Yesterday the Stanford Social Innovation Review published a 24-page supplemental section in its journal that was sponsored by the California HealthCare Foundation (CHCF) and entitled Innovating for More Affordable Healthcare. As a fervent UC Berkeley supporter it pains me to promote anything out of Stanford, but I admit this is some very interesting reading (it helps that a few of us Cal Bears snuck some editorial influence into the supplement, right Will?).
The supplement says it’s about “new ways for social investors to spur innovations that create better, stronger, faster, and less expensive healthcare in the US.” But if you read the piece as a whole, the 24-page supplement is really about how challenging it can be to bring about impactful innovation in the delivery of healthcare services and how very similar the issues are whether you are looking through a social or financial investor lens.
There are many articles in this document but a few items really stood out to me. Authors Stefanos Zenios and Lynn Denend underscore Mark Smith’s (CHCF) and Barbara Lubash’s (Versant Ventures) opening comments about how hard it is to get from a successful idea or pilot program to one that gains meaningful traction in the healthcare world. They highlight the story of Health Hero Network (HHN), which was the very first significant remote telemonitoring product for the chronically ill. Psilos had a front row seat for this story as its lead investor. One of the conclusions of the authors is that HHN ultimately suffered from a barrier to funding that limited its scalability. Actually, nothing could be further from the truth.
The company received tens of millions in funding that could easily have carried it to scale if only the company’s ideal customer, CMS, had not erected its own barrier to the company’s near-term success. In the end, CMS and other customers like them failed to commit to reimbursement for a product that had delivered savings and clinical quality results far beyond anyone’s expectations. After a remarkably successful pilot that demonstrated the product’s intrinsic value, CMS decided to extend the pilot in 2009, but after more than 4 straight years of results has failed to allow the pilot to expand to a standard of practice nationwide. In the end, they just haven’t been willing to bite the bullet and formalize reimbursement for the product and others like it despite the unarguable success. Private managed care and health system entities have also failed to belly up to the bar and provide reliable reimbursement for a comprehensive telemonitoring product/service. Why? Because who stands to gain and lose financially as a result of telemonitoring is complicated. There are clearly situations where the entity that might pay for the service is not the same one that reaps the savings and also situations where, when not paired properly with physician involvement, the service could actually cost more; these kinds of challenges make customers’ heads explode and they are an unfortunate but all too common story in the world of healthcare services innovation.
It is a remarkable but true fact that our healthcare system seems almost programmed to kill the innovation that seeks to change it, much like the immune system seeks to kill invaders, even ones that might be good for the body. In the end, the investors in Health Hero had a good offer from Bosch Healthcare to acquire the company at a time when it appeared that it could be a decade or more before the government would make meaningful headway in the reimbursement of telemonitoring technology. With all the talk of ACOs and even the specific mention of telemonitoring in the PPACA, we are not really even close to a universal plan for telemonitoring reimbursement. Interestingly, there seems to be a huge new crop of companies trying to perfect the telemonitoring service delivery model hoping that Accountable Care Organizations will see the light. My fear for them is that it never really was an issue of product, it was an issue of will. We shall see how they fare in this alleged new world order.
The Zenios/Denend article also suggests that young companies have basically two ways to fund their growth: venture financing and corporate investment. Several of the other articles in the supplement discuss foundation/social investment entities as a third. I was surprised to see little mention of good old-fashioned bootstrapping here. There are two mentions of this idea in the overall supplement, both from entrepreneurs (Bill Starling and Chaim Indig) and they are really on to something. If, as many of the supplement’s authors correctly assert, the key to growth and financing is demonstrable evidence that your service innovation works, the best way to build company value is by financing your own growth through that phase and not seeking outside financing too early. By and large the capital requirements of services companies are not that dramatic in the companies’ early life. Entrepreneurs who can build value without outside investors stand to gain a great deal as the companies grow.
We at Psilos see so many interesting services/IT companies that manage to scrape together $2-$3 million of revenue, but never quite get past that mark. One of the fatal mistakes they make is failing to build in early studies, in collaboration with their customers, that provide hard evidence that the service delivers meaningful savings. I wonder sometimes if they are afraid to find out if their hypotheses will play out in real life. All too often, when we ask for factual proof that their product delivers a meaningful return on investment to their customers (as specifically defined by their customers’ own objectives), we get an answer that sounds awfully like, “trust me, it works.” Asking a venture capitalist to trust you on this one is a little like asking your mom to believe you when she finds marijuana in your room and you tell her you’re just keeping it for a friend. We may say, “oh, ok” but we’re thinking, “dude, I may have been born at night, but it wasn’t last night.”
