Winners and losers will emerge in the digital health market correction. Specifically, certain categories of companies will fare better than others.
Service-based companies will especially feel the crunch, said Dr. Justin Norden, partner at venture capital firm, GSR Ventures. These types of companies often say they’re selling AI or software, but it’s people who are doing the work on the back end, he said. Thus, the companies have high operating costs.
“If you look at services-based businesses, it’s people who are involved with the costs,” Norden said. “They may label it as a research and development cost and there’s a little bit of a shell game going on there, but it’s the people driving that business. And if you look at the layoffs, it’s a lot of companies that had heavy service components because they had to hire a ton of people to make it happen.”
Digital health unicorns in this category were raising funds with the idea that they might not be profitable yet, but they could grow revenue and continue to fundraise, Norden said. With a market correction, a lot of these companies are being forced to course correct and focus more on profitability.
Dr. Bijan Salehizadeh, co-founder and managing director of private equity firm, NaviMed Capital, said the private digital health market is recognizing valuations and cash burn rates from six months ago are not sustainable. This is especially true for service-based consumer companies, he said.
These companies face tough margins in the good times, Salehizadeh said. “In bad times, consumers are less willing to give you that additional $200-$500 per year for that extra treatment you’re giving them,” he said. “Getting that incremental customer becomes that much harder. It takes an already stretched, thin margin and makes it an upside-down net margin at the end of the day.”
Salehizadeh said that if a company doesn’t have good pricing power, it’s going to be challenged in a down market with inflationary pressures. An example of this, he said, are self-pay primary care companies with an online component.
Nate Lacktman, chair of the telemedicine and digital health industry team at the Foley & Lardner law firm, said digital health companies that were originally self-pay are considering third-party reimbursement so they can maintain an attractive pricing point to the customer. However, the challenge with going this route is they have to consider all the compliance challenges that come with telehealth.
Companies face other challenges in making this transition, Lacktman said, and it’s going to be a strange, new world for many of them.
“Direct-to-consumer companies have not had to care about profitability, they've only cared about growth,” he said. “But now they're expected to care about profitability and operating budget. They’re having to look at their services in a different lens, which will be difficult for some of them”
More resilient categories
Despite this, Lactkman said a market persists for consumer-facing service digital health companies, particularly among younger people who are more price aware than older counterparts. He said many of these companies are filling this market’s needs, whether it’s with primary care, mental health, or medication fulfillment.
“I don't think patients want a better personal medical record, or a slightly quicker processing of their insurance benefits compared to needing a doctor or a psychiatrist because they can’t get an appointment for two months,” Lacktman said.
But he added that no one should get into the business if they’re simply seeking a financial return.
It’s not just the consumer-based businesses that could be in for a challenge, investors say. Salehizadeh said sales cycles for digital health products that cater to health systems are going to be even longer as those organizations face their own financial challenges.
“I don’t wish hospital sales cycles on my worst enemies because it’s so hard and it’s even harder today because their balance sheets are stretched because of COVID and loss of high-revenue procedure volumes,” he said.
On the flip side, Salehizadeh is bullish about those that sell into the pharma industry. He said pharma is flush with cash and interested in partnering with digital health companies for advancements in drug development and clinical trials. They’re also recession resistant because people will still need their medications, he said.
Norden said companies that demonstrate clear return on investment will be more resilient in a downturn. He said examples of these companies include those that offer customer relationship management and revenue cycle management software, as well as those that deal with upcoding.
“If I pay $2 for a software platform and it returns me $10, of course I’m still going to pay for it,” Norden said. “If you have a good product, a good story showing value and a strong analytics solution, people will keep paying for it. It's those companies that had a much fuzzier value proposition that are getting in trouble.”