Black Swan or Ugly Duckling?

I have heard a few people refer to the COVID pandemic as a “Black Swan Event.”   This concept – if you don’t know it – has been around since the 2^nd Century but came into common parlance more broadly when Nassim Nicholas Taleb wrote his popular books called Fooled by Randomness and The Black Swan in the early 2000s.  Here is Wikipedia’s definition:

A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black swan events are characterized by their extreme rarity, severe impact, and the widespread insistence they were obvious in hindsight.

It is a good description of the pandemic in some ways, because it’s hard to have a conversation about the pandemic without someone eventually saying, “We should have known…everyone expected a pandemic…blah blah,” even though we all know this to be false.  There were certainly some smart scientists predicting it, but the world at large was going along just fine believing that all was well.

Fun fact: the term “black swan” started as a reference to a mythical animal, presumed not to exist because no one (or at least no one who declared themselves in charge) had ever seen anything but a white swan.  It’s kind of like the people who were pretty darn certain the earth was flat, until they were proven wrong.  It’s that very point of an “absolute truth” being disrupted by facts that makes the black swan concept what it is.

According to author Taleb, here are the key factors that cause something to qualify as a black swan event:

“First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme ‘impact’. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable. “

Now let’s turn our attention to another story, this one told by Hans Christian Andersen.  Remember him?  He was a 19^th century Danish storyteller who wrote things called “books” before the advent of Netflix and HBO Max.  One of his best-known tales is The Ugly Duckling, which is the story of an altogether different swan – one who starts life thinking he is an ugly duckling swimming among beautiful fluffy chicks but who finds out later that, actually, when he gets a good look at himself in the reflections of a pond, he is actually a beautiful, graceful swan.  In other words, he finds in himself the “…dignity and worth, moral and aesthetic superiority” which are “determined by nature rather than accomplishment, according to Maria Tatar, the author of The Annotated Hans Christian Anderson.

So why all this swan storytelling, you ask?  Ok, let me draw you the thread I can’t get out of my head…

Every day I am asked whether there is a digital health bubble.  I get asked this by other VCs.  I get asked this by companies large and small. I get asked this by colleagues who are consultants, lawyers, journalists and all types of people who are, in one way or another, hanging around the digital health hoop.  And every single time, it creates for me a swan-like vision.  Here’s my thinking.

Before the pandemic, there was already a rising tide of entrepreneurship and investment in digital health.  Year after year the number of companies launched, the amount of money invested, and the lofty state of valuations was on the rise.  You know what wasn’t really on the rise? Adoption of digital health technologies.  Everyone on the creator/investor side was betting on the come.  If you are not a craps player (my absolute favorite game in Vegas), you may not know that this is where that particular expression comes from.  Urban dictionary does a great job defining this term:

“Betting on the Come” is derived from a gambling expression and means you don’t have what you want or need, now at the moment; but, you are betting or hoping you will have what you want or need when the time come.  For example: He thought he would win the lottery but he was just betting on the come.

So, when the pandemic hit, the Come line hit; in other words, winner, winner, chicken dinner, as one might say at the craps table.  Digital health companies suddenly had an avalanche of new business which they had never really had before.  Telehealth flourished, a thousand virtual health companies bloomed, digital mental health companies began sprouting out of the earth like those 17-year cicadas into a world where everyone was willing to pay by the bug.

So, is there a bubble if everyone in the world has suddenly got digital health religion, not just people who start and fund digital health companies?  Well, that’s an interesting question.

If you ask those who start and fund digital health companies, they should not believe that the pandemic was a black swan event on the digital health front.  They were already betting on the explosion of demand in the face of…not so much.  Clearly this surge was not “outside the realm of regular expectations” if one goes by the working definition.  If digital health cheerleaders weren’t already true believers, why are there so many companies with so much money at such high valuations?

Furthermore, to fit the “black swan” story, the event has to have an extreme “impact.” I am wondering about this one.  We have seen a lot of digital health proliferation, but that was happening with or without the pandemic.  There has been an impact, for sure, but extreme?  Nah.  The storm was already gathering for years as digital health investment momentum and valuations that start with “$B” for wildly unprofitable companies were already everyday occurrences.  Granted, everyone is talking about a mythical beast – in this case a sparkly unicorn, not a black swan—but they were not even mythical pre-pandemic, just not as prolific as those damn seagulls at the ballpark.

