“A Giant Hairball of Perverse Incentives…”

The best thing about going back to school is to think big thoughts, immerse oneself in what the great academic minds are ruminating over. This past weekend Harvard Business School hosted its annual healthcare conference for students and alums, and fortunately for us, some of the great faculty were on hand to share their views on the state of the healthcare industry. The quote above was the opening comment from the breakfast keynote by Prof Bill Sahlman, one of the best of the best!

While we all lament the fundamental conundrum that competition has not led to an improvement in quality at lower costs, which is the phenomenon experienced in every other industry vertical, the business of healthcare is now facing arguably the most profound transformation in modern history. But most troublesome were Prof Sahlman’s observations around the true costs, not yet acknowledged, to society due to this tragic paradox. Today the outstanding federal debt is over $17 trillion; the unfunded Medicare and Medicaid liabilities are estimated to be $30 trillion each, so a total of another $60 trillion of additional obligations – not recorded on the country’s balance sheet – sit out there due to the societal pact to fund healthcare costs for all citizens over 65 years old.

A couple of other fun facts and observations from the morning session:

• An employer-based healthcare insurance system obviously has left a lot of people uninsured
• At 18% of GDP, this implies $4,000 – $5,000 higher health costs per citizen than other developed societies; higher costs with more modest outcomes. This dynamic clearly hurts the global competitive position of the US
• The third leading cause of death is due to faulty medical care – ouch!
• Fundamental misunderstanding of the current reform debate is that we have modestly reformed access to insurance, NOT healthcare services – big difference
• And what are considered the greatest needs in healthcare today according Prof Sahlman? Greater transparency of costs and outcomes which need to be readily accessible, and a re-engineering of where healthcare services are delivered

This event also attracts CEO’s from leading healthcare franchises, and as such, we were privileged to have Mark Bertolini (Aetna) and John Brooks (Joslin Diabetes Center) address the audience later in the day. The juxtaposition of having a provider and then payer share their visions of the future underscored the “jump ball” around who will own the consumer/patient. Both view a very “patient centric” delivery model, enabled by many of the highly disruptive, highly innovative platforms which will enable these new and deep patient relationship to be fostered (frankly the types of companies my new fund at Foundation is investing in).

Some more fun facts from Mark Bertolini, who by the way if you have not heard him speak, make a point of doing so – he is great.

• According to the Institute of Medicine in 2009, 27% of the $880 billion of medical spend was unnecessary; 17% of that was on inefficient care delivery; and, 10% was considered fraud – staggering waste and inefficiencies
• In 2020 Bertolini expects there will be 75 million people on retail commercial insurance exchanges
• When asked about his strategic priorities, quite surprisingly he pointed to the need to enable providers to underwrite risk (be insurance companies?), foster greater sense of community by facilitating public/private exchanges and then drive hard on an integrated “digital experience” – very provocative and forward-thinking
• Worst 5% of the US population consumes 43% of healthcare spend – the two greatest costs are attributed to heart failure to people over 85 years old and end-stage renal disease for those under 65 years old
• Arguably better social safety nets (i.e., better education and healthcare systems) will lead to greater peace of mind, which leads to greater consumption rates and lower savings rates
• Medical device companies will soon be confronted with greater burdens to prove that their devices actually lead to better outcomes which is ostensibly measured by keeping people out of the hospital, thus Aetna’s work with Medtronic on taking data feeds from pacemakers to better monitor for cardiac incidents – before they occur
• The iTriage initiative with CVS – mobile apps to manage one’s entire healthcare needs – is borne from the realization that better quality is mostly correlated to convenience
• Bertolini’s best quote: “Give up control to get power…”

John Brooks, CEO of Joslin, had an equally expansive vision which is very focused on providing an extended care model driven by highly innovative technology platforms. The epidemic of diabetes demands close and regular patient engagement – better longitudinal care earlier can have enormous benefits – which is the real power of the “connected health” models.

All of this opportunity/confusion in the marketplace is reflected in recent financing data. In addition to the dramatic spike in overall healthcare tech investing, valuations have moved meaningfully over the course of 2013…

• First round pre-money valuations from 2012 through 3Q13 decreased from $7.1 million to $4.8 million – perhaps a reflection of the increased start-up activity in this sector and the risk of too many undifferentiated companies – just a guess
• Second round pre-money valuations from 2012 through 3Q13 remained essentially flat – $23 million to $22.5 million
• While Later Stage valuations from 2012 through 3Q13 jumped from $54 million to $64.7 million, which undoubtedly reflects some of the “break-out” winners and increased IPO and M&A activity.


