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Toward Better, Cheaper Healthcare
European Straits | Work in Progress
Hi, it’s Nicolas from The Family. This Work in Progress edition discusses the future of the healthcare industry and the sudden acceleration triggered by COVID-19.
This is an edition of my newsletter European Straits accessible only to paid subscribers. The goal of the Friday Reads is to furnish ammunition to investors and financiers that will let them dig deeper on whatever topics pique their interest. Today, I’m focusing on healthcare 👇
1/ It’s not only about drugs and devices anymore. When it comes to healthcare, the shift to the Entrepreneurial Age now includes a third segment: tech products—which are gaining even more steam because of the COVID-19 crisis! The amount of venture capital in healthcare has been growing for some time and most tech giants are diversifying into healthcare—driven by what I wrote about in a previous issue The Future of Healthcare:
For individuals, the key is the exceptional experience made possible by technology. Up to now, the healthcare system has been designed and managed under the old rules of Fordist bureaucracy. You needed to reach critical mass in order to make an average, standardized experience affordable for the masses. We all count on the healthcare system to be treated when we need it. But we also hate it for the complexity and endless frictions of its user experience.
2/ Even before COVID-19, various macro-trends were contributing to accelerating the shift in the healthcare industry:
Global economic development. As more and more nations catch up on the most advanced, nutrition habits change and more people turn to ingredients and lifestyles that are known to provoke disease (more meat, more sugar, more pollution). And while economic development comes with more sick people, more advanced nations tend to allocate more resources to taking care of those people, whether through the public or private sectors. Thus the market for healthcare products is bound to grow as the global economy reaches higher levels of development, both on the demand side (more patients) and the supply side (more resources).
Empowered patients. Thanks to computing and networks, today’s healthcare products are smarter, more portable, and easier to use. Because they are equipped with better and better devices, starting with smartphones, patients can afford to self-manage much of their own monitoring and communicate with their healthcare providers from a distance, rarely needing to actually visit the medical office. This makes a big difference for patients who would rather not move around too much, starting with the most vulnerable (and now, everyone given the current lockdown). This also makes it easier for professionals to go about their day-to-day business.
Shifting costs. Deploying more technology in healthcare contributes to reallocating costs, moving the burden from paying physicians and nurses in costly hospitals to paying companies that design, sell, and operate systems and devices that can diagnose and treat diseases in a more efficient and effective way. As the market grows, a larger share of the value added tends to be located in tech-driven segments rather than the traditional healthcare industry centered around in-person, paper-supported medical practices.
3/ The healthcare supply chain has always been divided among three links:
At the top of the chain are the pharmaceutical companies and manufacturers. The extreme concentration seen here, especially in pharma, is explained by the extremely high fixed and sunk costs of operating in these sectors. Not only does pharma involve research and development focused on discovering and improving drugs, it also includes a very large amount of work with governments and regulators to comply with health and safety regulations and to have drugs reimbursed by public insurance systems. The top link of the healthcare value chain is thus especially strong in comparison with other industries.
At the bottom of the supply chain are the many professionals that have their own practices and serve patients on a daily basis. This includes independent doctors (either general practitioners or specialists), as well as various other professions such as pharmacists, self-employed nurses, psychologists, and many others. You would expect this link to be comparatively weak, as is the case in other industries such as books, cars, or insurance. But in fact the sensitivity of the healthcare business, the level of intimacy those professionals reach with patients, and the deep involvement of government agencies in regulating and conducting how things go all give those professionals at the bottom a certain level of influence and market power.
In between the big guys at the top and the small practices at the bottom are the hospitals. Despite constant consolidation in both the public and private sectors, this link is still dominated by small- and medium-sized players. Since hospitals don’t have the collective firepower of professionals nor the critical mass of pharmaceutical companies, they tend to endure regulation rather than using it to improve their positioning. Plus, the very nature of a hospital’s business makes it difficult to reach profitability:
as explained by the late Clay Christensen here, their value proposition is to take care of any patient whatever their disease, which is an especially difficult model;
they employ a vast number of workers, which makes them uniquely labor-intensive and triggers diminishing returns to scale;
and they’re difficult to steer, with top-down management having contributed to degrading the quality of service rather than boosting productivity.
