“Service-enabled” Tech Models…

Around venture capital water coolers everyone brags about the latest “tech-enabled” service business model but in healthcare maybe these conversations need to be turned on their heads to focus on “service-enabled” tech models with the emphasis squarely on services. As the business of healthcare is transformed, many of the companies that appear to be scaling are fundamentally services businesses. Most healthcare SaaS businesses have always had a large services component, underscoring the balance (or tension) between services and product revenue. In fact, a review of recent funding data suggests that there are significantly fewer pure-play technology companies, raising less capital.

Thanks to one of our star Flare Scholars, Carlos Rodriguez (recently of Harvard Business School), who looked at the aggregate of both Rock Health and MobiHealthNews 2016 funding data (340 transactions and $4.4 billion of invested capital), what is quite evident is that the more labor intensive sub-sectors of healthcare technology were the most active. Carlos – bless his heart – mapped all of these transactions to Flare’s core investment themes, listed below.

Slide 23

Anecdotally, this feels right and reflects much of what is seen in the market today. The emergence of novel care delivery models across healthcare (primary care, elder care (PACE), hospital-at-home, behavioral, palliative, etc) has taken hold over the last few years. Technology has made many of these services better and more efficient, but at a very fundamental level, effective healthcare is one human being helping another human being. Left to its own, technology alone does not provide healthcare.

Ideally, real-time intelligence across a population will make the healthcare delivery system smarter and able to better anticipate both acute and chronic medical issues. The system today is finely tuned for episodic issues, not chronic conditions. A system redesign with more effective services and more robust incentives to prevent disease are expected to reduce the incidence of high acuity cases. The migration to a more integrated care delivery model to better manage all the variability of care and patient hand-offs can be bolstered by technology, but it is still fundamentally a “services” challenge.

The healthcare technology venture landscape continues to be quite active, despite what is clearly a moderation in the overall venture capital activity. Industry analysts are using words like “disciplined” and “normalized” to describe the overall venture capital market for the first 90 days of 2017, which is obviously not how we might characterize the current political climate. As always, the headlines belie what might be more turbulent private capital markets under the surface, as quite clearly there is a continued and pronounced rotation away from the earliest stages of investment. Notwithstanding that, the healthcare technology sector continues to attract significant amounts of capital. For 1Q17, nearly $1.0 billion was invested in over 70 companies, which suggests that we are on pace to have the fourth year in a row with over $4.0 billion invested in nearly 300 companies, signaling continued maturation and depth of the sector.

Globally, according to Mercom Capital, over $1.6 billion was invested in 165 companies in the healthcare technology sector. Notably, Mercom also counted 49 M&A transactions in 1Q17, underscoring for investors that more predictable liquidity is available for many of these companies. For all sectors of healthcare, there were 390 announced M&A transactions with an aggregate value of $38.5 billion in 1Q17.

And the enthusiasm for healthcare services models has not been lost on public stock investors. On the heels of unprecedented political uncertainty last year, in general healthcare stocks are ahead 9% year-to-date while the broader S&P 500 index is up only 7%. More specifically, the iShares U.S. Healthcare Provider ETF has increased by 13% while the NASDAQ Biotech ETF has gained only 10%.

Last month Flare hosted its annual investor meeting. Several important observations emerged over the course of the day including: (i) tremendous opportunities exist as the healthcare system develops effective approaches to manage chronic conditions; (ii) notwithstanding the issues confronting the public insurance exchanges, there was consensus that affordability and not adequate coverage was the central concern; (iii) more effective management of social determinants will play a critical role in how the healthcare system is transformed; (iv) significant opportunities exist in the Medicaid population, particularly with improved access; and, (v) while somewhat elusive, the “tipping point” from fee-for-service to value-based models is now on the horizon. All of this overlays nicely with our core investment themes.

Slide 3

One of our keynote speakers, who was also a CEO of one of the country’s largest health insurers, articulated a migration path to more fully developed integrated care models which highlighted the need to directly impact downstream healthcare costs. Wholesale healthcare system redesign, including the introduction of meaningful incentives to prevent disease, should materially lower the incidence of high acuity episodes. Specific areas of focus to reduce “friction points” in the delivery of care included more comprehensive and transparent network design and more effective scheduling capabilities.

Many of the speakers observed repeatedly two significant unaddressed market opportunities: (i) healthcare delivery systems that dramatically reduced variations in care by provider, which will likely be addressed by evidenced-based approaches; and, (ii) solutions that will better manage end-of-life situations.

In addition to highlighting the need for business model innovations, it was important to review developments in the field of artificial intelligence (AI) and how these emerging solutions might either impact existing products and services, or should be incorporated into product design plans. One of the country’s foremost authorities on the field of AI in healthcare is Dr. Zak Kohane, who chairs the Biomedical Informatics Department at Harvard University and sits on the Flare Industry Advisory Board. At its essence, AI will – sooner than later – enable computers to replicate existing human behaviors. It is quite clear that, as Zak so eloquently stated, the “high-touch shamanistic” aspects of medicine will be significantly reinvented as AI proliferates across healthcare. According to HealthcareIT News, 35% of all healthcare organizations will “leverage AI” within the next two years; 52% will not for another five years.

Ironically, per a recent Circle Square study of 31 million EHR, it was determined that physicians now spend less than 50% of their time in face-to-face patient interactions with the balance being “desktop medicine” (3.1 hours vs 3.2 hours daily, respectively).

Separate, and only slightly related, Sanford C. Bernstein’s restaurant analyst (Sara Senatore) recently published a report on the “restaurant of the future” which will have far fewer employees, and all interactions will be electronic in virtual reality environments with robotic chefs and servers, replicating 5-star meals in almost any setting. Senatore concludes that there will be significant reductions in time and a much more pleasing overall experience, which will encourage greater patronage. How much of that promise could we see in healthcare, another labor-intensive industry? Actually, do we even really want to see it?

So, go ahead healthcare service models, embrace your lower gross margins.

1 Comment

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One response to ““Service-enabled” Tech Models…

  1. Great insight Michael.
    Another point is that healthcare organisations are not necessarily mature or sophisticated technology buyers. It’s much easier for them to buy a full stack capability from a third party (outsourcing) than it is for them to buy a pure technology stack that requires configuration and retraining of their teams.
    I would therefore argue that services revenue mix falls into ‘ongoing services’ where these constitute a core part of the value prop and ‘acceleration services’ where the services are designed to help get the customer on board.
    On the latter of these, if you look at Appian’s recent S1, you’ll see a 50/50 split of acceleration fees vs licenses due to their growth. It doesn’t appear to have hurt their valuation aspirations either.

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