Healthcare Disruption: Pharma 3.0 Will Drive Shift from Life Science to HealthTech Investing (Part I of III)

Editor’s note: This guest post was written by Dave Chase, the CEO of, a health technology company that was a TechCrunch Disrupt finalist. Previously he was a management consultant for Accenture’s healthcare practice and was the founder of Microsoft’s Health business. You can follow him on Twitter @chasedave.

Healthcare’s hyperinflation is driving the transformation of how care gets reimbursed resulting in a massive disruption in healthcare. For example, pharma companies will succeed or fail based not on how much drug they sell, but on how well their market offerings improve outcomes.

As the largest spenders on R&D in healthcare, massive changes in the way pharmaceutical companies operate are going to have a profound effect on health technology while letting pharma adapt to marketplace changes. It is creating opportunity for startup businesses that heretofore have been stymied when trying to make inroads into healthcare.

In the past, I have frequently said that healthcare is where tech startups go to die. A combination of factors ranging from risk aversion to entrenched legacy vendors exerting account control to health IT not being viewed as a source of competitive advantage for healthcare providers has made it difficult for promising new companies to make a dent. In this three-part series, I will lay out the most important dynamics transforming the opportunity for health technology startups.

In Part I, I will highlight how “Pharma 3.0” will drive a shift from traditional Life Science to HealthTech investing. In Part II, I will outline how healthcare providers will use HealthTech to differentiate and produce better outcomes. I’ll wrap up the series laying out how many healthcare organizations are on a path to repeat mistakes the newspaper industry made beginning in the mid-90’s. There are remarkable parallels that both spell peril for the incumbent healthcare providers if they repeat the newspaper companies’ mistakes and create massive new opportunities such as those I outlined earlier in pieces about The Most Important Organization in Silicon Valley No One Has Heard About and Hotwire for Surgery.

Pharma 3.0 Will Drive Shift from Life Science to HealthTech Investing

E&Y has produced industry reports for the Pharmaceutical industry that provide a comprehensive look at pharma’s history to outline its present condition. E&Y interviewed scores of innovators and senior executives to outline out a vision for what they call “Pharma 3.0.”

The following is an excerpt from their nearly 100 page report entitled “Progressions – Building Pharma 3.0” (read the full report here):

    The Progressions report identifies several industry trends driving nontraditional companies into the sector, including health reform, health IT, comparative effectiveness, and the rising confidence in consumer power. These factors and others are prompting pharmaceutical companies to broaden their focus from producing new medicines to delivering “healthy outcomes” – a shift that will be driven through creative partnerships and business model innovation.

    The Progressions report describes the rapid transition from the industry’s long-standing vertically integrated blockbuster-driven model, defined in the study as pharma 1.0, to today’s pharma 2.0 business model. Under this business model, companies have adopted a number of changes to improve productivity and financial performance, from pursuing more targeted therapies, broadening their portfolio of products and capabilities, to establishing more independent and flexible R&D units, to boosting partnerships with biotech firms, and universities and outsourcing many non-core functions.

    The report finds that even as pharmaceutical companies continue to implement strategies to prosper in pharma 2.0, these efforts may be overtaken by a pharma 3.0 “ecosystem” comprised of established industry members, nontraditional companies and an increasingly informed data-empowered consumer.

During my years working in health systems and hospitals, I rarely crossed paths with the pharma industry even though we were ostensibly serving the same organization. The only time I saw pharma reps was noticing well-dressed folks in the cafeteria that were clearly the pharma reps. My time was spent in the IT and Patient Accounting departments where much of Health IT was relegated. Whereas Health IT was viewed as a cost item to be minimized, pharma and Medical Device products represented revenue generation and differentiation opportunities for healthcare providers.

In the flawed fee-for-service model that has driven healthcare’s hyperinflation, financial rewards incentivized activity (order a test, prescribe a drug, do a procedure, etc.) rather than positive health outcomes. For example, there are 60MM CT Scans done per year in the U.S. despite the fact that there isn’t a radiologist in the world who believes anywhere near that volume is required. Nonetheless, we incur that high cost and excess radiation in the fee-for-service that is the underpinning of the legacy reimbursement model. Fortunately, there’s a sea change to change reimbursement to reward positive health outcomes over mere activity. In addition, electronic medical records are helping reduce duplicate tests.

Based on my past (non)experience with pharma, it has been remarkable the number of pharma companies that are now proactively reaching out to software companies who can help them enter with new services focused on outcomes that have little or nothing to do with what I would traditionally associate with pharma. Their strategies are varied and dynamic but they aren’t sitting on their hands. For example, one shared how they recently entered into a 10-year agreement to be responsible for the end-to-end health of a population of individuals with a particular disease. As I will touch on in the 3rd part of the series, this will have a profound effect on the competitive landscape for traditional health providers. Not many healthcare providers are prepared for this type of competitor.

Like it or not, healthcare is like most arenas – revenue (aka reimbursement) drives behavior. pharma has been extremely adept at maximizing revenue in the fee-for-service environment. As one pharma exec said to me, “We have spent billions on developing and marketing our product but $0 on ensuring it is properly used.”

As pharma companies strive to be a “health outcomes” industry, the focus on outcomes will radically alter their behavior. They recognize the competitive threat. As the E&Y report stated, “Pharma companies have expanded the number of pharma 3.0 initiatives by 78% since 2010. Yet non-traditional players have invested even more in Pharma 3.0.” The sense of urgency with the pharma organizations I’ve met with is remarkable.

To date, IT investment in healthcare has been mostly limited to the administrative/reimbursement facets of healthcare (e.g., claims processing). The primary exception is the software that has been embedded into medical devices with little or no ability for the clinician to interact with the device. There’s a contrast with where money is actually spent in healthcare – i.e., healthcare delivery versus therapeutics as outlined in a piece by angel investor and life science veteran Don Ross in his piece “Investor: Health tech is the next big opportunity”.

How big is the healthtech opportunity? Data from the Centers for Medicare & Medicaid Services (CMS) show that the U.S. spent $2.5 trillion on health care in 2009. Of this, 84 percent was spent on healthcare delivery, which includes costs associated with clinicians and insurance companies. In contrast, only 16 percent was spent on therapeutics, including medical devices and drugs. Although venture investors traditionally have put their money into therapeutics rather than delivery, the balance is shifting.

As Pharma companies recast themselves as “health outcomes” companies in response to anticipated reimbursement shifts, one can expect that venture capitalists and Pharma/Biotech will shift their investment focus from almost exclusively Life Sciences to integrated approach with Health Tech and an outcomes. Areas such as decision support, care coordination, patient engagement, etc. become paramount if one is going to address outcomes versus simply encouraging more activities that the legacy reimbursement model have incentivized.

Increasingly the very survival of the pharmaceutical industry is predicated on creative alliances with nontraditional players such as IT companies. No longer will healthcare be where tech companies go to die for the startups with transformative products that may have languished in the past. The very survival of one of the most profitable industries in the world depends on it.