About the author: Paddy Padmanabhan is founder and CEO of Damo Consulting, a growth strategy and digital transformation advisory firm that works with healthcare enterprises and global technology companies, and author of The Big Unlock: Harnessing Data and Growing Digital Health Businesses in a Value-Based Era.
Recent data from VC firm Rock Health on digital health funding numbers point to a declining trend of investments in early-stage funding, especially Series A and B. Of the 64 deals financed in Q1 2019, just four deals (or 6%) accounted for a third of the total capital of nearly $1 billion raised in this period.
Venture capital funding in digital health startups is driven by several factors — liquidity, macro-economic environment and changing risk preferences. While it may not be a perfect proxy for the state of digital health innovation, the funding trends point to underlying factors that may be holding back technology-led innovation in healthcare. I will focus on three key factors here:
The reimbursement environment
Despite the shift towards value-based care, digital health investments have to pass a “smell test” when it comes to return on investment. There is very little margin today for initiatives that cannot demonstrate tangible benefits and a relatively short payback period. Even strategically important investments, such as telehealth, are yet to show significant returns and are struggling to gain traction at the enterprise level.
A recent survey of healthcare CEOs indicates that in a margin-compressed environment, the risks and the initial investments required for digital health innovation can make it a tough choice when it comes to taking away dollars from clinical care. Recall that the digitization of patient medical records over the past decade was underwritten significantly by taxpayer money in the form of federal incentives. Not surprisingly, the CEOs in the survey expressed a need for further fiscal incentives to encourage digital health innovation.
No topic has perhaps generated more teeth-gnashing than “the I word.” After failing to ensure data interoperability between proprietary EHR systems during the passing of the Affordable Care Act (ACA) and the HITECH Act over a decade ago, the federal government has been trying to catch up. Health and Human Services and the Centers for Medicare and Medicaid Services have launched a national debate on the topic, taken vendors to task for information blocking practices and promoted standards such as FHIR in an effort to de-bottleneck the data sharing process.
However, the data interoperability problem is also partly attributable due to lack of willingness by healthcare enterprises to share data among themselves. Why does this matter for digital health innovation? Paul Markovich, CEO of Blue Shield of California, puts it this way: If digital health innovators cannot get access to the data they need, across multiple health systems, it is hard for them to scale. For VC-funded startups with a limited runway to grow and scale their businesses, the lack of interoperability adds an element of risk that could jeopardize further investment rounds and sound the death knell for the startups.
Technology and innovation risks
Innovation by definition carries significant risk, but with presumably a considerable reward if successfully executed. My firm’s work with large health systems indicates that there is significant interest in absorbing innovation into healthcare delivery processes, especially in improving patient engagement and experiences. However, healthcare CIOs are concerned about the technology risks, especially data security and privacy, that comes with startup companies. The lack of financial stability among early-stage startups is also an issue. Finally, CIOs have no desire to contract with and manage dozens of small startup companies, even if it means losing out on innovation. A path forward could be the emergence of corporate intermediaries such as Express Scripts, who recently announced a digital health formulary that aims to curate digital health startups and recommend them to healthcare enterprises.
The paradox of digital health innovation today is that there is a strong desire for innovation, but an equally strong dislike for the spending and risks involved. We may be in the midst of a natural progression in the world of startups and innovation, when periods of intense funding activity are followed by a lull, as everyone takes a pause to evaluate the state of their investment portfolios. Despite the risks and uncertainties, many startups have progressed steadily in their markets by continuing to demonstrate value, maintain the confidence of investors and, most importantly, demonstrate sustainable revenue growth. Several of them, notably companies such as Livongo and Health Catalyst, have achieved a billion dollars or more in valuations and are setting themselves up for IPOs.
On a smaller scale, there have been multiple successes from corporate innovation groups, such as UPMC and Providence Health, who have spun off some of their innovations as separate entities that in some cases have raised venture capital and exited through a sale of the business. Others, such as Jefferson Health, have set up standalone digital innovation groups that are developing superior consumer experiences and demonstrating tangible returns, often through a licensing of the innovation IP. “Think big, start small, scale fast,” says Neil Gomes, chief digital officer of Jefferson Health, and that may well be the mantra for success with digital health innovation in the healthcare sector. Additionally, an emerging factor for corporate innovation could be that healthcare enterprises are looking for incremental sources of revenue in an environment of declining reimbursements and margins for core healthcare services.
Our work with healthcare enterprises, and health systems, indicates that digital transformation is in early stages. There is a growing interest among leading health systems to look holistically and develop digital roadmaps that drive investments and innovations. It is possible that the slowdown in funding for digital health innovation may be a long overdue correction coming on the back of several blockbuster years of digital health investments and overly optimistic projections about the pace of digital transformation.
The transformation is coming and there is no dearth of innovation, based on what I see from my vantage point as a venture partner in an Angel Fund. However, the pace of transformation and the acceleration of digital health innovation will be determined by how effectively the healthcare sector can address the key factors I have outlined in this article.