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Into The Death Zone? What Digital Health Can Learn From Epic’s $3.8B Revenue

Into The Death Zone? What Digital Health Can Learn From Epic’s $3.8B Revenue Seth Joseph, Contributor

At 1pm on May 8, 1978, Reinhold Messner and Peter Habeler became the first people in history to reach Everest’s summit without the use of supplemental oxygen.

One year later and on the other side of the world, Judy Faulkner founded Epic Systems, the company that has become the standard for what a successful technology company in healthcare looks like. Epic’s EHR holds a dominant (and growing) position among U.S. providers: the company accounts for close to 50% of the market (measured by beds), more than 300 million Americans have an Epic medical record, and Epic is the only EHR that added material market share in 2022.

What do Reinhold Messner and Epic's Judy Faulker have in common? Summiting their respective Everests ... [+] without supplemental oxygen

Elia Saikaly

Epic is perhaps the largest, most critical technology player through which roughly half ($2.1 trillion) of all of all healthcare spending flows. Epic’s revenues are generated by selling software to healthcare providers, largely hospitals and health systems, but medical groups as well.

And how much annual revenue does Epic generate as a result of this position? $3.8 billion, as reported by Forbes.

While nothing to scoff at, compare that number to leading technology firms in other, smaller, sectors of the economy: Adobe at $16B. Salesforce at $33B. Microsoft at $218B. The list goes on.

The U.S. government put its finger on the scale to incent EHR adoption, contributing to Epic's ... [+] growth

getty

Epic’s current success is not due to market forces alone. Commonly understood by industry veterans, is that Epic and other EHRs grew from ~10% industry adoption to more than 90% adoption thanks to the EHR Incentive Program, which provided $35 billion in federal incentives for providers to adopt (and meaningfully use) EHRs, such as Epic. Centers for Medicare and Medicaid services also have tied reimbursement to providers’ use of EHRs.

In other words, the $3.8 billion in revenue that Epic generates comes not only from Epic’s own efforts, but as a result of, effectively, a federal mandate and billions of dollars in taxpayer subsidies.

As further federal largesse seem unlikely, this raises a question:


Is Epic’s relative success the absolute best case for digital health companies selling software to providers?


And if future market opportunities (TAM) for software-only ventures in healthcare are considerably smaller, what does that mean in terms of the attractiveness of investing in these companies?

The Background: $100B Invested in Healthcare Creating Dangerous Overcrowding

In healthcare, the “wiring up” of providers described above has resulted in a wave of investor and innovator enthusiasm for digital health. Rock Health reports that $100 billion has been invested into the space over a ten year period, spawning thousands of startups, many of whom sell their technology into the same provider groups that are just digesting their last investment into Epic.

Provider groups are overwhelmed, and adoption has slowed as they face their own challenges. Buyers bemoan the noise of ‘point solutions.’ Meanwhile, inflation has increased and capital has become scarce. Against this backdrop, some advise that for digital health startups, it’s eat or be eaten.

In short, we may be facing a situation in which digital health startups are above the proverbial “death zone,” without supplemental oxygen.

And yet we continue to see fundraising news for startups selling into providers. In some respects this is not surprising; the $2.1 trillion spent on hospital and physician services represents a compelling market opportunity, and healthcare is notoriously inefficient. But if we accept that Epic is the most successful technology firm in healthcare, then some important questions arise, including but not limited to:

  • Does Epic’s $3.8B in annual revenue represent the absolute ceiling of market opportunity for software sold to healthcare providers?
  • Is it realistic to achieve this type of scale more quickly than Epic did (40 years) given the tailwinds it had?
  • Why does capital continue to be invested in startups selling technology into the healthcare delivery system?
  • Are there alternative routes or better business models for technology firms seeking to innovate in healthcare?

Challenges To Reach The ‘Summit’ When Selling Software To Providers

Likewise, the challenges of selling software to hospitals and provider groups are not surprising, and have been documented (and compared to breaking one’s arm). Solid, well-reasoned recommendations for how to do so effectively also exist. Nikhil Krishnan, founder at Out-Of-Pocket Health, advocates for identifying multiple internal champions, explaining they can help overcome organizational inertia and pushback. “There’s also a very real risk your champion leaves, which is why you ideally want multiple,” Krishnan also says.

Nikhil Krishnan is Founder at Out-Of-Pocket Health

Nikhil Krishnan

Unfortunately, there are no silver bullets.

