In 2000, The New York Times could not have chosen a better phrase—“baby steps”—for its headline on health tech. The words aptly described not only the pace of advancement to that point, but also demonstrated great foresight on how the sector’s adoption of tech would unfold over the next decade.
By 2010, while technology progressed — social, cloud, mobile, big data, and so on — none of it had become ubiquitous within the healthcare system. In fact, the industry became increasingly inefficient; households, corporations, and the government were besieged by unsustainable cost increases while fewer and fewer people were covered. And then two landmark pieces of legislation (HITECH and ACA) arrived, designed to help usher in reforms to the way healthcare was accessed, delivered, and purchased.
In this shadow (2011–2015 or “post-reform”), venture funding of health tech companies began to grow dramatically; as a percentage of all venture funding, health tech funding doubled from approximately 4% in 2011 to 8% in 2015. Hundreds of companies were funded to “revolutionize healthcare.” By 2015, half the venture dollars went to companies started in 2011 or later.
All told, $17 billion of venture funding poured into health tech companies in the post-reform era. From that, nine companies (four private, and five that went public from 2011–2015) currently hold valuations above $1 billion; none above $5 billion. As of yet, no big health tech companies have emerged from this period.
Billion dollar outcomes are obviously non-trivial. But against an industry with more than $3 trillion in expenditures, or nearly a fifth of the country’s GDP, the success does not feel palpable. The healthcare system is not different in a way that Americans feel or recognize (like media, commerce, travel, transportation, and financial services). Today, most investors would agree that there is no large, fast growing health tech company that will remake American healthcare. One that at its terminal point, will invert the current structure.
When health tech value creation in this era is compared to the industry incumbents, it becomes even more clear that success has been heavily skewed. The collective value of large cap healthcare companies increased by $1.6 trillion, or nearly 100% (vs. S&P 500 growth of 60%) over the post-reform period. Startups have tended to focus on the existing industry value chain, wedging themselves into a place where they can shave pennies from the incumbents’ flow of dollars (many of which are simply shaving pennies themselves).
This approach is flawed and explains (in part) why there are so many struggling health tech companies; it is the key lesson of the last five years. The vast majority of startups that have focused on ratcheting the industry’s efficiency—on making it function better—limp to a meaningful size, if they ever make it. Health tech companies that want to be big will have to focus on making healthcare different, not just better.
Separated by just over a year, the Health Information Technology for Economic and Clinical Health Act (HITECH, 2009, under the American Recovery and Reinvestment Act) and the Affordable Care Act (ACA, 2010) both cited improving the quality and efficiency of healthcare amongst their major title objectives. These laws, which taken together with CHIPRA (2009) and MACRA (2015) constitute “healthcare reform,” were desperately needed. Healthcare continued to stagnate from a quality and consumer experience standpoint, while becoming more costly and less accessible.
Technology was and remains an obvious answer to the inefficiencies plaguing the industry — not a panacea, but certainly a worthy intervention. And one with the potential to improve the quality of care along the way to wringing out wasteful spending. Yet, labor productivity in healthcare had been declining by 0.6% per year for the 20 years prior to reform, directly clashing with 1.7% annual growth across the broader economy. The industry’s shared disregard for technology begat a sector that is dramatically under-digitized (McKinsey still ranks it amongst the worst-performing sectors), clearly contributing to its productivity malaise.
HITECH, seeking to accelerate technology adoption, explicitly traded more than $30 billion in subsidies for digitization in the form of electronic health records. The ACA’s technology requirements were implicit — insurers would have to become consumer-friendly while competing for their business on web-based health insurance exchanges, and providers, already subject to HITECH requirements, were pushed towards managing the total cost of care through new payment models that demanded better outcomes at lower costs.
These collective industry dynamics — a broken market that allowed spending to rise without questioning the return, a nearly complete absence of technology, and policy-driven reform — led to a belief that all of the ingredients were in place to create large, health tech companies.
So where are they?
