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Why Are VCs So Scared of Hospitals?

8 Nov

There is much conventional wisdom in venture capital.  One such belief is that hospitals are a really horrible market for tech startups to pursue.  Back in 2002 when we invested in Vocera, an innovative communications system for hospitals (think Star Trek), many other firms had looked at the deal and passed.  Although this was the company’s third round of financing, the company was still pre-revenue and pre-launch, and this was the first round raised subsequent to their strategic shift from a horizontal solution to one vertically focused on hospitals.  Most VCs ran from it.  Following are some of the reasons potential investors gave for hating the hospital market then, most of which persist as concerns, often valid, today:

1.      Hospitals are highly budget constrained

2.      Most hospitals don’t have profits motives and are not subject to the same competitive forces as for-profit businesses

3.      Hospitals are complex political environments with many forces that influence decision making and purchase behavior that seem counter to rational business judgment.  Those who decide, those who approve, those who pay, use, benefit from, can all be different roles in the organization.

4.      Sales cycles are very long, often measured in years.

5.      Hospitals are technology laggards when it comes to adopting information technology.

6.      Hospitals are dominated by large technology vendors such as GE, Cerner and IBM.

There is some truth to each of these, but here’s the counter argument that led us to make a second investment in the hospital market, namely Awarepoint, an indoor GPS system for tracking people and assets in the hospital.

1.      There are lots of hospitals.  Over 5500 in the US alone, and there are little blue signs pointing you to each of them.  Given the annual budgets of your typical hospital, this translates into a very big market.  Vocera now serves over 650 hospitals and more than 450,000 daily users, and is still growing very rapidly, believing they have tapped less than 10% of their core market opportunity.

2.      Hospitals are sticky.  Once your product is adopted, and assuming it works well, they are reluctant to switch you out because solutions get so enmeshed in different processes and systems, and so many employees get used to them.  You can’t screw up, or raise prices dramatically, but you may not have to sing for your supper every time a competitor issues a press release.

3.      Hospitals are willing and able to spend on IT if it is a priority and they see an opportunity for a large return on investment.  This is one of the things helping Awarepoint penetrate the market, and they are not alone. Companies like Allocade , which creates dynamic patient itineraries to improve throughput, are also having success based on the ROI they can deliver.

4.      Because hospitals are underpenetrated by information systems, there is lots of low hanging fruit and relatively basic problems to be solved.  Electronic Medical Records vendors are having a field day, both because of stimulus incentives but because many hospitals, especially the 72% of all community hospitals with under 200 beds, still don’t have this basic form of digitizing their information.  The trend towards Accountable Care Organizations, and the related financial incentives, will require greater clinical integration of care across health care settings (inpatient, ambulatory), greater financial efficiency, and increased transparency and flow of information about the process, costs, and outcomes of health care, all of which will require better healthcare information technology.

5.      Hospitals are similar to each other and willing to serve as references to each other.  Yes, they do compete in some ways, and each has its unique attributes, but you find a higher degree of collegiality and similarity than most industries where competitors hate each other and each may have very different ways of doing their core activities.

There are a few reasons why the hospital market is ripening for startups and the VCs who love them:

1.      Hospitals are feeling financial pressures to run efficiently.  With healthcare reform there will be more patients coming in their door requiring services, while price caps will get tougher.  And there will be financial penalties for things like readmission rates that often correlate to operating inefficiently, and which technology can help prevent.

2.      With the EMR mandates and installations, the Chief Information Officer is now in an elevated position in the organization and even considered a revenue generator.  Many EMR installation projects are leading to ancillary projects and opportunities to automate and digitize other aspects of hospital operations.

3.      New IT paradigms like cloud based services, open data initiatives (thank you Todd Park @ HSS), APIs, and Open Source means that it is less expensive to build and deliver better products into the hospital.

4.      Wireless technologies, and relatively cheap and robust devices like iPhones and iPads, make it easier to reach caregivers on the go, whether nurses at the bedside or Doctors on the golf course.  Companies like AirStrip are getting real-time info to the caregiver wherever they are, and caregivers love it.  Also, WiFi and Zigbee in the hospitals means your equipment and monitors, and even staff, can transmit their info from wherever they are without wires and expensive, disruptive installations.

5.      This current generation of Doctors and are used to technology in their personal lives.  They use email, carry iPhones and Blackberries, shop online, etc.  And the residents entering hospitals today are Digital Natives.  There will be an increasing expectation that hospitals adopt these technologies that most other verticals have embraced.

While we fear the unexpected visit to the hospital as much as anyone, Venrock is looking forward to more investments in companies that serve them with compelling HCIT solutions.

Building Healthcare IT Companies: 11 Insider Insights

5 Oct
This blog post was a collaboration with my Venrock colleague Bryan Roberts, who in addition to being a great bio-tech and medical device investor, was also an early lead investor in athenahealth, and currently on the Board of Coderyte and Castlight, two really hot HCIT companies.

Having participated in healthcare IT for the last 10+ years, we decided to collect and share some lessons learned. The list is by no means exhaustive, so let us know your thoughts – where you disagree, what you would add, etc.