4/ A key reason why the healthcare industry is a tough nut to crack for entrepreneurs is that consumption of healthcare-related goods and services is largely decoupled from payments:
Public and private insurers are the ones funding the entire industry. Drugs and devices might be produced by pharmaceutical companies and prescribed by physicians and nurses, but it’s public or private insurers (or both) who pay for most of it. The only exception is the highest end of the market where wealthier patients are used to out-of-pocket expenses related to extra care and a higher level of comfort and practicality. The decoupling of consumption and payment contributes to tweaking the distribution of added value in a unique way.
Typically, the reimbursement of healthcare products by insurance systems creates a low price elasticity. When a patient’s condition is critical, they or their family (or donors solicited via GoFundMe, if you’re in the US...) are ready to pay a lot out of pocket for the appropriate treatment—a situation that in some cases has led to skyrocketing prices. On the other hand, in the presence of insurance, whether it’s mostly public (as is the case in the UK and France) or mostly private (as in the US), the patient feels uninterested in how much the consultation, drug or device costs. In the end, prices are bargained between insurers and suppliers, without any patient involvement, and the profitability of any venture that sells such drugs, devices, or software solutions depends on the price agreed upon with the various insurers.
5/ The fact that everything is paid for by insurers creates a unique situation when it comes to returns on invested capital. Prices that are negotiated with insurers are not only a cap, they’re also a floor in terms of revenue for the provider. As explained a few weeks ago, this explains why biotech is historically the other segment, along with that of computing and networks (‘tech’), that has given birth to a venture capital industry. Unlike in tech, however, VC firms specialized in biotech don’t fund the go-to-market. Rather they fund the discovery of a product that works (a drug or a device) and then the bargaining with insurers so that those discoveries generate a steady revenue stream over years, even decades.
In other words, in tech the risk is taken in entering the market, whereas in biotech it is taken in trying to discover a product that works, as entering the market is rather straightforward and reimbursement is the only thing needed to render a company profitable over the long term. Here’s a quote from Bill Janeway in his masterful Doing Capitalism in the Innovation Economy:
When a molecule is identified as a potential therapeutic response to a disease state, the population of potential patients – the “addressable market” – is known. So is the approximate charge per treated patient based on drugs already in the market. And because demand is funded by third-party payers and is consequently inelastic, a plausible forecast of revenue can be projected contingent, of course, on successful clinical trials and approval by the Federal Drug Administration.
Thus, a biotech start-up is unique: only in this instance is it possible to estimate a fundamental value, the present value of the net cash flows from the investment, if – and it is a huge if – the scientific and regulatory hurdles to market entry are overcome. The fact that investors have repeatedly chosen to bet on that contingency demonstrates, as well, the weight that market risk bears versus scientific and technological risks: the biotech exception exemplifies the value attached to the minimization of market risks in a domain where scientific and technological risks are enormous.
6/ Even before the COVID-19 crisis, the healthcare industry was being confronted with many well-known challenges. First, it needs to treat a growing number of patients in the context of a greater scarcity of resources and decreasing productivity, which can be explained by the three following factors:
While healthcare keeps on growing as a share of GDP, the slowing of economic growth creates a fiscal gap. In every Western country, governments face rising deficits that force them to try and cut costs. This is most obvious in the places where the most taxpayer money is allocated, and healthcare is a huge part of that. Thus it is expected that the amount of public money flowing into the system will stagnate rather than grow in the future, with consequences at every level of the value chain: pharmaceutical companies might have to cope with lower reimbursements and will cut down on R&D as a result; professionals might have to bill their services at a lower rate; and hospitals and clinics might have to double down on reducing costs and improving efficiency.
One impact of this dire situation is that healthcare as a career has become less and less attractive for young graduates. Many Western governments (the US being the exception) now struggle to attract and retain healthcare professionals. The UK has tackled that challenge by massively staffing the National Health Service with immigrants from continental Europe, Asia, and Africa. As for France, it has to cope with the language barrier and corporatist resistance from medical organizations, with the end result being that entire regions are now deprived of physicians in many specialties. (This, by the way, is what prompted the Macron administration to accelerate the pace on the telemedicine front starting in 2017.)