Which brings me back to Hans Christian Andersen.

As the pandemic is moderating in the U.S., even receding in some lucky spots, we are starting to see some moderation on the digital health front too, or at least people are thinking about the role of technology a tad more thoughtfully, at least upon occasion.  There is a slight receding of telehealth usage and some clinical operations have even declared their willingness to conduct business by video as history, or at least partially so.  I am sure we won’t ever go back to the fundamental lack of use of digital health that we saw pre-pandemic, but it also seems likely that there will be a pull-back/right-sizing/moderation/questioning of when these products are best used and when they are overused.

The ugly duckling (digital health) that no customers really wanted to pay for in early 2020, has had a chance to look at its own reflection and it really likes what it sees.  If you listen closely, you can hear it: ”Damn, I’m hot!” “No one can live without me!” “I am the chosen one!”  Those that live in the digital health world (again, primarily entrepreneurs and investors) are even more highly confident of their beauty, worth, and “moral and aesthetic superiority” than ever before (god help us).   And the true believers are right in many respects – without their products, the pandemic would have been even worse for many.

So now the question is this:  Should everyone on the digital health pond legitimately feel this darn good about themselves post-pandemic, or will some look at their reflection and see that they have morphed back into ugly duckling mode?

That ugliness could take lots of different forms.  It could come in the form of declining utilization, declining valuation and, already floating by on a pond near you, inability to thrive as an independent company.  The M&A mill is already spinning hard at the far end of the pond, as some who managed to fight their way to the top of the swan pile are taking advantage of the weaker, less fancy swans.  You may not know this, but swans are notorious for committing acts of aggression against other swans.

I am particularly wondering about how this will all play out with health systems. Still reeling from epic revenue shortages (no pun intended) and massive patient backlogs, with a soupcon of cybersecurity nightmare sprinkled in, how will their buying behavior change, if at all, over the next year or three?  A few notable statistics:

• The pandemic projected to cause $320 billion in hospital revenues to disappear in calendar year 2020 and they are on track to lose $53-$122 billion more in 2021
• Health systems expect 15% shortfall in annual revenues, with almost one-fifth of executives projecting a shortfall of 30% or more.  (Source: Guidehouse/HFMA survey )
• Estimated that about 8% of all physician practices nationally, which actually equates to about 16,000 practices, had to close under the strain of the pandemic (Source: Kaiser Health News/Physicians Foundation)

Traditionally, the majority of digital health offerings funded have been targeted to sell to the healthcare system buyer universe.   Yikes.  We are seeing dramatic increases in funding for what I might term the “alternative to traditional health systems” provider community, so that may help, but it will be an interesting show to watch. And if the traditional health systems make any purchases, it’s going to be only for things that improve their top and bottom line in a very tangible, very immediate way.  The pandemic may well have been the black swan event that causes the traditional health system world to start down a slippery slope where new upstarts and non-traditional provider entities, including payer-owned provider organizations, step into their shoes (hopefully they will be a well-fitting, high quality pair of shoes if that happens).

I see early signs of a transition of digital health interest away from provider/clinical products and towards administrative/back office/IT-like solutions (e.g., to manage supply chain, clinical trials, etc).  If this happens in earnest, the swan-like self-confidence of many may be impaired by the foggy reflection back from the pond’s surface.

In any event, as one of those people who has lived in both the entrepreneurial and investor side of digital health, I have contributed my fair share of support to the wild flock we are currently watching fly by.  But I think it also pays to remain cautious, even if optimistically so, rather than get too wrapped up in our own pretty visage.  Digital health for the sake of digital health is not going to get deny its ugly duckling past for long.  Solutions need to be meaningful and must meaningfully demonstrate they improve cost, quality and outcome (clinically or operationally).

Remember that sentiment about “…dignity and worth, moral and aesthetic superiority” which are “determined by nature rather than accomplishment (see above)?  That’s the risk.  In business success, ultimately there is nothing persistent which is determined by nature that doesn’t eventually also derive from true accomplishment.  Ye Olde Fundamentals will eventually come home to roost.  And when they do, it will be essential to have built and funded businesses that can and have proven value.  It will not suffice just to prove that they aren’t mythical.