This is one reason why many VCs are calling for digital health startups to diversity their revenue models, seeking to sell into multiple healthcare constituents. Diversification sounds great on paper (and even better when it is achieved), but can also create tremendous challenges:

  • Mindshare and resources already constrained: A common saying is that startups die more commonly of indigestion, not starvation. In other words, in a very resource-constrained environment and with little discipline, startups tend to take on more than they can actually execute on already.
  • Products and go to market complexity and conflict: Achieving product-market fit in any one market is difficult enough, as is developing sales and marketing efforts that resonate in that market. Splitting efforts can mean distraction and diffusion of efforts, not to mention conflicts that come up as different markets require different product directions.
  • Competitors who optimize for one market: Companies don’t exist in a static environment, and competitors who spot a company that is distracted may double-down on focusing their efforts within any one market to great success.
  • Delay achievement of network effects: Many times companies selling into multiple markets may tout the potential for network effects as they build their customer footprint. Yet by focusing on short-term revenue, they are likely slowing down their own progress (potentially while a savvy competitor eyes a longer term prize).

So, if selling into providers is self-limiting and revenue diversification is ideal but fraught with operational complexities, what should digital health startups do?

Preparation And The Right Planning Help. So Does Supplemental Oxygen.

Amwell, Phreesia, Health Catalyst, and Augmedix also sell software to providers, and have achieved notable success as marked by going public.

But these are the rare exceptions, not the rule. (And all face challenges in the market, priced below their IPO).

For those intent on trying to replicate their success, settle in for a long road. Perhaps the only broadly relevant recommendation: seek counsel from those who have deep domain expertise, have traveled the path before, and have practical tips and tactics. For instance, Krishnan “sees more companies finding subcontract opportunities… [where] you can generally move faster and get proof points, though there are other tradeoffs.”

But there is a better strategy that can help to dramatically increase the odds of success, not unlike the role that supplemental oxygen plays for the vast majority of aspiring climbers on Everest.

Platform businesses create value by bringing different constituents together and facilitating an exchange of value between them, not by selling software to either side. Think of Airbnb or the Android mobile operating system. It is a different approach altogether, and generally leverages network effects to drive growth, defensibility, and profitability. It also works, as suggested by research showing that platforms grow faster, are more scalable, and more profitable than their software-only counterparts.

“The largest next-gen healthcare companies will be built within the interstitial spaces between entities, not solely focused on a single stakeholder,” as noted on X by Morgan Cheatham, Vice President at Bessemer Ventures.

For digital health startups looking to tap into network effects and platform business strategy, the good news is there are options.

Four Ways To Take Advantage Of Network Effects, The Supplemental Oxygen Of Healthcare

While network effects are certainly not a cure all, and bring in other operating and market complexities, they also have started to demonstrate success in healthcare. Research suggests they succeed at similar rates as their software-only peers, but as they start to realize the ‘flywheel’ of network effects, they are valued at 2.4X those peers. In other words, the reward is much larger.

Here are four ways that digital health firms can think about incorporating network effects and platform business strategy:

  1. Focus on digitizing interactions between healthcare stakeholders: Priceline and Expedia didn’t create new industries, but did change the way consumers interacted with and made decisions about travel purchases, making the process dramatically more efficient. Likewise, while Surescripts operates no end-user software for either doctors or pharmacies, it’s network that connects them together now processes 90% of all prescriptions in the country and has helped save the healthcare system an estimated $140 billion.
  2. Enable novel new transactions: Airbnb may be facing challenges, but it’s a $77B behemoth that has completely revolutionized how people travel, how and where people choose to live, and how homeowners utilize their homes. It did so by creating a new market, connecting homeowners with excess capacity with renters looking for more personalized and flexible accommodations. DocStation is a healthcare platform that enables pharmacists (an underutilized clinical resource) to provide clinical services and receive reimbursement from health plans.
  3. Subsidize one side, monetize another: In 2022 YouTube became the most popular streaming platform, beating even Netflix; it also doesn’t charge users, and even allows creators to make money. In healthcare, Evidation Health empowers consumers to take control of their health data, allowing them to opt in to research projects paid for by pharmaceutical and other healthcare organizations.
  4. Leverage third parties as an innovation platform: Android dominates mobile operating system market share. Alphabet, its parent company, figured out early that the basis of competition in mobile OS would be on the quality and breadth of applications. By exposing its APIs and inviting in third party developers, Android effectively tapped into unlimited external R&D with minimal costs. Innovaccer has started to pursue a similar approach in healthcare, creating a marketplace in which it allows other solution developers to leverage and build on top of its infrastructure.

What We Can Learn From Reinhold Messner and Judy Faulkner

More than forty years later, Reinhold Messner and his climbing partner proved that, with proper training, experience, skills and luck, it was possible to reach Everest’s summit without supplemental oxygen. Since then, however, of the 6,000 people who have summited Everest just ~200 did so like Messner, without supplemental oxygen.

Judy Faulkner and Epic have proven that it’s possible to build a massively successful software company whose revenue model is predicated upon selling to providers. But Epic is a fraction of the size of other industry-leading peers, and benefited from federal largesse and the equivalent of mandates that are unlikely to come again.

For the digital health entrepreneurs and investors who believe they are part of the ~3% who can make it without supplemental oxygen, steady on. For the 97% of others, they may want to consider how they can tap into network effects and platform business strategy.