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Some 2014 Predictions….

So I wanted to come up with some 2014 predictions – nothing fancy or too controversial – but hopefully somewhat thought provoking…

  •  IPO’s: This past year witnessed an extraordinary resurgence in IPO activity for venture-backed companies. It felt much like 1999 right before the crest of the wave. With modest growth, unsustainably high valuation multiples, little excess left for Corporate America to cut, profit margins are maxed out which makes the next 12 months feel very much like the year 2000. While it will not be such a disaster, clearly the pace of last year simply cannot be maintained. Even raging bulls need to stop and smell the roses once in a while.
  • Fundraising:  Very strong liquidity to LP’s in private equity and venture funds give them increased confidence to continue to increase – albeit modestly – allocations to the asset class. Notwithstanding every investor’s claim that they only invest looking forward, past performance (i.e., distributions) continue to fuel fundraising. Unfortunately the rich continue to get richer as established firms find it relatively easy to raise new and larger funds causing the overall roster of investment managers to continue to shrink.
  • Crowdfunding:  This form of financing continues to play an important role for start-up’s, although admittedly, mostly around the margins. The crowdfunding phenomenon simply does not have the heft to lead Series B and C rounds. And furthermore, in addition to capital, great entrepreneurs are also looking for great business partners in their investors. The risk here is that there will be a spectacular scam and Senator Warren and others come down hard with new consumer protection laws which chill the marketplace. Disaster scenario: some desperate African Prince just needs $10M more in Bitcoins to fund his next great widget…and he actually raises the “money!” – never to be heard from again  
  • Healthcare Technology:  Out of the carnage with the introduction of health insurance exchanges comes the broad and irrefutable realization that the healthcare industry simply must be fundamentally re-architected. Novel and innovative business solutions lead the way to greater efficiencies and productivity. Ironically improvements in healthcare at lower costs accelerate across society as more people get access to affordable care at the right time, right place. With this phenomenon comes the growing appreciation that extraordinary near-term societal benefits can be achieved and may even outweigh any distant future benefits hoped for with continued massive investment looking for the next great therapeutic or medical device.
  • Sports Grand Slam:  The Mets win the World Series, the Knicks win the NBA Championship, the Giants win the Super Bowl and the Islanders win the Stanley Cup.

Now you know I have no idea what I am talking about…


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An Interesting List….

Every year for the last nineteen years I have spent the final week of the year with a dozen of my closest friends (now there are also 14 children in our group) – some of these people have grown up to be real serious business executives! We reflect on the year just concluded and then prognosticate about the next 365 days. There is always a lot of smack talk which makes for a very entertaining week. One of my closest friends in the group is a senior partner at a leading Wall Street firm. The list below – much of it collected from various experts across his firm – captures many of the highlights for 2013. It is actually quite bullish – and not all of it is business related. Enjoy!

  •  The stock market did not turn negative (on a rolling YTD basis) at any point this year; that has only happened ten times since 1928
  • The total return of S&P since the March 2009 lows is 202% 
  • S&P added $3.7 trillion of market capitalization in 2013 to reach $16.4 trillion
  • US companies will earn close to $2 trillion this year, up 250% since 2000 
  • Excluding financial companies, US corporate cash balances are up 70% since 2007 
  • Twenty years ago, only 200 S&P companies repurchased stock; in 2013 that number was 425
  • Approximately $1.3 trillion of capital flowed into bond funds with 10-year notes yielding less than 3%
  • Global private equity dry powder is estimated to be $404 billion 
  • Rough math: the trend of household formation is 1.2 million units/year with nearly 300k of demolitions, which means that we need to build around 1.5 million homes (housing starts are running around 900k)
  • Texas is now producing more oil than the US imports from the Middle East 
  • Average value of farm real estate in the US has nearly doubled since 2005
  • The FDIC has taken control of nearly 500 banks since the financial crisis began in 2008 
  • Warren Buffett’s overall gain from 1964 through 2012 is 586,817% while the S&P increased 7,433%
  • EBAY sells nearly 10,000 cars a week on its mobile app
  • Over 400 million cups of coffee are consumed each day in the US 
  • Americans work 8.5 more hours per week than they did in 1979
  • From the 1992 highs, Chinese stocks are up ~ 50% while US stocks are up ~380%; over that same time period, Chinese GDP has grown 17 fold  while US GDP has grown 1.7 fold
  • Over 50% of start-up companies in Silicon Valley were founded by immigrants
  • The European Central Bank hiked rates in 2008 and 2011 – true story 
  • The Eurostoxx 600 index (SXXP) is up 17 of the past 19 months 
  • The corporate tax rate in Japan is 50% yet 70% of Japanese companies don’t pay taxes
  • Most all-time playoff wins by an NFL quarterback – Tom Brady (17)
  • Most all-time playoff losses by an NFL quarterback – Peyton Manning (11) 


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Hong Kong is on Fire…

Not literally but it might as well be given the smog in the air last week. Locals attribute it to the coal plants in Southern China and others say it is because of all the cheap fuels being burned by the hundreds, maybe thousands, of container ships and junks crowding the harbor.

