Digital Health: Overview of US landscape

To understand the healthcare space, I have broken down the landscape from the lens of who can pay for digital health solutions. In particular we answer 3 key questions:

• Who can pay for the digital solutions?

  • What is their total budget?

  • What are the core challenges they face?

  • What are the emerging themes?

• What is trending?

  • What are VCs saying?

  • What are healthcare stakeholders saying?

  • What's trending in popular media (eg. Podcasts)?

• How is the industry performing?

In future articles on digital health we will focus on specific themes emerging from our analysis. Please checkout 'Mental Health AI chatbots' for reference.

I. Who can pay for digital health solutions?

Payers:

Potential Budget: $30-35B in 2024 with potential to grow to $45-55B by 2030

• US health insurers had a net earned premium of ~$1.1Tn and a combined ratio of 98.2% in 2023  (NAIC, 2023)

• Premiums on track to scale to ~$1.6Tn at current growth rate of 8%

• Interventions can reduce Combined Ratio by 2-3pp on a base of $1.1Tn.

Core Challenge: Reducing and maintaining cost ratios. Payers operate on razor thin margins (98.2% combined ratio - estimate of costs as % of revenue) on a large premium base ($1.1Tn). Any intervention which can reduce the cost outflow by a few pp, can translate into major wins for the industry. The combined ratio can be broken down further into:

• Medical Loss Ratio: Industry average of 86.7% in 2023 (NAIC, 2023) vs min. threshold of 85% (80%) for large (small) group insurance set by ACA (CRS, 2015). Key drivers for medical spend include:

  • Higher care intensity: (OECD Health Statistics, 2023)

    • Avoidable hospital admissions: 137 per 100K pop. vs OECD mean of 125

    • Avoidable complications: 33 per 100K pop. vs OECD mean of 8

  • High Obesity rate: 43% vs OECD mean of 26% resulting in chronic diseases and complications (eg. cardiometabolic diseases)

  • Higher prices: Drugs, surgeries and procedures and even doctor salaries can be 1.5-2x of any comparable developed country (IFHP Report, 2022); Cost of GLP-1 Drugs, CNS drugs are major inflators

• Admin Expense Ratio: Avg: 11.5% (NAIC, 2023) vs ideal admin ratio of 10% (anecdotal). Key drivers for excess admin spend processing include:

  • Adapting to regulatory (state wise) changes: Need to adapt to Medicare Drug Price Negotiation program, Transparency in coverage Final Rule etc. (KFF Tracker, 2024)

  • Improving customer experience: 31% NPS for payers vs 55-65% for banking and retail industries (Bain, 2024)

  • Fraud control: Only upcoding might cost insurers (especially Medicare Part B) up to $3.5B per year (Health Economics Review, 2024)

Emerging themes:

• Home health and Elder Care

• Telehealth

• Mental and behavioral Health

• Chronic Disease Management

• Care coordination and collaboration

• Interoperability, data and analytics

• Claims processing and authorization

Providers:

Potential Budget: $15-20B in 2024 with potential to grow to $25-30B by 2030

• ~$2.5Tn hospital industry expected to grow to ~3.4Tn by 2030, growing at ~5% CAGR (Precedence, 2024); Additional ~20% to account for (private) primary care physicians (GVR, 2023)

• 3-5% Operating margins (Beckers Hospital, 2024); ~150Bn EBTIDA pool estimate in 2027 vs ~200Bn estimated by Mckinsey (2024)

• Major consolidation in industry: Of the ~6K hospitals in US only ~1.5K are independent (Forbes, 2024); Assuming consolidated players (~75%) can implement digital solutions

• ~1pp improvement expected balancing increasing cost pressures (eg. staff shortage) and efficiency improvement measures (eg. in-clinic decision support)

Core Problem:  Improving quality of care and outcomes without inflating cost base. This problem is further exacerbated by pressure from internal constraints, regulatory changes, pressure from payers:

• Staffing shortage and inefficient workflows: Expected shortage of 200K - 450K nurses expected by 2025, especially in direct patient care, equating to a 10 to 20 percent gap (McKinsey, 2022)

• Adoption of value based care models: CMS has set a goal of 100% Medicare and majority of Medicaid beneficiaries to be covered by VBC by 2030, increasing from ~60% currently (RTI Health Advance, 2022)

• Need for improved patient engagement: 7.7pp gap between 'Likelihood to Recommend' between patients in 18-34 vs 65-79, driven by need for improved ease of onboarding, less tolerance for friction and need to access more information about condition, medication and treatment (PressGaney, 2024)

