Health system leaders describe their strategic approaches to venture investing and share the insights and perspectives that have informed those approaches.
Improving Performance and Enhancing Innovation With Venture Investing: Perspectives From Leading Health Systems
Health system leaders describe their strategic approaches to venture investing and share the insights and perspectives that have informed those approaches.
Leading health systems are demonstrating how venture investing can extend an organization’s reach and effectiveness by helping it to improve the quality of care, diversify revenue streams, and create a flexible and innovative corporate culture.
U.S. health systems face major challenges as government payers and commercial health plans ratchet down prices, private insurers continue to consolidate, care and margins shift from inpatient to outpatient treatment, costs continue to escalate, and drugs and devices consume an increasing portion of the healthcare dollar. Meanwhile, the shift of risk from health insurers to providers through value-based payment has proved to be a long, expensive transformation, requiring development of new physician networks, new care management and delivery systems, new approaches to contracting, and new management disciplines and infrastructure.
To succeed in this challenging environment, many health systems are increasingly turning to venture investing to improve quality of care, increase efficiency, diversify revenue streams, and build more flexible, innovative corporate cultures. U.S. healthcare venture fundraising in 2017 totaled $9.1 billion, the highest level ever and 21 percent above the previous record set in 2015. a Of this total, a growing proportion represents investment by health systems. And, growth is not likely to slow anytime soon. A recent survey conducted by the American Hospital Association (AHA) and AVIA reports that 72 percent of the 400+ hospitals in the United States with more than 400 beds have already built innovation centers that support venture investing or plan to do so soon. b
The discussion that follows includes comments from a 2017 annual interview survey of venture investing by health systems. The 2016 version of the survey documented the substantial scale and rapid growth of health system venture investing. c The 2017 survey then sought to understand how health systems use venture activities to support their corporate strategies and spur innovation in their organizations.
Changing Patterns in Venture Investing
Among health systems, the fastest-growing approach to venture investing today differs from past approaches. For many years, academic medical centers and some large community health systems focused on commercializing inventions developed by their researchers and practitioners—what could be called “inside-out” investing. These organizations developed intellectual property (IP) policies for internal innovations that usually included some sharing of benefit with inventors to encourage innovation. The IP policy of Johns Hopkins Medicine in Baltimore, for example, allows inventors to earn 35 percent of annual licensing fees after unreimbursed patent expenses and licensing expense. And the Cleveland Clinic shares 38 percent of licensing fees with inventors.
For some health systems, these commercialization programs have produced a steady flow of internally developed innovations.
The Mayo Clinic, for example, has been investing in and supporting internal ventures for 150 years, producing more than 5,900 disclosures, 5,500 patent filings, and 2,600 licensing agreements. d Mayo’s recently formed Office of Business Development—which consolidated Mayo Clinic Ventures with its tech transfer, licensing, and corporate strategy groups—sifts through more than 600 ideas per year, turns a handful of them into formal ventures, and provides seed funding for many more.
Like Mayo, the Cleveland Clinic has been promoting internal innovations since its founding and, in 2000, launched formal venture investing under a business unit called Cleveland Clinic Innovations (CCI). Since then, CCI has issued more than 850 patents, executed more than 500 licenses, and helped launch 77 companies. In 2017, the Clinic created a separate unit, Cleveland Clinic Ventures (CCV), to manage its venture investments. Jack Miner, CCV’s managing director, notes that 90 percent of CCV’s portfolio is invested in IP owned by the health system.
The rapid growth of venture investing over the past few years, however, has been focused more on “outside-in” than “inside-out” investments. Health systems are seeking to achieve their own strategic goals by developing internal venture arms to direct capital toward promising ventures, most of which are invented by others.
The ultimate impact of these investments remains unclear. Whether venture investing will improve health systems’ quality and efficiency, accelerate their shift from volume to value, improve their price-performance, or transform them into more leveraged companies with diversified revenue streams remain open questions.Despite this uncertainty, valuable insights can be gleaned from examining the venture-investing approaches that leading health systems are using to support their corporate strategies and spur innovation in their organizations. The principal strategies they have implemented are:
- Ensuring tight alignment between investment strategies with corporate goals
- Using syndication to partner with other strategic and financial investors
- Differentiating investing activities from operations to maintain investment discipline
- Integrating investments with operational and clinical activities to ensure they are relevant and connected
- Engaging top health system leadership in venture activities and investment decisions
In addition to these strategies, leading health systems implement venture management processes that avoid common pitfalls and maximize their ventures’ chances of success.