Meanwhile, patients are not only more numerous, they’re also more demanding. They’ve gotten used to a higher quality of service in a world that's more and more eaten by software, and they have a harder time understanding the long waiting lines, the complicated forms, and the obsolete means of communication that dominate in both hospitals and insurance organizations. In addition, governments forcing hospitals to bring down costs makes those hospitals even more rigid and unable to experiment with new ways of delivering care. Thus for tech startups, the barrier to entry is high but so are the potential rewards if they can deliver a radical improvement in taking care of patients—that is, in an effective and affordable way.
7/ Despite the difficulties, the technological shift is underway. Various trends have been at work more recently:
Overall, the healthcare industry has been deploying more and more technology to improve productivity and deliver better performance. Pharmaceutical companies, in particular, are diversifying into selling devices that empower patients and make them more able to take charge of their treatments. For these companies, selling hardware devices in addition to drugs represents both a growth driver and a way of maintaining a grip on the entire value chain by being present at two different levels: selling the drugs paid for by the insurer at the top and providing a device to patients that makes following their treatment easier at the bottom.
At the same time, the pharmaceutical industry has grown aware of the importance of data. There are many safeguards in place that prevent them from collecting all the data they want. But when they are able to access it, it can be reinvested in researching new drugs at the top of the value chain as well as in customizing treatments in the middle of the value chain. The importance of data and computing in biotech has become such that as prominent a venture capital firm as Andreessen Horowitz declared that the two long separated worlds of venture capital (that of biotech and that of software) were about to be reunited, with software enabling powerful platforms to facilitate drug discovery and clinical trials in general.
The pace of innovation has been increasing at the bottom of the value chain as more and more startups, positioned in wellness as well as in healthcare, attempt to enter the market by providing devices and software products to the patients themselves. Wearable devices have played a key role in that segment, and there has already been one wave of innovation that attracted a lot of attention. At about the same time, the radical upgrade of the US healthcare system under the Obama administration (also known as Obamacare) attracted millions of new customers into the market for healthcare insurance, in turn attracting hundreds of user-centric entrepreneurs willing to seize that opportunity to reinvent the industry.
8/ However, the nature of the industry’s value chain has so far made it difficult for all those efforts to deliver concrete results from the points of view of both patients and professionals:
Entrepreneurs at the bottom have been slowed down by the unique organization of healthcare’s financing value chain. Because patients are not used to paying out of pocket for any drug or device, startups with products targeted at patients usually fail to monetize them, except for the (narrow) high end of the market—which is usually not enough to reach critical mass and see precious increasing returns to scale kick in. This is why many startups tackling challenges with a primary focus on patients have ended up in a dead end: they’re trying to sell their products to wealthier and better served patients, but because those patients expect and can afford the highest level of care from healthcare professionals, they actually don’t see the point in purchasing such tech-driven products.
Selling products to hospitals also presents numerous obstacles. For hospitals that belong to the public sector, there are the frictions derived from the rules that govern public procurement. And if those products are considered part of the treatment protocol, you must have public or private insurance systems willing to reimburse them. If one were reorganizing the entire value chain by starting with hospitals, this is clearly a way to bring costs down while improving effectiveness. But in the absence of such a global upheaval, and with hospitals focused on squeezing down their budgets, it’s merely an additional cost that those managing hospitals or those in charge of the public insurance system are quite reluctant to take on.
9/ A key problem for startups in healthcare is negotiating with the government to ensure reimbursement of their product:
The use of software products in healthcare systems is not new. However the situation has long been that such products were mostly used for administrative purposes within hospitals, without any interaction with other medical practices or the patients themselves. It has only been recently, with the rise of both personal computing within medical practices and smartphones on the patient side, that entrepreneurs have aimed to solve certain problems in the healthcare system with software, starting with telemedicine.
A major obstacle to the widespread adoption of such approaches was that the concept was difficult to fund. Because it involved patients, it went well beyond the perimeter of administering a hospital and thus couldn’t be included in overheads. And because it didn’t fit into the official definition of what consulting a doctor involved, it couldn’t be reimbursed by the public insurance system. In France it was only in 2017, following the installation of Emmanuel Macron’s government, that things started to move forward and protocols were designed to experiment with telemedicine and tele-expertise, paving the way for reimbursement becoming the norm.