Big game hunting
The growth of health tech funding
The private market provided more than enough access to capital to fuel building large scale health tech companies, with annual venture funding growing from $1.5 billion to $5.8 billion from 2011–2015. Investors had clearly bought the story around the potential of technology to revolutionize healthcare.
In total, $13–17 billion flowed into hundreds of health tech companies from 2011–2015. Investments poured into categories riding sector trends such as consumerization and population health management, and horizontal technology trends such as big data and wearables.
Yet, in the private market, only four health tech “unicorns” have emerged: Oscar (founded in 2012), ZocDoc (2007), Proteus (2001), and 23andMe (2006). Notably, three of these startups are consumer companies.
From 2011–2015, eleven venture-backed health tech companies went public, eight of which debuted in the last two years alone. The companies averaged slightly over $1 billion in offering value (with a combined value of $12.2 billion) and have since appreciated by only 13%, to $13.8 billion. Two companies, Veeva and Fitbit, make up nearly 60% of the total current market value.
Amongst the group, five companies are currently trading above $1 billion in market value (Veeva, Fitbit, HealthEquity, BenefitFocus, and Evolent Health), and none above $5 billion. Only four active companies are currently trading more than 5% above their initial offering prices.
Valuations of recently debuted health tech companies are depressed due to significant challenges with top-line growth. Veeva and Fitbit were the only two companies in the IPO set to best $250 million in revenue in 2015; only one additional company (Everyday Health) is expected to cross that threshold in 2016, on flattening growth.
This zone of revenue death, from $100–250 million — where growth rates decay rapidly — is the challenge for nearly all health tech companies that choose to serve incumbents over competing with them. Within this set, the median time to $100 million in revenue was 8 years from founding, with a range of three (Evolent Health) to fourteen years (Teladoc). For the companies selling efficiency software to payers and providers, the market math — selling ROI to fragmented, low margin, verticalized customers — works against the creation of large top-line tech companies. The prospects for many of these health tech companies achieving $1 billion market caps, much less $5 billion, is dire.
Evolent Health appears to have the strongest case for continued growth past the $100 million mark; it will surpass $200 million in (adjusted) revenue this year on >30% growth and a value-based care tailwind. Evolent enables something different—providers transformed into managed care organizations.
From 2011–2015, 18 venture-backed health tech companies were acquired for more than $100 million, totaling $4.4 billion in exits and an average transaction value of $240 million. The largest acquisition was made by a company from outside healthcare: Under Armour’s $475 million purchase of MyFitnessPal.
Looking across the targets, the incumbents have not been ready to do non-accretive, strategic deals that can position them for a tech-enabled future. Acquisitions by horizontal tech firms and consumer companies seeking footholds in the digital era of healthcare are accelerating. This outside-in approach to the industry is not only represented in M&A markets, but also broadly in tech, with Apple and Alphabet both investing heavily in health.
Post-reform unicorn hunting in health tech didn’t turn up many leads — four companies on the private side (including none in M&A), and five recently-debuted companies on the public side. The two major success stories, Veeva and Fitbit, were both defined by tremendous capital efficiency (and are considered outliers amongst all unicorns); investors do not believe that they validate the health tech space. Veeva is seen more as validating Force.com, while Fitbit validated connected devices.
Where $1.6 trillion in value accretion happened
As annual healthcare expenditures rose by $600 billion from 2011–2015, surpassing $3 trillion annually, the incumbents were perfectly positioned to accumulate value. Large cap healthcare firms, consisting of managed care organizations (MCOs), pharmaceutical benefit managers (PBMs) and pharmacies, drug wholesalers, biopharmaceutical companies, medical device companies, and diagnostics providers saw their aggregate market value nearly double to $3.3 trillion (95% growth), outperforming the S&P 500 (61% growth) over that time period by more than 50%.
