Vertical Software Series: Healthcare IT
Let us take a deep dive into industry-specific vertical software trends and companies. In this segment, we will discuss the trends within vertical software in the healthcare space. Healthcare is fascinating in the US because it is such a large, regulated, and fragmented market. This creates opportunities for sticky businesses and moats around data, implementation, and channel. At the same time, the key considerations are around market size, steady customer acquisition costs, and pricing power/add-ons (market/product expansion).
Trend 1: Sales and marketing, payment processing, and workflow companies focused on healthcare
There is a suite of companies that has always targeted the healthcare vertical to provide financial services and workflow tools. These companies are often stratified into the particular sub-market they target in healthcare (i.e. individual doctors, mid-market, hospitals), which can drastically affect their product development, cost of acquiring customers, price points, and churn.
One trend to keep an eye on is gross margin and services in this trend. That speaks to the scalability and go to market strategy companies use. We can take the recently IPO’ed Phreesia (NYSE:PHR) as an example. PHR has ~40% gross margins, which is typical for companies that need to implement their software and charge for professional services. Another company with a similar gross margin profile is Health Catalyst (NYSE: HCAT). HCAT dervies roughly 40% of revenue from services, which drives down profitability to ~50%.
Looking beyond recently IPOed companies, there is a history of companies targeting segments of the medical market. In the dental space, these include Dentrix, and in the medical space include companies like hCue and MediTab. There seem to be many players developing generic CRM tools targeted at the healthcare space after EPIC demonstrated the power in hospitals, but these long-tail players are fighting for market share in the lower mid-market and individual practices. This often proves to be difficult to scale beyond a certain point or geography, and they may compete on price. It may explain why this segment has not produced many public companies.
Strengths
Once these tools are embedded and have gained market trust, they are hard to remove. The classic example is EPIC Systems which has become a system of record for hospitals to track patients, accounting for ~50% of all hospital patients in the United States.
Considerations
Think about pricing power in the SMB space. Many times, small private healthcare practitioners do not have the margin to pay for additional services, so growth of these software companies is capped by willingness to pay.
Trend 2: Products have to consider HIPAA and compliance which becomes a competitive moat and also a security risk
Companies in the healthcare space must carefully consider patient data and make sure it is secure. Companies are ultimately responsible for a data breach, and HIPAA is very strict on maintaining compliance across all elements of the HIPAA and HITECH Act Rules. Entities do take into account a “good faith” effort to work by the rules, but that does not mean companies are absolved of a breach. Companies focusing on compliance itself include SIMBUS, CynergisTek, and Acentec. In this space, we see established players that use a combination of software and consulting to provide compliance solutions to different verticals within healthcare.
Strengths
Companies can build product moats by focusing on helping their customers maintain compliance. They often have built sticky customer bases and are able to upsell customers with additional services and ongoing compliance. Data is only getting trickier to manage and the pain point is growing.
Considerations
The data streams are complex and compliance is becoming harder to scale and manage across companies. Companies have to be careful about modularizing their technology to allow for implementation across industries in healthcare and sharing data across users. This creates a larger market opportunity but also makes engineering difficult.
Trend 3: IT to make creative use of doctor space and time
A few companies in the telemedicine space are exploring how to better utilize their doctor’s time. These basket of companies include Teladoc (NYSE:TDOC), Doctor On Demand, HealthTap, and BreakThrough. Kaiser Permanente also recently rolled out a virtual service in their in-house application.
Often, these companies differentiate from each other on the supply side (focusing on a specific vertical, for instance, such as mental health). The pricing models (usage-based) and delivery (video, chat) are fairly standard, and the differentiation comes from landing unique channels that lower cost of acquisition or finding creative ways to increase user engagement.
Strengths
There is real value and cost-savings from allowing expertise to travel globally over the internet, and promise of telemedicine not just in diagnosis but actual operation. Combining robotics with telemedicine could help alleviate the brain dump of highly-skilled doctors in Tier 1 countries and cities to places where it is needed.
Considerations
The technology is fairly commoditized in telemedicine, and the supply of willing, technology-forward doctors who are willing to engage will eventually tap out. Further, there is no proof that telemedicine actually increases engagement. It is still a new concept to patients, and some elements of care are not naturally enabled by video.
Trend 4: Conglomerates buying innovative companies that utilize modern data and go to market strategies to fuel organic growth
In 2018, Roche bought Flatiron Health for $1.9 billion, one of the largest acquisitions in the healthcare IT space. Flatiron structures oncology data for analysis and uses modern techniques to capture data from unstructured sources like doctor notes, labs, and other processes. The acquisition was strategic to Roche as its core revenue streams are in the oncology space, where Flatiron has established a strong data lake.
Beyond data acquisitions, we see the potential for more IPOs and M&A dependent on unique go-to market strategies. Some companies in this space include Clover Health, which has built a tech-enabled insurance platform, and companies like Livongo and Omada Health. Livongo and Omada focus on chronic, lifestyle-based diseases that can be cured with consistent monitoring. These types of companies focus on acquiring customers in unique ways, either directly, through hospitals, or in partnerships. By partnering with traditional, adjacent companies like insurers, hospitals, or existing health IT companies, they become a natural target for M&A.
Strengths
By focusing on core revenue streams of large conglomerates, small startups can prove their value quickly and in established markets. In the case of Flatiron, Roche acquired a 12% stake prior to buying the whole business. In this way, startups can build expertise and gain access to insights they would not be able to come to on their own.
Considerations
Large companies can often try to compete directly with new entrants in this space, and many often do. There is a lot of venture capital money going into these segments, which often inverts the unit economics in these businesses. It remains to be seen how sustainable many of these models are.
Sources:
https://www.hipaajournal.com/hipaa-compliance-software/
https://hitconsultant.net/2019/08/30/health-it-ipo-analysis/