• Pressure to reduce readmission and inpatient utilization: Payers are pressuring providers to reduce patient readmission; There is potential to reduce readmission by 8-10pp through real time decision support, improved post-acute care, and digital patient engagement (McKinsey, 2023)

• Shift from legacy systems: Need to implement FHIR APIs under CMS and Prior Authorization prior rule; Increasing demand from payers to improve medical record management and interoperability (CMS Interoperability and Prior Authorization Proposed Rule)

Emerging themes in Digital Health:

• Value Based Care and SDOH

• In-Clinic Intelligence

• Digital Front door and patient engagement

• Revenue Cycle Management

• Workflow automation and digitization

• Advanced diagnostics and patient monitoring

• Value based care and Social Determinants of Health

• Interoperability, data & analytics

• Claims processing and authorization

Pharma:

Potential Budget: $35-40B in 2024 with potential to grow to $45-55B by 2030 (Triangulated with McKinsey, 2024)

• ~600B Pharma market in 2024 growing at 5.5% (GVR, 2024)

• Avg EBITDA margin of ~29% (Full Ratio, 2024)

• ~$250B of Pharma R&D Spending (McKinsey, 2024)

• ~$175B Non R&D spend by Pharma companies

Core Problem:  Maximizing RoI on commercial drug development. Pharma IRR on late stage pipeline has fallen from 6.5-7% in 2013-14 to 1-4% in 2022-23, driven by an increase in cost to develop an asset (discovery to launch) from $1.3B to $2.3B and fall in peak sales per pipeline asset from $520M to $360M in the same period (Deloitte, 2024). Key factors driving this include:

• Declining R&D productivity: R&D spending increased ~45% in the last decade (2012-2022) from ~$170 B to $250B, while drug approvals per year have remained flat i.e. ~43 per year, meaning the attrition-adjusted cost to develop a single novel asset is now estimated to be as high as $2.8B (McKinsey, 2024);

• Pricing pressure from Inflation Reduction Act: (BCG, 2023)

  • Direct negotiation: IRA grants Medicare authority to negotiate drug prices with Pharma Cos; 60 drugs have been selected for negotiation by 2030

  • Part D re-design: OOP spend is capped at $2K per month, making drug manufacturers liable to provide 20% discount in catastrophic phase

  • Inflation Price Caps: Limits rate of drug price increases in Medicare to Consumer Price Index for Urban Consumers (CPI - U)

  • Need for Real-World Evidence Generation: To determine appropriate negotiated price, CMS will ask companies to submit evidence to justify the price eg. scientific quality, diversity and inclusion, health outcomes and financial impact

• Margin pressure from dynamic supply chain: Ascent of new modalities (eg. mRNA vaccines, CAR T therapies) require specialized supply chain (cold chains, storage facilities etc.); Increasing regionalization, re-shoring of manufacturing hubs, and diversification of suppliers as companies prioritize resilience puts further pressure on pricing (BCG, 2023)

• Evolving GTM strategies: Need for personalized content creation, medical and legal review, consumer insight generation, patient experience optimization (McKinsey, 2024)

Emerging themes in Digital Health:

• Drug discovery platforms

• Clinical trials tech 

• Supply chain and logistics management

• Commercialization support

Pharmacies:

Potential Budget: $3-5B in 2024 with potential to grow to $5-10B by 2030

• Annual prescription revenue of ~500B in 2024 across retail chains (33%), regional pharmacies (15%), independent pharmacies (12%) and mail-order and online pharmacies (40%) (McKinsey, 2023)

• ~60B EBITDA (12%) in 2024, however ~30% are captured by PBMs, distributors and wholesalers  (McKsiney, 2023); Walgreens Pharmacy operating margin fell to -5% in 2023, while CVS operating margin hovered around ~5% (CNBC, 2024)

Core Problem: Improving per unit margins. Key reasons for downward pressure on margins:

• Low pricing power: Retail pharmacies have minimal pricing power as 3 PBMs (Caremark (CVS), Optum Rx (United Health) and Express Scripts (Cigna)) handle ~80% prescriptions, set low reimbursement rates and enforce "take it or leave it" contracts (CNBC, 2024)

• Labor Shortage: 90% burnout rate post COVID due to understaffing and increasing workloads (USA Today, 2023); Applications in pharmacy schools have fallen by ~64% compared to 2012 (Axios, 2024)

• Regulatory requirements: Elimination of retroactive DIR Fees (direct and indirect remuneration) 2024, 340B Drug pricing Program which require 3rd party verification of prescription, USP 800 tightening restrictions around how medicines are stored and DSCSA 2013 which necessitates tracking of drugs at package levels as they move through supply chain

Emerging themes:

• Pharmacy 2.0

Consumers:

