Why digital health startups need "network effects"

This post is written by Jason Stoffer, an investor with Maveron, and the latest in our new guest authors series.

I’m not a dedicated digital health investor. But I will occasionally invest in the area, particularly when there’s an opportunity that aligns with patients and consumers. So consider this analysis as the perspective of an outsider with an insider’s seat from time to time. It gives me an opportunity to take a birds’ eye view, but also to be as objective as possible. 

After a wild roller coaster ride of digital health funding in the past five years, I have come to a singular conclusion: "To the incumbents go the spoils."

From 2019 to 2023, U.S. healthcare spending increased from $3.8 trillion to $4.8 trillion (a whopping +26%!). 

At the same time, the COVID pandemic relaxed many prior restrictions on delivering care virtually. Given these factors, there was an inevitable Cambrian explosion of startups, many of whom were peddling hype versus strong business fundamentals. Venture funding of digital health startups ballooned to $38.7 billion from 2020-2023. During this time, there were some big value creation moments. Teladoc acquired Livongo for $18.5 billion in 2019, Amazon acquired One Medical for $3.9 billion in 2022 and CVS acquired Oak Street for $10.6 billion in 2023. 

The significant funding and exit activity led to at least 17 IPOs that could be considered health-tech. However, the promise of these IPOs since then has broadly fallen flat. The median digital health IPO fell 33% from the time of IPO until today. Many high profile companies, such as Smile Direct Club, Talkspace and 23&Me, looked like huge winners before crashing back to earth. Earlier this month, 23&Me’s entire board publicly resigned over a lack of buyout options. 

Meanwhile, as startups were failing by the dozens the past few years, health care incumbents added huge chunks of market value: Novo Nordisk is up 5x over 5 years, Eli Lilly is up 8x, HCA is up 3x and UnitedHealth is up 2.3x. 

So the logical next question might be: Should you invest in health care startups at all?

For example, instead of investing in a high-flying startup like Noom for weight management, you would have been much better off investing in Novo Nordisk. Noom promised improved weight loss outcomes. Even if this was true, Noom needed to verify those improvements with long clinical studies – and then, maybe they could secure a value-based contract. The process takes years, and Noom itself I’d argue is easily replicable by others. Noom might claim they are better at treating patients due to network effects leading to a virtuous flywheel. In other words, every additional patient adds more data on outcomes, which informs patient recommendations and leads to better outcomes.  The reality is there is no real evidence (at least not yet) this has borne out.

In most cases, the ideal option for a health care business that drives some economic value, is to sell it to PBM, a provider or an insurance company. Look at PillPack - it developed unique expertise in delivering pre-sorted prescription medications directly to customers. But that is a process improvement that is not long-term defensible, and the company sold itself to Amazon for $753 million. 

Staying standalone is difficult and building durable long-term competitive advantage is even more so - payors, providers and software companies like United, HCA, Amazon and Epic Systems are brutal in extracting every dollar of potential economic value.  

So given the lack of investment outcomes in health tech, the question really becomes: Where should our industry look to invest? It’s really quite simple in concept but difficult to accomplish - you need to be a pioneer in an emerging area and design a product that benefits from the virtuous flywheel and scale advantages we described above.

An example is Progyny, which provides fertility benefits to employers. The company was founded in the early days of companies considering this benefit and they have used their early market leadership to become embedded in the employer channel in which they sell into. Progyny has a network of fertility clinics and specialists, and uses its scale to negotiate favorable terms. It designed a unique product that payers and benefits brokers didn’t offer and achieved enough scale where network effects made them the low cost incumbent even as others entered the market. That is why Progyny has performed well as a public company, worth over $1.5 billion today, even as it’s encountered some stumbles along the way. And there is now more competition, including the likes of Carrot Fertility and Maven, but I’d argue the space can hold few additional players as fertility has become a more prominent benefit amongst employers.

Another example is Medbridge Education, where I was previously an advisor. Medbridge is a leading provider of continuing education software for allied health professionals. Medbridge started as an alternative to in-person continuing education for physical therapists. They then began to track outcomes data for physical therapists in a proprietary learning management system. 

The system then assigned physical therapists the continuing education that best fit their developmental needs. Following that, Medbridge designed patient modules for home exercises. 

Slowly but surely, Medbridge became one of the de facto digital solutions for clinicians and patients going through physical therapy. They are able to tie physical therapy education directly to patient outcomes with millions of real life data points. The company successfully exited to private equity several years ago.  

We will continue to see a lot of value destruction in coming years as overfunded venture businesses limp to mediocre outcomes. However, health care is 18% of GDP and there will be opportunities to build.

So if you are building a business with compounding network effects in health care, please don’t hesitate to reach out. I would love to hear from you.