It wasn't that long ago that money flowed steadily to entrepreneurs who dreamt up whiz-bang medical devices.
Hospitals souped up their surgical suites with robots or high-tech radiation machines for cancer treatment. Cost wasn't an issue: They just got passed along to insurance companies, who passed them on to employers and patients.
But after the Great Recession hit and the 2010 health law passed, the financiers behind the medical arms race started to rethink their investment calculus.
"If you come in with [a device] that's 10 percent better and twice as expensive, it's hard to get anyone to care," said Bryan Roberts, a Palo Alto, Calif.-based venture capitalist at Venrock, a Silicon Valley company that invests in firms working on health services, medical devices and drugs.
"The changes in the health system are rocket fuel for entrepreneurs," says Roberts' partner Bob Kocher. He is a former Obama health policy adviser who was hired by Venrock in part to capitalize on the expertise he cultivated working on the law in the White House.
The share of venture dollars flowing to seed and early-stage investments in biotechnology and medical devices has plummeted since 2007, when investors pumped $3.6 billion into 332 deals in which a price was disclosed, according to data compiled for Kaiser Health News by FactSet Research Systems. Overall venture investing declined by nearly one-third as the economic recession set in.
Kocher is eyeing businesses that do things like help hospitals keep patients from returning to the hospital with complications soon after treatment — a big-ticket cost that the health law will now tie to new penalties. Like other investors, he also anticipates that many people who gain coverage under the law will face high insurance deductibles. So, Venrock and other firms have funded Castlight Health, a technology company that helps patients choose the cheapest care.
The opportunities within complex health care ecosystems are in things as mundane as billing. "There's a half a person per hospital bed on average that sits in the hospital doing coding and collections and trying to get paid," Kocher says.
Their solution? Drop the manual coding and create "a software system that learns as it codes and keeps getting better and better. And all of a sudden you can say to the hospital, Look, we'll charge you 50 or 70 percent of what you're paying now. You guys save 30 percent. But by the way, we can make great margins and make a terrific business because our costs are so much lower, because we've actually used technology rather than just people to attack the problem," Roberts gushes.
On the treatment side, the investors in Silicon Valley understand that hospitals don't want space-age solutions for tomorrow as much as they want cheap, pragmatic products that can solve basic problems. When it comes to controlling urinary infections, for instance, the future is indeed in plastics. Plastic catheters.
Vicki Farrar started a company called Catheter Connections, based in Salt Lake City. She's almost evangelical about building a better catheter – one that kills the microbes that cause infection – and it's not hard to understand why. The infections are totally preventable and Medicare won't pay for them.
"It's directly impacting the hospital's bottom line, so they don't want this out-of-pocket cost. It's about $50,000 per infection rate," she says. Meaning, the hospital loses $50,000 for every catheter-related blood stream infection. The DualCap catheter she sells, which looks like a spark plug and smells of rubbing alcohol, costs less than a dollar.
DualCap investor Anne Degheest figured the catheter was a good business to bet on, because it prevents hospital readmissions. She points to another promising investment: In-room televisions that walk a patient through a doctor's orders – from bed rest to getting prescriptions filled.
"Like while you're in the hospital, they educate you on the TV so that you cannot see your shows until you've gone through the education, and they test you," she says.
It's a bit like not getting dessert until you've had your vegetables. Maybe this all sounds incredibly simplistic, but venture capitalists say one of the trickiest things about this new world of investing is that their returns, in many cases, hinge on humans changing their behavior. And that's a lot harder than building a robot.
STEVE INSKEEP, HOST:
Now, the health care industry has begun trying to address a problem that politicians have not resolved. It is the rising cost of health care. President Obama's health care law is projected to restrain health care costs but would also add new burdens on the government. The savings the law did find were attacked by Republicans, even as they proposed their own cost-cutting which Democrats have attacked in turn.
All along, venture capitalists in Silicon Valley are quietly finding ways to save money. They're adapting to an increasingly cost-conscious health care industry. And we have more this morning from Sarah Varney of member station KQED.
SARAH VARNEY, BYLINE: Oh, the aughts, and for that matter the '90s,t hose decades when money flowed steadily to entrepreneurs who dreamt up whiz-bang medical devices and shiny robotic surgeons - cost be damned. Hospitals souped up their surgical suites. They spent millions of dollars and passed those costs on to insurance companies and patients.