Potential Budget: $5-10B in 2024 with potential to grow to $10-15B by 2030

• ~$500B spend OOP in 2024 on health expenditure growing 6.6% (CMS, 2022)

• ~1.4K annual OOP expenditure per person (KFF, 2023), ~$1120K in 2024 on copays, deductibles and co-insurance growing at 4-5% (KFF, 2019); Avg annual spend on dental care ~$432 (Value Penguin, 2024); ~$32 spend on eye care (Statista, 2023)

• ~45B spend on gyms and fitness by 2024 (IBIS, 2024)

Core Problem: Need to improve health and wellbeing. ~82% US consumers report wellness as top priority (McKinsey, 2022)

• Need for testing and monitoring: (McKinsey, 2022)

  • ~26% consumers interesting in testing vitamin and mineral deficiencies, 24% interested in cold and flue symptoms and 23% in cholesterol levels; Need tests at right prices, with feedback loops and tools to analyze results

  • ~75% consumer willing to try out a wearable in the future, ~50% consumers have purchased wearable at some point, ~33% have used it more than last year; Need actionable insights based on parameters

• Need for at mental health: ~40% adults receiving mental health diagnosis do not receive any treatment (Bain, 2022); Cited as the most important health issue (IPSOS, 2024)

Emerging themes:

• AI led Chatbots, screening tools and virtual therapists

• Women's Health

• Nutrition and Gut Health

• Weight Management and in-person fitness

• At-home testing

• Wearables

• Mental Health

II. What is trending?

We answer this question by looking at 3 different trends:

What are VCs saying?

US Digital Health startups raised $5.7B across 266 deals in H1 2024. Mental health and clinical AI are top investment areas as VCs are shifting focus away from telemedicine and on-demand healthcare tools. Top funded value propositions were treatment of disease and non-clinical work flow, while top funded clinical indications were mental health and cardio-vascular health.

Source: Rock Health, 2024

 Key sectors highlighted by investors: (Medcity, 2024)

• Claims process and authorization: Opportunity to drive cost reduction by using AI to simplify eliminate redundancies and reduce cost burden eg. Cohere Health and Smarter Dx (Michael Greely, Flare Capital)

• Drug discovery platforms: AI can to accelerate drug discovery based on previous drug candidates and 3D structures eg. Exscientia is attracting most of the investor capital alongside tools automating back end processing (Steve Kraus, Bessemer Ventures)

• Behavioral Health and Chronic condition management: Massive burden in both these categories - 90% of health expenditure is attributed to chronic conditions or mental health eg. Spring Health, Headway, Talkiatry and K Health (Ian Wijaya, Lazard)

What Health System Executives are saying?

~75% surveyed executives listed digital transformation as a high priority with insufficient planning or resources. There is a mismatch between current investment priorities and what they feel will drive the highest impact. Although there is alignment in virtual health and digital front doors where 70% expect a high impact, in areas such as AI for data analytics and remote patient monitoring 88% and 55% executive expect a high impact respectively but 20% and 25% respondents don’t plan to invest over the next 2 years. This is largely driven by a combination of difficult to upgrade legacy systems and budget limitations.

Source: McKinsey, 2024

What's trending in popular media (eg. podcasts)?

Source: Wharton Digital Health Pulse Podcast (VC podcasts excluded in analysis)

• Telemedicine, Value based care and Social Determinants of Care have been recurring themes

• Chronic disease Management has picked up interest recently in 2023-24

• Mental Health and Admin / Data analytics were popular in 2020-22 but lost steam in 2023 (Revived interest in Mental in 2024)

III. How is the industry performing?

• $5.7B was invested in 266 deals in H1 of 2024 outpacing the numbers last year by ~7% but still trailing the peaks in 2020-22. (Rock Health, 2024)

• Median Series D deal size has fallen considerably: (Rock Health, 2024)

  • Series A: ~$15M remained unchanged since 2022

  • Series B: ~$30M remained unchanged since 2022

  • Series C: ~$50M remained unchanged since 2022

  • Series D: ~63M fallen by ~40% since 2022

• Avg EV  / sales multiple is 4.8x (up from 4.5x in Nov 2023) and the Avg EV / EBITDA multiple range is 10x to 12.5x, break down by sector: (Nielsen Advisors, 2024)

  • Telehealth companies: 5.5x to 4.7x

  • Wellness companies: 4.0x to 3.2x

  • Drug discovery companies: 7.0x to 5.5x

  • Medical device companies: 5.0x to 4.0x

  • Healthcare IT companies: 3.5x to 2.5x

• EV to sales revenues fell from 14.1x in 2020-21 to 3.4x in Dec 23 (What if Ventures, 2024)