LIFE SCIENCES VALUE GAINS
From 2011–2015, biopharmaceutical companies had their most productive stretch in decades, with 182 novel molecular entities (NMEs) approved in the U.S. And with new drugs in hand, the innovators extracted their rent — spending on prescription drugs in the U.S. grew by 12.2% in 2014, the largest annual increase since 2002, following over ten years of moderating year-over-year spending increases.
This era (2011–2015) encompassed three of the most productive years for the biopharmaceutical sector in the last two decades. And the pace of new drug approvals is not expected to abate, with CVS Health forecasting up to 200 additional FDA approvals over the 2016–2018 timeframe, while drug spending approaches $400 billion.
MIDDLEMEN VALUE GAINS
The industry’s middlemen — the managed care organizations, PBMs, pharmacies, and drug distributors that pass medical and drug costs from suppliers on to buyers while keeping a markup for themselves — grew in value by $347 billion (136%) primarily by watching continued growth of health spending and sitting idly in the spread.
MCOs are exceptional at this strategy, nearly tripling overall prices (significantly outpacing GDP or wage growth) while net customer growth stagnated. Overall, price increases (vs. customer growth) drove 95% of the growth in sector revenues from 1995–2014. In spite of doing little to control prices, the cost to administer health plans (the net cost of private health insurance) also tripled, rising from $39 billion annually (or $210 per person) to $122 billion ($643). Essentially, MCOs have declared there are no administrative efficiencies, only taxes.
For whatever success health tech companies did have during this era, it amounted to a rounding error relative to the incumbents. Looking back, it is clear that the existing value chain of the industry — where dollars flow from households, corporations, and the government through the pipes of medical and drug payers, ultimately depositing in the sinks of the suppliers (providers and life sciences companies) — was the real winner, by a long shot.
How does ‘different’ look?
A few ideas
The problems with unrestrained growth in health spending are not limited to the disastrous consequences on households, corporations, and the government. For the healthcare industry, rising expenditures have masked serious underlying issues in their businesses. The ability to pass price increases on indiscriminately has created free growth, atrophying an efficiency muscle that is nearly impossible to rebuild as this practice comes to a halting conclusion.
Incumbents are necessarily reaching a point of inflection. The challenge is not that health expenditures will suddenly decline (in fact, they may reach past $5 trillion annually over the next decade), but that their performance has been so historically poor, buyers are now deeply scrutinizing every price increase and desperately seeking something different. In the face of this, many firms are proving to be strategically bankrupt, grasping for horizontal mergers and tax inversions in order to wring out any remaining profit growth.
The real work, of innovating on the way health outcomes are improved under hard cost constraints, how networks are constructed, and the way people access the system is out of reach for established firms. This is the big opportunity for health tech companies—freeing the value that has been amassed within the incumbents by building a different healthcare system.
Over the last decade, biopharmaceutical companies have shifted R&D budgets away from primary care and towards high margin specialty drugs. Ceding ground on the major lifestyle-related chronic diseases of our time makes sense for them—significantly outperforming generics (in order to justify a new brand’s pricing) is a huge R&D challenge, especially when the largest addressable markets, including cardiovascular disease and diabetes, are deeply affected by individual behavior, not solely biology.
Significant gains in outcomes across these disease areas are more likely to result from grinding out the critical health maintenance tasks that avert unnecessary complications and care, and from scalable behavioral interventions. These domains play to the strengths of tech companies — they require sophisticated use of data (for continuous measurement, stratification, and personalization), collaboration tools (for intelligently dividing maintenance work across people and locations), telehealth and AI (for scale), and the development of consumer mobile products (for engaging individuals more days than not, over extended periods of time). In this model, the difference is that drugs are adjunctive commodities to reorganized healthcare services and digital programs.
For the companies that directly improve health, the goal is to own the outcome from a product and financial standpoint. To own an outcome, products need to be reliable (i.e., backed by rigorous evidence), attributable (i.e., extend deep enough in the medicine chain of diagnosis to intervention so the improvement is credited), and defensible (i.e., the outcome improvement is novel and cannot be readily copied by competitors).