In his supplement contribution, entitled Reinventing Health Care Services, Dr. Arnold Milstein, a guy with a long pedigree in the healthcare cost saving trenches, says VCs are basically uncomfortable with healthcare services investing because it lacks the intellectual property protections that you can find in biotech and medical devices. I would agree that many life sciences VCs see it that way, but I believe it to be an erroneous view. With rare exception, an ingenious engineer can work around practically any patent and come up with an entirely new way of approaching a technical problem. The real reasons VCs like devices and drugs is that it is easy to see the results of your work and the acquirers have punted their R&D pipelines to the start-ups so exit opportunities are more clear. Scalpel cuts…check; take drug, tumor shrinks…check. Company X needs to best Company Y and so they buy the thing that leapfrogs them to the front of the technology curve.
On the services side, however, seeing the results of your work gets so caught up in the complexities of who owns the financial incentives and the time it takes to measure outcome that the average ADD-afflicted venture capitalist throws their hands up and runs for cover. And yet, one thing I know for sure is that the idea that great services ideas are easily copied is an epic-sized myth. There is nothing more complex than building a large-scale system that is massively dependent on customer service, financial rigor, risk management and the intricacies of juggling the needs of patients, payers and providers. If it was that easy to copy services businesses, every retail store would be Nordstrom and every coffee chain would be Starbucks. But they’re not.
Investors’ reticence about financing healthcare services companies is really a shame, because the big dollars are definitely in fixing the healthcare services/delivery system nightmare. Those investors with strong stomachs who have trafficked here have seen some pretty stellar returns. Active Health and Definity Health are two from our portfolio at Psilos. IPC: the Hospitalist Company and Visicu are other great examples.
It is definitely a good thing that CMMI, CHCF and others are stepping in with cash to support young ideas here, but there is no doubt in my mind that the criteria that the average VC looks for should really be the same ones that any sophisticated social investor would also want to use. The social investor may not care quite as much about a specific financial return-on-investment, but the things that deliver that ROI are exactly the same things that deliver the proof that a business is viable, scalable and meaningful and thus worthy of receiving their precious support. Three articles in the supplment (one by me so mea culpa, one by Physic Ventures’ Will Rosenzweig and one by Chaim Indig, CEO of healthcare services/IT firm Phreesia) sum these requirements up well: quality of management, quality of visiom/strategy and good old fashioned quality of performance. When talented, driven people do the right thing and do it well, you get results and ROI. Not exactly rocket science, I know, but sometimes people get so caught up in the magic of the idea they forget to look hard at those other “details.”
In fact, the supplement features an interview with Todd Park, the U.S. Chief Technology Officer, in which he provides a list of his 5 rules for innovators and underlines my point above. His first two rules are 1) downsize your idea and 2) pick 5 people who can work as a team to execute. While I’m not giving you his other 3 rules here, I can assure you that he does not list “boil the ocean” or “any warm body will do” among them.
The supplement appropriately closes with an interesting article about mission investing by Margaret Laws (CHCF) and John Goldstein (Imprint Capital Advisors). One point that I believe deserves more attention is that investing in businesses that serve the public sector (inclusive of the underserved populations) can be extremely lucrative. Sometimes entrepreneurs and investors shy away from healthcare businesses that are dependent on public flows of funds, but that is a mistake. For one thing, more than 50% of all healthcare is paid for by the government if you count not just federal and state entitlement programs, but also federal, state and local goverment employee programs, the VA and the military. But for another thing, it is not only the aerospace industry that has cashed in serving the public sector. Many a managed care company, pharmaceutical company, healthcare IT company has hit the jackpot by really understanding this marketplace and taking the time to know how to work their way in. There is great money to be made here if one takes the time to really understand how the money flows, who benefits and who is negatively affected and where your company can get its foot in the door. I have been involved with numerous companies, both directly and through Psilos’ investments, that have prospered greatly through serving public sector clients. Smart companies and smart investors should closely track the ideas that are nurtured by CHCF and others as there might just be a yellow brick road back there behind the house with the witch under it.
Lastly, I want to thank CHCF for including my voice in this supplement and encourage you to read it in its entirety. Good people, those CHCF folks. Plus, their CEO sends me comedy videos. What’s not to like?
Lisa, it’s nice to see that at least some investors understand and appreciate that services may be just as complex as products. As an “recovering” engineer who has worked with guidance systems for ballistic missile interceptors, ultra-sensitive photodetectors for the Space Station, and the world’s fastest (at the time) computer networks, I can honestly say that the complexities of the healthcare services world may even be more difficult to fully-understand!