  1. The product must be a true “have-to-have”, not a “nice-to-have”. Any healthcare IT product needs to solve an important problem for a defined customer base (providers, payors, patients) and this is where lots of companies go astray. The product needs to help someone enough for them to be compelled to adopt it, while they are busy worrying about a lot of other things, and it is not enough to have a product that helps out the “system”. If you can’t convince yourself that it is one of the top three things that your specific customer is concerned with, forget it.
  2. Healthcare is actually an aggregation of many small “markets”. While the overall healthcare market is measured in billions – if not trillions – very few needs, ideas or businesses can span the entirety. Many companies/ideas are only applicable to a subset (breast cancer, arthritis, heartburn, etc.) of healthcare or require significant re-work as one moves from one disease area to another – think content for different diseases. This dynamic also substantially impacts some of the revenue stream opportunities and the critical mass needed to make a business viable. For example, pharma advertising for a given drug is targeted at patients with a specific disease, not all healthcare consumers, and so the number of overall users needed to amass a specific target population and access that ad revenue, is many multiples of that target market.
  3. Start-up revenue streams and value propositions are elusive. There are lots of potential revenue streams in healthcare, but many are only accessible to a business that has hit scale (perhaps $100MM revenue) and critical mass creates an ecosystem such that the network has value above and beyond the interaction between the individual customer and the product. This is especially true for advertising and data revenues, but also for lead generation and others. It is much simpler to create viable revenue streams when your business reaches a substantial size than it is to find the revenue stream that gets you from $0 to $50MM… So think hard about the value proposition and revenue stream for the start-up phase of your business before you hit critical mass and dominate a space.
  4. Customers must have more money with your product, than without it. There is no room for broad adoption of products that are a financial drain. Remember that every participant in the healthcare system is strapped for cash – hospitals are lucky to run a profit, doctors’ earnings have decreased consistently over the last decade and patients are used to “free” healthcare. You have to offer hard, demonstrable ROI. You can get away without it for a small number of leading edge customers for a while, but the primary goal of those customer engagements must be to get the ROI data that will be necessary to support broader customer engagement. Adding another cost, even with a long-term ROI is very hard.
  5. Businesses with strong network effects are gold mines. Given that healthcare has complex problems and customers are tough to secure (long sales cycles), a network effect can solidify a first mover advantage and continually decrease sales cycles, as well as afford sub-5% annual churn rates. Happily, the healthcare industry is ripe to create businesses with network effects given the historical underinvestment in the space and the proliferation of “big data” business opportunities. Every customer should benefit from the cumulative customer base, with each subsequent customer deriving and creating more value than prior customers.
  6. The customer is mobile. Unlike many verticals, most health care providers do not sit at their desks all day; they are doing rounds and moving between exam rooms or even buildings. Meanwhile, consumers are making decisions that impact their health (eating choices, exercise, lifestyle) while out in the real world, living their lives. This situational complexity cuts both ways. On the one hand it makes some traditional enterprise strategies more difficult, while on the other, especially when combined with the proliferation of smart wireless devices, it creates opportunities for a new breed of mobile healthcare applications not seen previously.
  7. Expect to have a service component to your business, but avoid becoming a customized consulting shop. Healthcare is complicated and confusing, and although technology may solve a multitude of problems, it will require some handholding and take time. There is nothing approximating shrink-wrapped software in healthcare – and you want to use the service component of your business to help improve your software product. There is a virtuous cycle between the software and service. On the other extreme, the technology infrastructure should not be stove piped or custom-built for each individual client, even “marquee” clients. In healthcare, for a variety of reasons, there are significant pressures to bring your technology infrastructure directly under the thumb of the customer—the servers, the code, the management of the upgrade schedule, etc. Try to resist these pressures and ensure that you build a common chassis that you own with “plug-ins” for individual clients as needed.
  8. Beware of businesses dependent upon heroics…Make it easy. The healthcare sector is a notorious technology laggard, and for good reason. The environment can be chaotic, collaboration is complicated and staffing is convoluted. Simplicity is key with user interfaces and alerts are essential. For businesses targeting health systems, if your business depends on the brilliance, creativity and bandwidth of hospital IT, think again. Hospital IT is massively overworked and understaffed and has a list of number one priorities a mile long. The perfect solution for hospital IT is one that requires little or no effort on their part. For business targeting consumers, it’s dangerous to assume that consumers will wake up and start taking better care of themselves. Consumers will eventually start taking better care of themselves, but it is unlikely to occur before you run out of cash.
  9. Know your domain. Healthcare IT is neither healthcare nor IT. Concepts and actions that traditionally work in each of those established spaces can run afoul in Healthcare IT. Navigating this sector is complicated – from a regulatory perspective, privacy, relationships, etc.
  10. Secure customer references and studies. Winning “lighthouse” accounts, such as the prestigious clinics and teaching hospitals (Mayo or Johns Hopkins), can be great validation for your product or service. These customer references will earn you respect, but unfortunately many customers will look at those institutions as fundamentally different from their own situation (whether based on size, financial resources, scope, etc) and thus not relevant as case studies. Often you will need multiple, credible local references in each geography before you can enjoy the efficiencies of reference selling. Same goes for ROI and effectiveness studies.
  11. Do well by doing good. Healthcare can be viewed as a business or a calling, but the most successful ventures view it as both. It is hard to beat an entrepreneurial team that is powered by the dream of both financial and social rewards. So strive to create value across the board (customers, investors, community).