If a company is able to do this, and takes on risk (utilizing either shared savings, or outcomes-based pricing), then the pathway for creating a large company becomes clear; the addressable market denominator is potential savings on global spend (and spending growth) by person or disease. Companies may organize horizontally against people (e.g., Aledade) or vertically against disease (e.g., Omada Health). This efficiency-based alignment, where companies win by saving money (instead of inflating prices), represents an entirely different model of value capture.
Strong middlemen generally add value to one or both sides. In healthcare, the market-leading MCOs and PBMs have grown to be despised by both sides. And it is not just these two actors; middlemen exist everywhere in the healthcare industry, eating off spread and perpetuating opaque pricing. The inefficient submarkets within healthcare (beyond medical care and drugs) are too numerous to enumerate—markets for clinical trial participants, professional labor, medical equipment/supplies, and even health data itself to name a few.
This has created a broad attack surface for new entrants, who can not only pursue opportunity from either angle, but also head-on, as companies start as full stack middlemen (e.g., Oscar, Collective Health, Clover, Bright Health). New full stack suppliers (e.g., providers such as Iora Health and pharmacies such as PillPack) could also contract directly, bypassing middlemen that do not add value.
Intelligent networks (supply side). As suppliers gain the capabilities that enable high performance around quality, coordination, transparency, convenience/accessibility, and consumer experience, they become better positioned to contract directly with the buyers demanding this performance. The companies that furnish these capabilities (or operate networks themselves) should pay close attention to the opportunity to unbundle network management from MCOs within specific domains. By shifting risk towards suppliers, MCOs are also actively leaking capabilities towards the supply-side, reducing their own value proposition to buyers and further accelerating direct purchase models.
If networks continue to be managed, they must operate more like telecommunication networks than toll booths. It’s likely that future network managers will have a real-time, continuous connection to supplier information via clinical data. This connection can enable routing of data in the network and collective learning, while also abstracting the requisite clinical data for payments under new contracting models and removing that administrative burden from suppliers.
Permissionless consumer (user/buyer side). On the opposite side of the suppliers are the individuals who use the healthcare system (and represent anywhere from 0–100% of the actual buyer). A growing segment (37% of non-elderly adults) is now under high deductible health plans (HDHPs), paying out of pocket for most of their healthcare services. Narrow networks, pre-authorizations, referrals, and every other rule invented by MCOs to restrict unfettered access to care will necessarily be limited to the highest cost scenarios—HDHPs imply no first dollar coverage, and thus no need to ask for permission. This looming shift (when consumers realize buying insurance is now distinctly separate from buying healthcare) has created an opportunity to establish new consumer relationships and access models for the expanding set of out of pocket categories.
Companies that take advantage of new technologies to enable different ways to access and pay for healthcare—empowering consumers to self-diagnose their conditions, self-direct their treatments, and choose service/product providers, with a maniacal focus on affordability, transparency, and experience—will not only squeeze MCOs towards managing only catastrophic care, i.e., acting as actual insurers, but will also challenge the traditional role of providers as intermediaries. Healthcare will be different when consumers enjoy a technology-mediated experience that speeds their path through the healthcare system via alternative routes.
Different is easy to criticize; it doesn’t play to the current power structure, operate within existing workflows, or assume behavior is static. And while that makes different effortless to recognize, it also makes it challenging to evaluate whether it will succeed when there is no pattern or historical winner to model.
Hundreds of health tech companies, funded by billions of dollars, form a wealth of data. Simply being better—servicing the existing industry structure—has not been a path to success. In fact, it has bred a lot of companies designed to serve a broken market that continues to grow in size and power, ultimately only pushing the system forward incrementally.
Rather than trying to improve them, the most exciting health tech companies will ignore the parts of healthcare that have become obviously anachronistic, actively discarding convention. The seeds of this difference have been sown in a handful of companies started in the last few years. They are painstakingly taking relationships from incumbents, winning with deflation, and making healthcare markets more efficient. A different healthcare system will inevitably be created.