But it all seems to work. An economic system with seductively lax rules, unfettered entrepreneurial spirit and no capital gains tax (!) continues to amaze me whenever I am back “home” (I spent much of my teenage years living there). While there last week I met with a number of local investors and asset managers – it is always energizing to see how excited they are to be operating in the shadow of China. Thought I might share just a few of my observations and highlight some of the recurring themes from those conversations – and close with a big insight:

  • Everyone is looking to expand into the numerous frontier Asian markets, especially China. No surprise there but people are also talking about Myanmar and Mongolia (apparently the miners in Mongolia are absolutely killing it). The other two most talked about countries were Malaysia and Thailand.
  • With this diversity and fragmentation many found the landscape confusing and chaotic. The laws and financial regulations in many of these regions are unclear, undocumented, inconsistent, poorly enforced yet the growing financial assets and wealth is intoxicating. I often heard comments that “we just have to be here.”
  • Consistent with the above, there was much discussion about distribution and access. Hong Kong, after much concern with the hand-over back to China in 1997, continues to be the undisputed gateway to China. But there was anxiety on how best to access (i.e., sell to) the emerging Chinese middle class. The definition of the mutual fund laws are under active debate now in Hong Kong. Today most mutual fund products are sold through less than a handful of local Chinese banks.
  • Surprisingly some fund managers saw the rise of social media as an important customer acquisition tool.
  • Local tax laws in China – a mess. Capital gains laws are still not resolved.
  • A lot of discussion around brand and the legitimacy of a US brand. Brands in the US have been imbued over many generations with attributes of trust and strength, but they today have no value in many emerging Asian markets.
  •  With the “one child” policy China is confronted with real challenges on best to support an aging population which has modest financial assets set aside for retirement. Pension systems are being overhauled and minimum contribution levels are being increased. Fortunately, when compared to the US, China and many Asian countries have consistently greater personal savings rates.

The subtext to all of this is the unspoken gradual transition of a population from having to rely solely on the state for all of one’s needs. That is what I find so fascinating with the maturing of the financial markets in Asia. With sophisticated new investment products, and with greater understanding of how these products are meant to work, the state is gently moving people to be increasingly self-reliant and empowering them to manage more of their own well-being.  


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Land of the Setting Sun…

With no disrespect to Japan at all, the population is aging so quickly, that new healthcare technologies must be deployed to navigate this dilemma….  

Over the past four days I have been meeting with government officials and executives of some of the leading healthcare companies in Japan (I am traveling with Governor Deval Patrick of Massachusetts as he promotes the extraordinary healthcare technology community in the Commonwealth). Meeting with Japanese leaders who are tasked with solving many of the same problems we have in the US – aging populations, role and costs of advanced medical technologies, novel insights into disease progression, etc – has been fascinating. But the Japanese have a unique set of challenges which profoundly defines their healthcare technology agenda.

First some context. Many entrepreneurs I met with this week talked about the “Lost Two Decades” of economic vitality. Imagine an entire generation experiencing nominal economic growth – how dispiriting, and frankly, quite damaging to the entrepreneurial community. Notwithstanding the current genuine enthusiasm for Prime Minister Abe’s economic policies to finally spur demand – “Abenomics” recently levied a 3% point increase in national sales tax rate concurrent with the pending termination of a massive $130 BN fiscal stimulus program – early results are mixed. Recent quarter trade balances swung to a deficit as import growth spiked. Many of these initiatives are structured to address the extraordinary levels of government debt which looms frighteningly over the rapidly aging population. Real income per worker is falling quickly which makes the future cost of healthcare more daunting to the next generation.

It is this economic background which now frames the healthcare technology agenda. Often executives in Japan referred to their society as a “super aging” society. Some analysts forecast that two-thirds of the population is older than 50; in 1970 that would have been well below 20%. In urban centers 18% of the population is over 75 years old. There does not appear to be significant investment in new hospitals, and given it costs roughly one-third to provide in-home care, new technologies are being deployed to both rationalize healthcare costs and improve remote care.