Aligning Venture Investing Strategies with Corporate Goals
Venture investing by most health systems is strategically driven. Health systems look for “strategic payback” as well as financial payback to justify their investments. Key elements of an effective strategy for maximizing returns, according to the interviewed health system leaders, are collaborating with start-ups, helping them develop products, and using these products to create value in their organizations.
Health systems’ experience with products and services they use makes them better investors. Despite its allure, however, venture financing is an unforgiving world. In the experience of one angel investing group, 30 percent of early-stage investments go out of business within two years, 30 percent survive and break even for investors, 30 percent survive eight to 10 years and provide a 2:1 to 3:1 payback, and only 10 percent or fewer create the 10:1 or greater paybacks the industry is known for. Given these odds, health systems must play to their strengths, including their expertise in the spaces they invest in, their ability to experiment and refine solutions, and their ability to scale investments rapidly.Strategic investing is exemplified by the approach used by Providence Ventures (PV), a venture fund established by Renton, Wash.-based Providence St. Joseph Health (PSJH). The overarching goal of Aaron Martin, PSJH’s executive vice president and chief digital officer and PV’s managing general partner, is to integrate PSJH’s digital strategy into its business strategy. PV focuses on “needle-moving problems” with high impact and high ROI, according to Martin, using what he calls a “technology cascade” to guide its investment strategy. The “technology cascade” is a series of questions PV uses to tailor its venture portfolio to PSJH’s strategic goals:
- What are PSJH’s strategic goals?
- Can its internal resources be configured to address each goal?
- If not, does PSJH have an available licensed technology that could be adapted to address the goal?
- If not, is a commercial solution already available in the market?
- If not, should PSJH build a solution to seize the unfilled opportunity and commercialize it?
Commercialization, Martin believes, is important to avoid creating orphan solutions.
Syndicating Venture Investments
Syndication, the process of attracting additional investors in a funding round, creates opportunities for health systems to invest in promising innovations and share in their success without taking undue risk. Syndication attracts capital and helps ventures grow. Financial co-investors provide capital, reduce financial risk, and help validate commercial potential by pressure-testing and honing growth plans. Strategic co-investors like other health systems help refine ventures’ value propositions, offer alternative pilot sites (learning labs) for testing feasibility, and provide implementation sites for scaling up ventures once feasibility has been established.
Syndication is relevant to both “inside-out” and “outside-in” venture investing. Inside-out investors like the Cleveland Clinic must first decide whether to license the technologies they develop to other companies or to develop them into new start-ups. Peter O’Neill, executive director of CCI, puts it this way: “The complexities in developing a venture are significant, and we agonize over this. The important thing is getting products to patients, whether by licensing the technology or forming a new company.” If the Cleveland Clinic’s leaders decide their organization should develop the technology themselves, rather than license it, they usually syndicate ownership with other investors.
A number of collaboratives and private-equity firms have emerged to help health systems syndicate investments and build and manage their portfolios. Chicago-based AVIA is a member-owned innovation network that multiplies its impact through collaboration and scale.
“Our health system members are serious about investing in innovation,” says Eric Langshur, CEO and cofounder. “AVIA’s network model allows them to participate in ‘advantaged investing,’ where members curate ventures and facilitate co-investments, creating a knowledge-rich environment that inspires confident decisions.”
Independent healthcare venture funds and diversified venture capital firms serve a similar function, linking health systems with other investors. The result is a complex web of syndicated ventures owned by multiple health systems and financial firms.
Differentiating Venture Investing From Operations
Health system venture investing requires a team of investment professionals, apart from line managers, who can objectively evaluate innovative technologies, nudge and cajole their champions to demonstrate value, decide how best to develop them, find investment partners, and provide the market and financial analysis needed to justify capital investment. These venture professionals are generally organized in venture organization units that are distinct from line operating units.
