Digital health investments: between a rock and a ‘kill zone’

Even with high levels of VC funding, startups can face a number of “kill zones” where innovators can be put out of business simply by being in the wrong place at the wrong time. Digital health startups need a “moat.”

At a recent healthcare conference I attended in Silicon Valley, I met an entrepreneur who introduced himself briefly thus: “I’m the CEO of [his company]. We’ve raised $50 million in VC money.” That was it. No introduction to his product, no mention of how many employees, what clients they serve, or anything else about his business.

I wondered if this is the new digital health startup landscape, where raising millions of venture capital or VC money is the goal, not necessarily a means to a goal.

Let the facts speak for themselves. Digital health funding exploded in the first half of 2018, at $6.8 billion until the end of Q3, according to Rock Health, one of several firms that tracks these numbers. More investors, bigger average ticket sizes, more companies funded; there is no better time to be a digital health entrepreneur. Money seems to be there for the asking. Big money, early on. Series A looks like the old Series B. (The last time I saw anything like this was when people were buying second and third homes a decade ago with easy credit.)

What do the latest digital health funding numbers tell us?

Let us parse the latest numbers a bit. The most significant funding category in the report has been “on-demand healthcare services,” which includes any form of telemedicine and at-home healthcare services. This makes sense. Healthcare is shifting away from the clinic and hospital environments to home-based and virtual healthcare. Indeed, this shift is the whole premise of digital health transformation at this time (never mind that the reimbursement model for virtual care delivery is yet to evolve). Other dominant funding categories included consumer health information, fitness and wellness, and disease monitoring. All these categories of healthcare services are primarily delivered through mobile apps or with the help of remote sensors and devices from which data is harvested to personalize the service.

The slew of digital health startups, continuing to raise eye-popping amounts of venture capital money, flies in the face of what the naysayers have predicted for the past couple of years – that most of these startups are “zombies” headed for certain death in the next 18 to 24 months. Evidently, that has not happened. Is there something we’re missing?

The Rock Health mid-year funding report provides a couple of clues to solve the mystery. Firstly, the number of exits, especially in the form of IPOs, has significantly trailed behind the fund-raising. While more companies are progressing to later funding rounds and getting there faster than before, there does not seem to be a definite end in sight. Maybe the dam is about to break, and we will be flooded with IPOs next year, but it certainly does not look like it now. Secondly, the exits that are happening are those where one digital health company is acquiring another. This could also explain why the conference I attended felt as if it was a group of digital health startups pitching to other digital health startups. Hardly anyone in attendance seemed to be from the VC or healthcare enterprise community unless they were there in the role of speaker or panelist.

So, the first thing we learn from the latest funding report is that digital health startups are not scaling fast enough to merit IPOs or big exits. This is the rock they are pushing up against. I have discussed this in a previous column here.

In my book, The Big Unlock, I classified the technology vendor landscape as Custodians (electronic health record or EHR firms), Enablers (big tech platform companies like Google and Microsoft), Innovators (startups) and Arbitrageurs (consulting firms). There is a degree of inter-dependency among all these categories of vendors when it comes to transforming healthcare through technology. However, there are significant asymmetries in the interdependencies.

As an example, innovative startups cannot go on their own if they are looking to sell their solutions to large enterprises. For the most part, digital health startups are focusing on “last mile” solutions. These solutions must sit on another platform such as a Google or Microsoft Health Cloud, or more likely an EHR, such as a Cerner or Epic. While many of these new digital health solutions are innovative and user-friendly, there are many reasons they do not reach scale quickly. In this piece, I discuss the several “kill zones,” or situations a startup can find itself in and become vulnerable to external forces.

A common kill zone is the pilot phase deployment for a digital health solution in a large healthcare enterprise. “Death by pilot,” “pilotitis” and “pilot purgatory” are some of the colorful terms used to describe this painful situation. The gaps in handoffs between innovation groups and operations in the health system is another. Innovation groups by and large are set up as separate, stand-alone units which, while facilitating innovation, often fail in the process of transiting the solution to a broader adoption through the enterprise IT function. The no man’s land between the Chief Innovation Officer and a CIO is a potential kill zone for startups.

Even if digital health startups successfully cross the Rubicon into CIO-land, they face the ultimate kill zone: a dominant EHR vendor who has a similar solution on their product roadmap. Many health systems will choose to go with the EHR vendor’s solution by default even if the choice is to go with an inferior solution.

“Kill zones,” where innovators can be put out of business simply by being in the wrong place at the wrong time, are common threats to startups across the spectrum. Digital health startups need a “moat” – an unsurpassable advantage from a superior product or service to keep the big tech firms at bay. The investors pouring money into these startups are presumably betting on some of the startups achieving just that. For the vast majority of digital health startups that do not have it, they can only hope to continue to raise money and stay afloat till they become cash flow positive or score a successful exit. The other options are not pretty.

Originally published on CIO.com