Why So Many New Tech Companies Are Getting into Health Care

This article was first published in the Harvard Business Review.

Note: In addition to Bob Kocher, this post is authored by Bryan Roberts, also an investor at venture capital firm, Venrock.

A flood of new health care IT companies has been pouring into the U.S. health care market. The cause of this torrent: the recognition that as market and regulatory forces alter incentives in health care, IT companies will play a powerful role in combating the overemployment and declining productivity that has plagued this industry and in helping providers improve the quality of care.

The dam broke in September 2007, when Athenahealth went public, the price of its shares jumping by 97% on the first day. Since then, the company’s value has risen to $5 billion. Athenahealth proved to entrepreneurs, software engineers, and investors that the health care sector is fertile ground for creating large technology-services companies that use a subscription-based business model to offer software as a service (SaaS).

Despite its size and growth rate, the health care sector was long considered an impenetrable, or at least an unattractive, target for IT innovation — the entrepreneurial equivalent of Siberia. Athenahealth broke the ice by proving that it could sell SaaS efficiently to small physician businesses, get doctors to accept off-premises software, and achieve the ratios of customer-acquisition costs to long-term value that other sectors already enjoy.

As Athenahealth accomplished its goals, several larger forces have dramatically widened the scope of opportunity in the sector:

  • The Great Recession led to a loss of 8.8 million U.S. jobs and big declines in demand throughout the economy (including health care services) — yet health care employment grew by 7.2%. That reality increased awareness that a decline in labor productivity was driving much of the excessive spending in health care.
  • The American Recovery and Reinvestment Act of 2009 included the Health Information Technology for Economic and Clinical Health (HITECH) Act, a $25.9 billion program to give doctors and hospitals incentives to adopt electronic health records. EHR adoption has now grown to nearly 80% of office-based physicians and 60% of hospitals, fueling many successful software start-ups, such as ZocDoc, Health Catalyst, and Practice Fusion.
  • The Affordable Care Act (ACA) requires that an enormous amount of data on cost and quality be made freely available. In addition, digital health applications, mobile phones, and wearable sensors, as well as breakthroughs in genomics, are creating truly big data sets in health care. These data contribute to greater market efficiency, more consumer-oriented products and services, and clinical care that is evidence-based and personalized.
  • The ACA has led to a proliferation of risk-based (rather than fee-for-service) payment models. For example, providers inaccountable care organizations are rewarded for generating annual savings, and providers who use bundled payments get a fixed budget for an end-to-end course of treatment. Effectively responding to these changing economic incentives will increase reliance on software that helps providers manage population risk, understand costs and trends, and engage patients.

These macro-level developments set the stage for other SaaS companies to follow Athenahealth’s lead in enormously improving labor productivity and quality of care.

Within the next decade, software tools will eliminate thousands, perhaps millions, of jobs in hospitals, insurance companies, insurance brokerages, and human resources departments. Not the jobs of people who actually provide care — but those of administrative middlemen, whose dead weight contributes to economic loss. Here are five examples:

  1. Digital insurance markets, combined with ACA-enacted regulatory changes such as guaranteed issue and community rating, make it possible to price and sell health plans to anyone immediately. These developments will decimate the armies of brokers who act as intermediaries between customers and insurance services.
  1. Price transparency, digital insurance products, and tools such as reference pricing make it possible to generate an exact price and instantly collect payment for a health care service. As a result, revenue cycle managers in hospitals and claims adjudicators in insurance companies will be displaced.
  1. The inevitable shift to the cloud will render obsolete the costly, insecure data centers that most doctors and hospitals are now building, staffing, and running.
  1. Adopting self-serve mobile applications will eliminate the forms, faxes, and excess staffing at many call centers, thereby improving satisfaction for everyone in the process.
  1. Centralized clearinghouses that share information across organizations and state lines will eventually replace the byzantine, paper-based process of credentialing doctors, tracking continuing medical education, and keeping licenses up-to-date. That means smaller staffs in hospitals’ medical affairs divisions, health plans, medical boards, and state and local health departments.

Given that wages account for 56% of all health care spending, improvements in labor productivity could generate enormous value. Simply reducing administrative costs could yield an estimated $250 billion in savings per year.

As compelling as the prospective labor efficiencies are, the benefits of SaaS extend beyond direct labor costs. Easier access to data on physician quality, specialization, and adherence to evidence-based care will better match patients with doctors who provide high-quality, efficient services, thereby averting health complications for their patients. Moreover, software can help bring relevant clinical guidelines and personalized risk scores to patients and clinicians as they improve care plans, engage in shared decision making, and avoid duplicative services. Such efficiencies will, in turn, enhance how patients perceive and experience the care they receive. SaaS companies can trumpet all of these advantages, not just the employment savings they yield.

To seize on the new opportunities in the health care sector, SaaS companies can take these steps:

  • Attack economic inefficiencies in order to generate immediate, tangible customer return on investment. Witness howCastlight Health’s transparency tools are generating annual savings for employers and employees. And be clear about the source of the ROI, given that in most cases the revenue comes from another health care stakeholder who may be able to undermine the business.
  • Focus on building in network effects so that improvements made by one user enhance the product’s value for current and future users, just as Athenahealth does when it rapidly disseminates changes in payment rules at one provider to all other providers. Most SaaS businesses in health care IT cannot protect their intellectual property; so it is important to continually augment the value of the product to achieve scale.
  • Use software-enabled service models, rather than pure SaaS. For example, Grand Rounds’ software not only recommends an expert doctor for a patient but also collects, organizes, digitizes, and summarizes the patient’s records — and then books the appointment for the patient. In effect, the software makes it easier for patients to adhere to high-quality, cost-effective care, thereby enhancing the overall ROI for the product.

It took Athenahealth a decade, from 1997 to 2007, to go public on the strength of its SaaS model. It took Castlight Healthonly six years, from 2008 to 2014, to do the same. Now an array of highly valued healthcare SaaS companies, each worth more than $100 million, is emerging. They include Zenefits, Grand Rounds, Doctor on Demand, Omada Health, Health Catalyst, Doximity, and Evolent Health. Indeed, Zenefits is one of the fastest-growing SaaS companies ever, regardless of industry, surpassing $500 million in enterprise value in its first year.

The success of SaaS companies in health care is thanks, in part, to an influx of leaders from other sectors. They bring with them teams of technical talent that deliver consumer and enterprise software faster, better, and more cheaply than many legacy health care IT companies can do. Witness ZocDoc, founded by first-time entrepreneurs from McKinsey; Grand Rounds, founded by Owen Tripp, who cofounded Reputation.com; Zenefits, founded by Parker Conrad, who cofounded SigFig; and Doctor on Demand, founded by Adam Jackson, who cofounded Driverside (just to name a few). This type of cross-pollination is an essential ingredient of innovative change.

The barriers between health care IT companies and IT in other industries are clearly coming down, and we expect the number of sector disruptions and billion-dollar companies to swell. As each innovation wave generates more data, disruption-cycle times will shorten, thereby forcing all players in the health care ecosystem to address inefficiency as they compete on quality and value creation. Those who fail to act will be washed away by the tide that lifts all other boats to greater productivity.

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