Venture units. The core organizing element of a venture unit is the venture team, the group of professionals responsible for moving the venture forward. The functions of venture teams evolve as ventures move through various stages of development, with team leaders often becoming board members when ventures are financed and syndicated. Syndication also creates opportunities to add investment professionals from independent healthcare venture funds and private capital firms.Some health systems differentiate venture-investing units based on the type of ventures they manage. For example, Intermountain Healthcare (IHC) in Salt Lake City has three distinct venture units, according to Jeremy Porter, director of business development:
- An internal accelerator program, the Intermountain Foundry program, for funding and supporting early-stage internal ideas
- The Intermountain Innovation Fund, which funds and manages syndicated ventures
- A business development department that oversees these two activities (in partnership with Healthbox), spins out new companies, provides operational oversight of ongoing commercial activities within the health system, and works with companies with compelling products and services to pilot and help them mature within IHC.
- Protecting venture investments from fluctuations in operating earnings
- Attracting high-quality investment professionals
- Facilitating co-investments with other venture firms
- Helping to maintain financial discipline (given these funds’ orientation to achieving financial returns)
- Building capital and expertise to support larger investments
On the other hand, not all innovative health systems have defined venture funds. Cleveland Clinic Ventures, for example, has resisted creating a defined fund because management believes the fund structure imposes artificial financial constraints on their investments (e.g., the need to invest all the funds and liquidate investments in three to seven years). CCV’s leaders believe funding ventures directly from the balance sheet gives the clinic greater flexibility. Of course, health systems that do not create defined funds can always define dedicated pools of capital that obviate the need to make separate funding requests for every venture.
Integrating Venture Activities With Operations
Although venture investing needs to be differentiated from operational and clinical activities, investment professionals cannot judge value effectively unless they have an intimate understanding of the health system’s strategic goals and performance levers. In other words, differentiation of investing activities must be balanced with thoughtful integration of venture investments with operational and clinical activities. This is especially true if the health system’s goals are strategic as well as financial—if it is trying to address operational or clinical issues in its own organization. Sam Brasch, senior managing director of Oakland, Calif.-based Kaiser Permanente (KP) Ventures, emphasizes the time and effort his unit spends understanding the strategic needs of Kaiser Permanente’s clinicians and administrators.
Venture activities are also integrated with operations through pilots and demonstration projects aimed at establishing value. Running effective pilots is an art form: Although they are essential to testing and refining ventures, overdoing pilots can deplete resources, divert attention from building scale, and, in some cases, protect underperforming ventures.
P. Nelson Le, MD, medical director of AVIA, sums up the philosophy of Sacramento, Calif.-based Sutter Health in using rapid pilots to identify and fix problems, manage risk, and scale up innovations: “If you can’t imagine scale, don’t bother to pilot. Scale is the only way to create real system impact.” e
The first test of any venture is usually whether one or more potential pilot sites can be convinced to spend time and attention piloting it. Constructing realistic pilots that provide legitimate validation of value requires careful planning and extensive monitoring. Pilots are fragile and can be easily undermined by extraneous events like budget cuts. Conversely, there is sometimes a tendency to keep pilots going longer than necessary, especially when the decision should be to “cut the cord” and abandon an underperforming venture.
Most health system venture units report to senior levels of their organizations to ensure they have visibility and engagement from top management. In addition to providing top-level support for venture investing, senior managers often contribute important ideas that can change a venture’s trajectory. And occasionally, the intuition of top leaders has rescued valuable ventures from the scrap heap.
If venture units do not report to senior management, another means of achieving high-level visibility is through a high-level venture-management committee. KP Ventures reports quarterly to a venture fund management committee, co-chaired by two of the most senior executives in the corporation: the executive vice president of Health Plan Operations for Kaiser Foundation Health Plan and Kaiser Foundation Hospitals, and the executive vice president, finance and strategy, of The Permanente Federation, who is also medical director, business management, of the Southern California Permanente Medical Group.
At Peoria, Ill.-based OSF HealthCare, the commitment to venture investing was championed by the health system’s CEO, according to Michelle Conger, senior vice president and chief strategy officer at OSF. Since it was founded three years ago, the organization’s $75 million fund has made nine investments and become a limited partner in Ascension Ventures Fund IV. The performance of each investment is monitored quarterly by a committee that includes the system’s CEO, CFO, president, Conger, and several members of the board investment committee.