10/ We’re about to witness a radical upheaval of the healthcare industry, and investors need to be ready to act. Just like the financial crisis paved the way for the rise of startups in financial services in 2008, COVID-19 could do the same for healthcare’s equivalents of Square, Stripe, Venmo and Plaid in the US, or Revolut, Monzo, and TransferWise in Europe. Here are three things to bear in mind:
The COVID-19 crisis will tip the balance. Patients will get used to being empowered and relying on tech-driven products more when it comes to their healthcare. Professionals will get used to the relief of not needing to allocate too many resources to patients with mild symptoms. Hospitals will start redeploying their resources to acknowledge the switch to telemedicine. And governments will be tempted to upgrade the regulatory framework to make the most of this shift. But there’ll still be some pushing needed. The temptation to try and find the old normal will still exist, and some countries will miss the mark as a result.
The shift will trigger a virtuous circle for every party involved. As once explained by economist James Bessen, deploying more technology in healthcare makes it possible for less qualified nurses to take over from expensive doctors, thus reducing the unit cost of delivering care. In turn, this makes it possible to create more jobs, reducing waiting times and improving the patient experience. Then when the whole system becomes affordable and effective again, it will become possible to invest more in prevention that aims to improve the health of the many.
This is also an opportunity for an industrial policy perspective. As I often explain to journalists, Europe will never grow its own champion in cloud computing if the goal is only to compete with Amazon and Microsoft. However, since the market for tech-driven healthcare is still ripe for conquest, you can actively support the rise of healthcare tech giants in Europe and hope that they’ll eventually grow to become global players in cloud computing (remember: Amazon started in retail, not in cloud computing).
One interesting use case: Doctolib is a rising French star focused on facilitating appointments with doctors; thanks to COVID-19, it’s accelerating in providing its own telemedicine product; at some point, they’ll have to scale up the right infrastructure to host personal data and handle sensitive communications in the cloud, all while guaranteeing privacy (this is healthcare, after all); and then they could seize the opportunity to open up that cloud infrastructure to third parties, entering the cloud computing market from healthcare like Amazon once entered it from retail.
Will they be up to it? If not, will other startups step in? And will all those entrepreneurs have the right amount of support from investors, governments, and the public? This is the opportunity that’s been presented to us by COVID-19!
As always, please don’t hesitate to reach out if you want to pursue this discussion or if you’d like me to dig deeper into one of the questions above 🤗
This Wednesday, the free weekly edition of European Straits was dedicated to: The Rise of a New China.
And here’s the related reading list:
An Insider Views China, Past and Future (Michiko Kakutani, The New York Times, May 2011)
The beginning of a new world order (Martin Jacques, The New Statesman, April 2012)
Lee Kuan Yew on the Future of U.S.- China Relations (Graham Allison & Robert Blackwill, The Atlantic, March 2013)
How to Not Try (James Amblin, The Atlantic, March 2014)
Clay Shirky explains how Xiaomi became China’s Apple overnight (Clay Shirky, Quartz, October 2015)
Making China Great Again (Evan Osnos, The New Yorker, January 2018)
Silicon Valley would be wise to follow China’s lead (Michael Moritz, The Financial Times, January 2018)
China economy FAQ (Sakunthala Panditharatne, Medium, July 2018)
Try to Answer the Hardest Question in Economics (Noah Smith, Bloomberg, August 2018)
A Preview of Your Chinese Future (Bruno Maçães, Foreign Policy, December 2018)
As competition increases between China and the US, who is gaining the edge in tech? (Tom Upchurch, Twitter, May 2019)
12 Books on China (me, European Straits, May 2019)
The China Story: How Not to Build European Tech Giants (Emilie Maret, The Family, May 2019)
The Thucydides Trap: Are the U.S. and China Headed for War? (Graham Allison, The Atlantic, September 2019)
Europe Is a Developing Economy (me, European Straits, October 2019)
The Future of China (Melissa Taylor and Peter Zeihan, Zeihan on Geopolitics, December 2019)
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From Normandy, France 🇫🇷