While the prevailing discussion around our $2.7 trillion health care system has been about deficits and political posturing, a more important message is being overlooked—there is a massive, potentially trillion-dollar opportunity emerging for savvy entrepreneurs in health care.
For 50 years, the US health care industry has operated under a fee-for-service model—we pay for what we collectively use. Although physicians try to do right by their patients, a fee-for-service system inherently inflates costs, incentivizes overuse, and prioritizes intensive, individual care over the population’s collective health. Alas, the US health care system has performed exactly as it is designed to: we are No. 1 in the world for health care expenditures per capita (50% more than the next country) and we have little to show for in terms of population health (we are dead last among developed nations).
But all of this is about to change, and as numerous other industries have demonstrated, tectonic changes inevitably create both spectacular winners and losers. As venture capitalists, our aim is to deploy our resources toward ushering the next generation of winning health care companies that will reverse the cost trend and deliver better value to the American public.
Why now? What is creating the opportunity?
Unlike a fee-for-service system, an Accountable Care Organization (ACO) is a health system where providers—doctors, hospitals, etc.—agree to align financial incentives with better health for a particular population. ACOs come in various flavors, but one particularly disruptive ACO business model is capitation. In capitated systems, organizations receive a fixed payment for delivering care, which means that they accept the financial risk for managing the costs of their covered population. Doctors who successfully control the costs of their patients get to pocket the difference between the fixed payments and their patients costs. This type of system ultimately profits by unleashing entrepreneurial innovation towards lowering health care costs.
Given their limited track record and sparse distribution, ACOs are widely perceived as a tiny movement with oversized hype. However, as Geoffrey Moore, venture partner at Mohr Davidow Ventures; innovation expert and Harvard professor Clayton Christensen; and others have long observed, industry disruptions follow an S-curve of penetration: they start out slow, accelerate rapidly, and eventually slow again as the market saturates. Fitting an S-curve (Figure 1) to the growing reach of ACOs over the last three years suggests that in the next few years, ACOs could become the dominant operating model in health care, thereby unlocking tremendous opportunities in a $2.7 trillion industry. (Early 2013 data on ACO growth also supports an exponential growth phase. It is worth noting that these data points reflect the reach of ACOs and not just the lives covered under true ACO contracts, so they are much more optimistic; nevertheless, the delay for conversion to true ACO contracts is likely to be nominal, as in additional years, not decades.) Although the Affordable Care Act catalyzed this movement by enabling Medicare to enter into ACO contracts, increasingly, the growth of new ACOs is coming from the private sector.
Candidly, much of the ACO developments seen today are incremental—in addition to limiting the scope of their contracts (i.e., shared risk, small populations), organizations are implementing ACOs primarily as an accounting measure, while still operating their delivery structures in a fee-for-service manner.
This can be problematic for novel, enabling technologies in the short term because it restricts their ability to demonstrate value and align financially. However, over the long-term, the financial opportunity in operating true capitated ACOs is too large (up to 20-30% margins vs. less than 5% today) for entrepreneurs to not realize the potential of ACOs and the technologies that support them.
Where is the emerging opportunity?
Given health care’s fee-for-service legacy, the technology being employed by providers today is fundamentally designed to maximize billing and enhance service frequency. But the radically different incentives in ACO systems demand a complete rethinking of the way health care is delivered.
Characterizing financial risk, managing populations over individuals, streamlining care coordination, identifying high cost patients, leveling up (i.e., nurses performing traditionally physician tasks), and online interventions are all critical components of healthcare delivery under an ACO system. Moreover, capitated ACOs will need clever consumer-facing technologies that engage consumers, build brand loyalty, and influence behavior to avoid the pitfalls experienced by the capitated HMO systems of the ‘90s. The emerging opportunity, therefore, is both in taking on capitated risk as well as developing the technologies to enable these capabilities in scalable and monetizable ways.
Though a trillion-dollar market capitalization seems unfathomable, the sheer size of health care spending dwarfs so many other industries that it is very possible. As the figure above illustrates, the annual average revenue per user (ARPU) in health care is several orders of magnitude greater than some of the most successful companies today. Despite significant regulatory challenges and the fragmented nature of health care, a future winner-takes-all technology company in health care could feasibly be bigger than Facebook, Amazon, or Google.