Executing Effective Venture Development Processes
Successful venture development requires managing a complex set of processes timely and effectively. The sidebar above lists elements of an effective venture development process.
Different health systems use different vetting processes, but most have multiple layers of review. At the Cleveland Clinic, innovations are reviewed first by peer review committees, then by one of three advisory councils (health IT, devices, and diagnostics and therapeutics), which include outside investors, and finally by the Cleveland Clinic Commercialization Council.
Filling critical venture roles. Forming the venture management team is a critical step in managing ventures. Dave Tamburri, managing director of Health Enterprise Partners in New York, cites “strength of management” as being one of the three most important due diligence items for venture investing. f
Within the venture team, the most critical role is the venture champion, owner, or leader—the person who stakes his or her reputation on the success of the venture. Without a capable, committed champion, ventures have little chance of success. UPMC Enterprises has built a stable of “entrepreneurs-in-residence” to lead new ventures. And Ascension Ventures in Clayton, Mo., uses psychometric testing to identify potential entrepreneurs, which has the effect of “shortening the trust cycle” with its management teams, according to Matt Hermann,senior managing director.
Other venture team roles are also important. Executive sponsors can be important to venture success, especially for ventures that aren’t protected by a defined fund and/or co-investors. And it is important to have a venture team of experienced investment professionals who can act as translators, bridge-builders, collaborators, conveners, and project managers.
Managing transitions and uncertainty. Managing key transitions in the venture development process is a critical skill. Jack Miner of CCV emphasizes keeping the exit in mind whenever a venture hits a decision point: “The worst thing you can do is get excited about something without any concept of where it is going to end up.”
Although the processes shown in the above sidebar provide good direction, the venture development process is inherently uncertain and must be flexible. “The timing of strategic and investment goals doesn’t always line up,” according to Porter of IHC: “You can’t always wait until you get all the customer input you might want. You need to get clinical and financial inputs, but then you need to make investment decisions quickly and efficiently.”
Venture Investing Traps
Interviews with health system leaders also disclosed some venture investing traps that less-experienced investors sometimes fall into. Most mature venture funds avoid early-stage investments, and they make a point of investing in things they use internally. Less-experienced investors that do not adopt these approaches may deprive their investments of two main points of comparative advantage: the ability to validate efficacy and impact, and the ability to help the validated venture scale up to achieve critical mass.
Trying to apply non-healthcare solutions to health care is another trap, says Brasch of KP Ventures. He notes that KP Ventures avoids investing in companies that are trying to migrate technologies proven in other industries into health care. The U.S. health sector has created such a distinct set of requirements that non-healthcare players—no matter how innovative—will always be challenged to apply their concepts to the sector.
Over-reaching can also be a trap. The number of new ventures any health system can successfully evaluate, facilitate, and bring to market depends on the number of qualified champions and investment professionals available to the venture group, and the amount of attention the ventures can command from senior managers. Richard Roth, chief strategic innovation officer for San Francisco-based Dignity Health, notes that his organization targets three to five new investments per year and has successfully exited at least one per year over several years. Potentially serious consequences from over-reaching include delayed launches, write-offs, reduced returns, and loss of confidence among senior managers in the venture enterprise.
Using Venture Investing to Spur Innovation
Venture investing is a potential game-changer for health systems if it can spur innovation in their business and operating models. In one report, industry experts advocate balancing corporate investment portfolios among incremental investments to existing businesses (50 percent), logical extensions of the core business (30 percent), and new growth initiatives (20 percent). g Most health systems allocate the vast majority of management time and capital to keeping the trains running. Although health systems are filled with innovative technologies, most of these are developed by pharmaceutical companies, device companies, equipment manufactures, and the like. Except for the “inside-out” companies described previously, innovations that originate in health systems typically are incremental, often driven by individual physicians with new approaches to care delivery.Increasingly, however, health systems are using venture investments to stimulate innovation. A recent blog post describes NYP Ventures’ development of NYP OnDemand, the health system’s telemedicine program, as an “innovation stack” of six core tasks: h
- Clarifying the problem to be solved and developing appropriate use cases
- Researching solutions with potential users in their own and other organizations, with government regulators, etc.