Then the people with the checkbooks said no more. We're not paying for all these fancy technologies that aren't any better than the ones they replace. And that, say venture capitalists, has pretty much ended the buying the spree.
BOB KOCHER: Hospitals are looking for companies that help them save money.
VARNEY: Bob Kocher is a partner at the venture capital firm VenRock. I met Bob and another partner, Bryan Roberts, at their office in Palo Alto to talk about how the cost pressures on hospitals have changed the kinds of companies they invest in.
BRYAN ROBERTS: If you come to them and say, hey, we've got this thing that's really cool and its going to cost you a bunch of money, it's a total non-starter. But there are so many opportunities to essentially put a replacement cost in there.
VARNEY: Give me an example.
KOCHER: Yeah, there's a half a person per hospital bed on average that sits in the hospital doing coding and collections and trying to get paid.
VARNEY: To Bob and Bryan, the answer is simple: find a cheaper way to help hospitals collect on their bills.
KOCHER: So bring software and technology into health care billing. Right? So rather than having people doing coding manually, have a software system that learns as it codes to get better and better. And all of a sudden, we can make great margins and make a terrific business because our costs are so much lower because we've actually used technology, rather than just people, to attack the problem.
VARNEY: This is not the sexy stuff of Silicon Valley lore, home to some of the world's most venerated venture capitalists and a lot of Porches. The investors here get that hospitals don't want space-age solutions for tomorrow as much as they want cheap, pragmatic products that solve basic problems, like managing data, making workers more productive, and, say, controlling urinary infections. The future is indeed in plastics. Plastic catheters.
VICKI FARRAR: So we have DualCap here. It comes in a sterile package that you open up, just like I did. You take it out and you've got two caps, a light blue cap and a dark blue cap. It's directly impacting the hospital's bottom-line.
VARNEY: Entrepreneur Vicki Farrar started a company called Catheter Connections. She's based in Salt Lake City, Utah, and she was kind enough to mail me a few catheters. They look like a spark plug and smell like rubbing alcohol.
Vicki is practically evangelical about building a better catheter â one that kills the microbes that cause infection â and it's not hard to understand why. The infections are totally preventable and Medicare won't pay for them.
FARRAR: So they do not want to have this out of pocket cost. It's about $50,000 per infection rate.
VARNEY: Meaning the hospital loses $50,000 for every catheter-related bloodstream infection. The DualCap costs less than a dollar.
DualCap investor Anne DeGheest says that's a good business to bet on. Under the federal health law, hospitals will get paid less if they have high infection rates, so they're on the hunt for solutions.
I met Anne at her sprawling home in the Los Altos Hills in Silicon Valley. She seems to have made some good bets.
ANNE DEGHEEST: A lot of these companies I help, they got started right here, like Visicue(ph)..
VARNEY: On this table right here.
DEGHEEST: You've got that table outside there in the garden. It really allows the right brain to kick in, and people start thinking outside the box.
VARNEY: These hills are covered by the estates of wealthy venture capitalists who have made a lot of money off the medical arms race: surgical robots, hip replacements and the like. Anne says those days are pretty much over. With the federal health law, the new opportunities lie in electronic tags that track medical supplies, software that evaluates a doctor's performance, and one of the biggest opportunities for investors: companies that help patients who leave the hospital from returning any time soon.
DEGHEEST: So I think that's an area there where hospitals are begging for help.
VARNEY: That's because this year Medicare will begin slashing payments for patients who return to the hospital unnecessarily within 30 days. So hospitals are trying to figure out how to get patients to stay healthy. They're even using the television in patients' rooms to walk through a doctor's orders, from bed rest to getting their prescriptions filled.
DEGHEEST: They educate you on the TV so that you cannot see your shows on TV until you've gone through the education and they test you.
VARNEY: It's a bit like not getting dessert until you've had your vegetables. Maybe this all sounds incredibly simplistic, but venture capitalists say one of the trickiest things about this new world of investing is their returns in many cases hinge on humans changing their behavior. And that's a lot harder than building a robot.
For NPR News, I'm Sarah Varney.
INSKEEP: This story is part of a reporting partnership that includes KQED, NPR News, and Kaiser Health News. Transcript provided by NPR, Copyright NPR.