Over the last few months, I have taken time off to reflect on the health tech space, and I am excited to start sharing what I have learned and begin a conversation. I’d love to hear from you if you have feedback, or if you are contemplating starting or joining a health tech company.
 Viewed under the lens of results versus passage of laws (HITECH and ACA), post-reform is a misnomer. Only by the end of 2015 had:
- 95% of hospitals and 56% of physicians adopted EHRs (vs. 9% and 17%, respectively, in 2008)
- Medicare reached $117 billion in value-based payments (vs. “practically zero” in 2011)
- Accountable care organizations covered 23 million individuals (vs. 2.7 million in 2011)
- 13% of adults aged 18–64 remained uninsured (vs. 20% in 2013)
- 12.7 million Americans shopped on the Health Insurance Marketplaces (vs. zero in 2013)
MACRA will be similar; despite being passed in 2015, we will not begin to see its effects until 2019.
 Though not publicly reported, it is likely that Flatiron Health is also a health tech unicorn. Jawbone could potentially be considered a health tech unicorn; however, it is unclear how much of the company’s value is related to wearables.
 There are at least eight publicly-traded health tech companies trading above $1 billion, that either held IPOs before 2011 or were not venture-backed; this group is led by Cerner, which is valued at $18 billion.
 As a major stakeholder in the healthcare industry, provider organizations are notably absent from the discussion of incumbents in the post-reform era. While the overall provider sector has accreted significant value from 2011–2015, the gains are widely distributed across highly fragmented, local entities. The three large cap provider organizations that were publicly traded at the beginning of 2011 increased in value by 86% to $53 billion by the end of 2015. This figure is not representative of the absolute value gains in the provider sector, where annual spending on hospital and physician services alone increased by over $300 billion from 2011–2015.
 More than 75% of this aggregate, $1.6 trillion increase in value was driven by life sciences companies versus the middlemen, although middlemen grew more (on a percentage basis) over the time period. The factors underlying this base level of disproportionality are driven by two major factors:
- Direct impact on health. Novel products developed by the life sciences sector directly improve human health. Middlemen primarily act as an administrative tax (whether the tax is value-add or not depends on who you ask) on the delivery of the healthcare services and products that improve health.
- Global reach. Improving health is a global business. While the U.S. prescription drug market is the world’s largest and most important, it still represents less than half of the overall market for biopharmaceutical companies. The middlemen operate predominantly within the U.S., capitalizing on special market dynamics.
 Inorganic growth has played a role in value creation for the middlemen group as well. Amongst this group, over $50 billion in large cap acquisitions occurred from 2011–2015; PBMs/pharmacies/drug distributors have explored various forms of vertical integration; and the five national managed care organizations are attempting to shrink to three.
 The opposite will be true across a number of specialty areas, where there is still a tremendous unmet need for innovative drugs. It is likely that the lines between digital and non-digital therapeutics will blend together into holistic molecule/digital disease solutions, where the value is split based on the relative degree of commoditization within each component part.
 Historically, network performance has been defined simply through unit prices (in industry parlance, “discounts”). Performance on this definition has strictly been a function of the MCO’s scale versus the supplier’s. As performance definitions broaden to evaluate the total output (in the form of health outcomes and consumer experience) relative to the total cost, the importance of unit service/product pricing begins to diminish.
 Think of Doctor on Demand operating a low-acuity telemedicine network that is accessible to employees regardless of the employer’s choice in plan administrators or One Medical operating a primary care network accessible to consumers regardless of their health insurance carrier. Additional examples can be found in specialist care (both surgical/non-surgical), post-acute care, home health, and others. Low efficiency performance has forced buyers to begin seeking “best in class” solutions, causing the creation of niche, high performance networks. The obvious problem (and opportunity) this creates is the need to aggregate these unbundled networks into a seamless experience for users.