- Identifying best-of-breed vendors through a rapid evaluation process
- Implementing solutions based on use cases that balance need and speed to execution
- Scaling through partnerships to broaden the reach and capabilities of the venture
- Making investments in core technologies to help refine product offerings and capture more of the upside benefit from the innovation
NYP is committed to using NYP OnDemand to transform their organization by delivering 100,000 telehealth visits by the end of 2018. This commitment shows the intimate connection between venture investing and organizational transformation. Committing to aggressive implementation plans engages operational leaders in the venture and reinforces and energizes the venture team’s efforts.
Venture investing can help health systems nurture cultural values of innovation and entrepreneurship in the following ways.
Changing leadership mindsets. Rasu Shrestha, MD, executive vice president of Pittsburgh-based UPMC Enterprises, emphasizes the need for a high tolerance for risk and a long runway to develop successful ventures. Venture investing programs can help health systems build a “transient advantage” that can deliver returns on a shorter time frame than long-term investments in bricks and mortar and in staff i , and leaders who adopt this mindset will be much more supportive of innovative endeavors throughout the organization.
Creating incentives to innovate. Companies with strong venture programs have experience in creating and applying innovation incentives within their organizations. By rewarding venture successes and making innovators heroes, organizations can inspire others to take on riskier projects and free up the organization to try more new things.
Building innovation skills. Venture investing builds key skills required for innovation such as business planning, entrepreneurship, communications, influence, and teamwork, as well as personal qualities like persistence and resilience. Companies that build these skills can’t help but become more innovative.Providing symbolic reinforcement. Venture investing can reinforce the importance of innovation across the organization, especially when combined with other initiatives. Most of the health systems surveyed in this report have made highly visible commitments to encouraging innovation on and off their campuses. Johns Hopkins, for example, has two separate organizations aimed at commercializing internal innovations developed by their researchers and clinicians:
- Johns Hopkins Healthcare Solutions, which sells services to health plans and large employers
- Johns Hopkins Technology Ventures (JHTV), which employs more than 100 people and offers a variety of programs to encourage and support innovation across the university (not just in health care)
Attracting innovators. Health systems with active venture-investing programs naturally attract people who have the desire and skills to be innovators. In this way, innovation becomes self-reinforcing.
Researchers have identified many factors responsible for the high cost and mixed performance of our health sector, relative to other advanced economies. j Whatever the causes, transforming our health systems into more flexible, innovative companies that can allocate capital more efficiently to meet the needs of consumers and patients has great potential to improve the price-performance of the sector. Properly structured and managed, venture investing by health systems can play an important role in revitalizing U.S. health care.
David G. Anderson, PhD, is a director, BDC Advisors, San Francisco.
Mary Jo Potter is a senior advisor, BDC Advisors, San Francisco, and a member of HFMA’s Northern California Chapter.
Dudley E. Morris is a senior advisor, BDC Advisors, Los Angeles, and a member of HFMA’s Southern California Chapter.
a. Norris, J., Joyce, T., Tolman, C. & Patnalk, R., “Trends in Healthcare Investments and Exits: 2018,” Silicon Valley Bank, January, 2018., https://www.svb.com/healthcare-investments-exits-report/
b. AVIA and American Hospital Association, Digital Innovation Survey: Executive Report , 2017.
c. Potter, M.J., Wesslund, R., “Provider Venture Capital Funds,” hfm, May 2016.
d. Mayo Clinic Ventures web site, accessed September 2017 (ventures.mayoclinic.org/about.php).
e. Le, P.N., “Sutter Health’s Approach to Innovation and Physician Burnout,” Becker’s Health IT and CIO Review, Dec. 20, 2016.
f. The other two important due diligence items, according to Dave, are getting the market timing right and making sure the venture is following a good trend line and has the ability to capture market share.
g. Anthony, S.D., Johnson, M.W., Sinfield, J.V., “Institutionalizing Innovation,” MIT Sloan Management Review, Jan. 1, 2008.
h. J. Gordon, J., Fleischut, P., Tsay, D., Coyne, S., Barchi, D., and Deland, E., “How NYP Used Its Innovation Stack to Launch a Telehealth Program,” NEJM Catalyst, July 10, 2017.
i. McGrath, R.G., “Transient Advantage,” Harvard Business Review, June 2013.