Why Digital Health Startups Are Struggling To Gain Traction And What They Can Do About It
Today, there seems to be an enormous gap between expectations and success for digital health startups. The digital health companies launched in the past few years are facing a moment of reckoning as customers rationalize their application portfolios and venture capitalists tighten their funding terms, revise valuation thresholds and seek a pathway to profitability. Digital health funding, which scaled to a record high of nearly $30 billion in 2021, is set to shrink significantly this year to around $21 billion. As the VC funding market pulls back, digital health startups that raised hundreds of millions of dollars are facing slow growth and having to lay off employees to conserve cash and stay afloat.
The macro outlook for the economy looks like a recession in the coming year, and for health systems, it may already feel like one. Some of the largest health systems in the country posted significant losses in Q1 of 2022, forcing many to refocus on growth levers in the immediate term. For many digital health startups, it’s show-me-the-money time. The healthcare leaders I consult have confirmed that they are having very active conversations with their solution providers about expectations of tangible benefits from the solutions deployed.
How did this come to pass? One plausible explanation is that inflationary pressures, compressed profit margins and an overall economic slowdown have resulted in increased scrutiny on all kinds of investments, including technology, at healthcare enterprises. In this context, it is helpful to understand fundamental differences in expectations between digital health solution providers and health systems in the digital health opportunity landscape. Here are a couple that I think explain the expectation gap:
- VCs tend to bet on entrepreneurs, not on solutions. VCs often assume that the product strategy will undergo several pivots before landing on something that works. They focus on the founding team’s credentials and track record and expect the team to figure it out over time. Founders, for their part, assume that they will continue to receive regular rounds of funding from the VCs as they iterate through their product strategy. Healthcare leaders, on the other hand, tend to bet on solutions, not on entrepreneurs. They don’t have the luxury of multiple failed pilots because they can’t afford it in a low-margin business such as healthcare services.
- Startups keep score with funding levels and valuations. To maintain the funding pipeline, they need a constant stream of new clients and fast sales cycles. For the most part, their next round of funding, and consequently, the company’s survival, depends on showing rapid growth. Healthcare leaders tend to keep score by a different set of metrics: They focus on the impact on patient access to care and health outcomes. Health systems are usually slow and careful, and they prefer an incrementalist approach, which is at odds with a VC-funded startup mindset.
My clients often cite other differences as reasons why they struggle with digital health startups. Founding teams tend to lead with technology, user interfaces and user experience. In contrast, healthcare executives lead with workflow integration with clinical validation. In my experience, very few startups have robust clinical validation for their offerings today, which turns the digital health solutions landscape into a wild west.
Most large health systems seem to be moving from risk and innovation to safety and stability. They now prefer the deep pockets of large enterprise technology firms over the fickle finances of startups. When they partner with startups, they often do so for specific features that are otherwise unavailable with traditional platform providers. They prefer companies with a larger surface area (i.e., multiple solutions instead of just one). The days of the highly focused startup with a single best-in-class solution may well be over. Scale and coverage matter more today, and cool user interfaces and user experiences are secondary compared to the ease of integration and workflow efficiencies.
Notwithstanding the challenges for startups, digital health is alive and well for healthcare enterprises. If anything, health systems are ramping up their digital health programs. They are building foundational capabilities to understand and map patient journeys, unifying patient and consumer data to understand their audience better, enhancing analytics capabilities for improved patient targeting and engagement, and consolidating their technology platforms to enable a more seamless data flow and integration. Digital health leaders continue to selectively invest in new solutions from innovative companies. However, they are scrutinizing the impact on patient experience and financial returns more closely.
Digital health solution providers that had a head start in building a foundation of customer success will likely continue to do well in today’s market. Those on the margins, however, may find themselves struggling to balance the need to retain existing customers, invest in growth and conserve cash for the inevitable down cycle ahead. As the spigot of VC money dries up, a Darwinian culling of the herd may occur.
There will probably be much hand-wringing over the coming quarters as many digital health startups go out of business, merge with other startups to buy time or make distress sales to larger tech firms. While this plays out, their employees will feel the pain of job losses, declining values for their stock options and continued uncertainty.
So what should digital health startups be thinking about? First, focus on creating demonstrable value that might include risk sharing. Many startups are already operating in a risk-based payment model for their solutions and services. Second, try to go beyond being a single-point solution and offer a larger surface area that enables your customers to minimize the costs and risks of vendor sprawl and create more tightly integrated solution sets. Third, and more generally, try to demonstrate that you’re genuinely committed to patient data privacy and security. Many startups have used the monetization of consumer data obtained through their apps and services as a primary source of revenue. Consumers are already wary of sharing personal information, and the aggressive moves by large tech firms such as Amazon into the healthcare services space—most recently through its acquisition of One Medical—only add fuel to the fire.
Healthcare is a long game—the ones left standing at the end will be the ones who avoid the shortcuts.