Due to recent natural disasters like the earthquake that crippled the Fukushima nuclear facilities, and the ever-present threats of future disasters, across the country the Japanese healthcare system is encouraged to provide more innovative and distributed care coordination systems. For example, nearly three years since the devastating tsunami hit Ishinomaki City, one third of the residents still live in compromised housing. This is exposing a debilitating set of social costs as well – 40% of residents have experienced a reduction in household income, 25% are reporting social issues, and 6% are at imminent risk of suicide.  

The healthcare priorities most referenced in Japan this past week tended to center around a few key themes:

  • Connected Health:  given the demographics cited above, lack of hospital capacity forecasted, and the constant fear of the next natural disaster, distributed systems to manage patients are paramount. Being able to provide “end-of-life” care in the home, manage patients in a rapid response manner, intelligent remote monitoring all appear to be top of mind with healthcare executives. Industry leaders demonstrated a wide range of platforms from voice activated psychological assessment tools, “quantified self” peripherals (wristbands, sensors, etc), to a “check-up” toilet by Toto – not kidding, Toto has developed a medical screening and monitoring system which is used exclusively in the bathroom – the ultimate connected device.
  • Robotics:  Not surprisingly, given strength of the Japanese robotics industry, there were numerous fascinating robotics platforms on display from motion-assist systems (like the “robot suit”) to rehabilitation devices.
  • Personalized Medicine:  But not necessarily in the manner VC’s in the States but think of it. There is the concept of “Me-Byo” which is a continuum of one’s state of health from “Healthy to Sickness.” New care models are forming which rely on more sophisticated IT infrastructure and are data centric and tend to be very consumer-centric (mostly app’s).

There was little discussion around predictive modeling and population analytics which is all the rage in the US today, in part driven by the advent of accountable care and the new healthcare insurance exchanges. The Japanese have a Universal Health coverage system which in 2016 will adopt a universal identifier numbering system which will serve as both one’s social security and tax ID; once this has been rolled out perhaps we might expect to see a greater emphasis on population management tools.

Only around the periphery of conversations was there discussion of a more holistic, population-centric approach to Japanese healthcare.  It does increasingly appear that there is a movement toward (as John Halamka, CIO of Harvard Medical System suggested) a system that is a health care system, not a sick care system.

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Big Data to Make Boston StreetSafe…

This is not just another Big Data story. Or just another post on innovation. Or another good read on entrepreneurship. But it does touch on all of those things. And it shows the very real impact innovation and big data can have on our lives.

A few nights ago I walked some of the toughest Boston neighborhoods with Ed Powell, the Executive Director of StreetSafe Boston, meeting former gang leaders. StreetSafe is an organization which puts young caseworkers on the most violent streets in Boston to intervene in gang activity – literally standing in the line of fire. Ed is a real inspiration himself, having grown up in these same neighborhoods.  The brilliance of this start-up is to focus resources directly at one of the most disturbing problems facing our cities today – kids killing kids. You see, Ed has recruited his own gang – a team of counselors, some of whom are former gang leaders (whom he calls “street workers”), to connect with current gang members to re-direct them toward job training and other social services. After a shooting in these neighborhoods, Ed’s “gang” is up most of the night literally preventing further retribution violence.

That night I learned a number of troublesome and distressing facts about Boston’s gang situation.

  • 70% of shootings in Boston happen on only 5% of the city’s blocks so the problem is readily identifiable.
  • One in 100 of Boston’s youth belong to gangs; those kids account for nearly 75% of the city’s gun violence.
  • There are estimated to be 120 gangs in Boston, but few if any national gangs. Our gangs tend to be smaller and organized on a hyper-local basis, literally a gang on each street – which makes for dramatic scenes of urban warfare given the proximity of these gangs. Watch a gang member on the street and see how his head is constantly swiveling.
  • A 1.5 square mile area accounts for nearly 80% of our shootings and murders – that is a really small area. It is effectively a one mile stretch down Blue Hill Avenue, which is monitored by only four of Boston police districts.
  • Not surprisingly these gangs are highly organized and are run like small start-up’s. Unlike years ago, drugs today are not the major contributor to gang violence in Boston, but rather historic grievances passed from one generation to the next. Coincidentally, my firm (Flybridge) met with a very interesting start-up out of Harvard today called Nucleik, which has developed software to map gang hierarchy (they were also featured on 60 Minutes this past weekend).
  • Recently enacted local legislation, which instituted 10-15 year mandatory prison sentences for gun shootings, has led directly to a significant spike in stabbings. For some reason, not yet understood, stabbings in the South End have increased even more dramatically this year.
  • Nearly 25% of gang shootings result in death.
  • The Big Data angle: Ed is aggressively capturing a number of variables to better characterize gang profiles – ethnicity, number of conflicts, age and race of participants, addresses, social connections, etc.

