearable-technology firm called Fullpower, proposed that Jawbone license the band technology and make the device under the Jawbone brand.  

As it negotiated the licensing agreement over the next eight months, Jawbone experimented with different form factors for the band, which it dubbed the Up, Mr. Rahman said, aiming to release it ahead of the holidays in 2011.

One issue that arose related to the size of the band. Mr. Rahman wanted the device to offer a sleep tracking feature, as a way of differentiating it from other similar products. But when Jawbone had tested different versions of the Up with consumers, it found they were less likely to wear it in bed if it was too big and therefore wouldn’t use the sleep tracking feature. So Mr. Rahman pushed engineers to make the Up smaller than Mr. Kahn had originally envisaged -- and they complied.

Jawbone doesn’t “make money on the products because they’re not designed really for profit. They have a beautiful design, but they’re expensive to manufacture,” said one former executive.

Partly as a result, the final look of the Up was thinner and more uniform than Mr. Kahn’s original design. Instead of using a strap attached to a small pod containing the electronics, the hardware was placed throughout the length of the bendable wristband. Spreading the electronics out made the device look like a bracelet, which fit with Jawbone’s goal of making electronics that doubled as jewelry.  

That created problems in manufacturing. In initial manufacturing efforts, the device’s electronics were destroyed when hot rubber was injected into the mold. Over time, the process improved, but not enough to convince everyone that the device was ready to be shipped to consumers. When devices broke, it was difficult to decipher the reason because the electronics were encased in rubber.

Up and Down

In the fall of 2011, Mr. Kahn’s Fullpower tested versions of the Up Band and found that more than 75 percent of them stopped working after normal consumer use was simulated, according to a person involved in the production of the Up.

This percentage could not be independently verified. In an interview, Mr. Rahman said he does not recall anyone from Fullpower telling him there was a 75 percent failure rate.

Fullpower’s Mr. Kahn worried his company would be associated with a glitchy product, or worse, so his lawyers sent stern emails warning Jawbone against shipping a product that wasn’t ready.

In an interview, Mr. Drysdale said he didn’t believe Fullpower was testing the device properly. He said faulty devices Fullpower sent to Jawbone before the product was released were outdated because Jawbone was rapidly updating its manufacturing process in the weeks leading up to the launch.

The device arrived in stores in November 2011. Consumers quickly began complaining of failures, while tech blogs and news articles pointed to problems. Jawbone said in a press release on Dec. 8, little more than a month after the release, it was “working around the clock to identify the root causes” of the problems and offered anyone who bought the device a full refund, regardless of whether it was defective or not. The show of goodwill helped Jawbone save face in the wake of the crisis.

A spokesman said “there were product issues with approximately 10 percent” of the items and "once we found the problem, we stopped shipping.” Jawbone said the total returns of the Up band were "less than 20 percent,” including people who bought devices that weren’t defective.

Jawbone’s position is that when the product was ultimately released, the company didn’t think it was defective. Mr. Rahman said he would never knowingly release a product with defects.

Rizvi’s Funding

Spending on new products and the Up refunds proved costly. Jawbone raised $136 million in 2011 in three separate fund-raisings. The following year the company released a new version of the Up band that was more reliable and proved popular, as well as a line of portable Bluetooth speakers, the Big Jambox.

By 2013, the company had to raise even more money. Starting that fall, Jawbone began several months of discussions with venture capital and private equity firm Rizvi Traverse.

In February 2014 Rizvi agreed to put $25 million into the company, with an exclusive option to put as much as an additional $150 million into the company over the next six months.

After Rizvi invested the initial $25 million, it was given board representation, Jawbone says.

In following months, relations between Rizvi and Jawbone grew tense. According to people close to the company, Jawbone expected Rizvi to exercise its option to invest more money. But Rizvi balked, as was within its rights, leaving Jawbone short of cash and with suppliers and vendors disgruntled. The cash shortage also caused Jawbone difficulty in the development of its newest products, the Up2 and Up3. By the summer of 2014, Rizvi said it would not put in the rest of the money, these people said. Rizvi’s board representation was downgraded to observer status only, the person said.

Without the capital, Jawbone was forced to look for funding elsewhere.

More Glitches

Meanwhile, more product glitches emerged. Last winter, Jawbone announced it was delaying the release of its latest fitness band, the Up3, initially due to be released in November. It didn’t release the product for a further six months, missing the holiday shopping season, and when the product did come out it was missing a key feature originally promoted, the ability to function in water. The company said it began shipping the product in April to people who had pre-ordered it.

After its release, consumers began complaining. In an email to staff, Jawbone’s vice president of software Jeremiah Robison said, “We have to fix the basics,” noting problems with the device’s clasp, how consistently it synced with other devices and its data accuracy. “These issues are killing customer confidence, and until we have them resolved we will be on our heels,” he wrote. “Second, we need to expand our heart health offering to deliver a solution that covers the entirety of the day.”

“We have got to do everything we can as a company to get these products into the best shape possible,” the company’s new president, Mr. Samat, said in a separate email.

A Jawbone spokesman said the company plans to launch several new firmware updates Tuesday to address some of the issues and that it will also release new clasps for the wristband.

Mr. Rahman said that because of the problems with the Rizvi fundraising, he spent too much time away from the company and missed warning signs that there were problems with the development of the new Up devices.

He said the company is taking customer complaints seriously and doing what it can to fix the products.

As it was grappling with the Up3’s issues, Jawbone was finalizing a $300 million loan from private equity firm BlackRock. The loan is convertible to equity. According to public documents, BlackRock’s investment, called the “Series Z,” guarantees that BlackRock will recoup at least three times its investment if the company is liquidated, before any other shareholders are paid. A person familiar with the board said this provision was only in effect for one year and was designed to ensure Jawbone didn’t sell  itself off cheaply.

The BlackRock investment gives Jawbone another lease on life. And by appointing Mr. Samat to the number two position, with all the senior executives report to him, Mr. Rahman told staff in an email he wanted to strengthen the company’s coordination between research, product and engineering.

In the internal email to the Jawbone staff, Mr. Rahman said the company was entering a new chapter, one in which there are “mountains to climb to reach the Promised Land.”