With better data capture, Ed believes he can more precisely segment gang populations and therefore develop more tailored, more appropriate solutions to reduce gang violence. Ed has the “street workers” carry diaries to log dozens upon dozens of data points when they are out on their shifts. Impressively, in StreetSafe’s third year of operation, his 20 “street workers” are engaged with 332 active gang members and have spent, on average, 52 hours with each youth – a highly leveraged business model. His four Case Managers, who manage transitions for these gang members into job training, remedial education or other social service programs work with 171 youths and have placed 67 of them in jobs.

And the initial data support his thesis of the power of this type of intensive intervention. The gangs which work with StreetSafe exhibited a 32% reduction in shootings over the first three years of engagement. Many of the neighborhoods studied showed even more dramatic reductions (Grove Hall down 46%, Bowdoin/Geneva down 54%, Morton/Norfolk down 47%), while some neighborhoods were only modestly down, and for some yet unknown reasons, Dudley was up 43%. Better analytics should bring more clarity to why that is. I hope to have one of our Big Data analytics portfolio companies look at this problem as well.

As StreetSafe expands, and more data are collected, it should be even more evident that this level of outreach will lead to far fewer fatalities. On behalf of the Boston Foundation, StreetSafe’s most significant benefactor, Harvard University is conducting a multi-year, multi-million dollar Big Data study to better understand the complexities of inner city youth violence, so there is an expectation of greater insights shortly.

But how do we calculate the ROI on fewer shootings? When you meet these kids, you conclude it is immeasurable.

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Is that the Fat Lady?

One of the more interesting press releases from the National Venture Capital Association (NVCA) is the VC Quarterly Fundraising announcement which came out yesterday for 4Q12. The data serve as a weathervane for the industry, indicating how much capital was raised – by firm, by geography, by investment strategy.

For a reasonably extended period of time – over the past four years – the VC industry has been investing more capital than it has been able to raise in new funds. I have been worried that this dynamic will end abruptly (i.e., badly) as one would logically conclude the investment pace needs to dramatically slow as firms invest the balance of their funds. Or fundraising would increase materially (but that has not happened). This imbalance is not sustainable.

The headline for this past quarter was quite positive; 42 funds raised an aggregate of $3.3 billion, which meant for all of 2012 $20.6 billion was raised by 182 funds, which compares favorably to 187 funds and $18.7 billion in 2011. Notwithstanding the more modest 4Q12 activity ($5.1 billion was raised by 56 firms in 3Q12, $6.2 billion by 54 firms in 4Q11), that felt understandable given the concerns and distractions surrounding the election and fiscal cliff, and frankly, the continued lack of meaningful and consistent liquidity. But some of the details buried in the data provide a more nuanced picture of 4Q12 fundraising activity.

  • The largest fund in 4Q12 was Sequoia’s $700 million Growth fund, which interestingly is only the ninth largest fund raised in all of 2012. The second largest fund in the quarter is only the 16th largest fund for the year. Clearly funds continue to trend smaller in size.
  • The top 5 funds accounted for 56% of all capital raised; the top 10 accounted for 75%. Clearly continued concentration of managers.
  • 17 funds were classified as “new” while 25 were “follow-on.”
  • Of the top 10 funds, one is in New York, none are based in Boston, two are healthcare, and two are deemed “new” – which is perhaps somewhat misleading – NovaQuest Capital (~$250 million) is the investment team from Quintiles which had been investing together since 2000 (in fact the fund is labeled “III”) and Costanoa Venture Capital ($112 million) is reported to be constructed with a number of existing positions spun out from Sutter Hill Ventures.
  • The average size across all 42 funds is $78 million but the median is $24 million.
  • The average size of “new” funds (including NovaQuest and Costanoa) is $34 million; excluding them the average drops to $14 million.
  • Of the 42 funds, 13 are less than $5 million in size while 5 are less than $1 million!
  • Many of the funds raised this past quarter appear to be “side car” funds of existing, longstanding venture firms.

Consistent returns and liquidity should reverse the fundraising trends driving the VC industry to be smaller and more consolidated. Given the strength of the public markets over the past year the overhang of the “denominator effect” should also be less of a concern in the near to medium term. Unfortunately it may take time for many LP’s to adjust their portfolio allocation models to increase exposure to VC. But that will happen. Hopefully the news in 90 days will hint at that.


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