October 9 2014
by Todd Hixon

How Venture Capital Helps Drive Up Health Care Costs

[This post first appeared at on March 14, 2012.]

The venture capital industry gets a lot of good press, especially for job creation. [Bear in mind, however, that entrepreneurs do the heavy lifting.] But, from a health care cost perspective, I think venture capital is part of the problem. I’ve criticized doctors in recent weeks; it’s time to look at the role that we (venture capitalists) play.

The problem is the “high tech product” paradigm that is at the core of health care venture capital. The paradigm goes: invent a new product based on a new technology that creates new value for customers, price it high to capture the value, market it aggressively, and make lots of money. Think of Apple or Google as current masters of the paradigm.

This business paradigm dovetails nicely with the American consumer’s view of health care, which is: health care is how you get yourself fixed by wizardly doctors with advanced technology when something goes wrong. We eat the wrong stuff, drink too much, and merrily watch TV on the couch, until we get sick, and then we go to the doctor (or too often the E-room) to get fixed. And, most of the time, someone else pays most of the bill.

Some doctors have been co-opted into the paradigm by profit opportunity: as normal fees have been driven down by payers, selling advanced technology to patients has been a way to maintain or grow income.

Venture capitalists feed this business paradigm with money and investment choices, and they make money from it. About 90% of the venture capital invested in health care goes into biotechnology and medical devices*: high tech products sold into the health care industry.

The problem with the paradigm is that it drives spending on high-tech medicine up. The U.S. is approaching the upper limit of what it can spend on health care. We need to allocate finite medical resources cost-effectively. More high tech medicine is often not the best place to spend scarce money.

As an example, consider MRI and CT scanners: high-tech, high-cost medical imaging equipment that enable much more accurate diagnoses and treatment planning. What follows is a summary of a detailed analysis of this business performed by McKinsey Global Institute (MGI)**.

Manufacturers and financiers of these products market them aggressively to hospitals and (increasingly) independent clinics, many of which are owned by doctors. Part of the sales pitch is “here is how you can make more money by buying this equipment and keeping it busy”.  The number of scanners per capita in the U.S. is now 7x (for CT) and 2.5x (for MRI) the average of France and Germany, and many of these scanners are poorly utilized but still profitable for their owners at prevailing price levels.

Chart via McKinsey Global Institute

As capacity has grown, procedure volumes have grown with it, and, as MGI states in the sidebar, there is good reason to believe that a significant part of the increased volume results from “supply push” by the owners of scanners versus patient need.

The second problem with the high tech health care paradigm: investment in important classes of health care products is showing declining productivity. Consider the bio/pharma sector. In 2010, over half of health care venture capital (17% of all venture capital) was invested in biotechnology*. While bio/pharma R&D continues at high levels, the number of new drugs approved has steadily declined, and many experts observe that the drugs that are approved are often of only incremental benefit to patients***.

Breakthrough technology in the form of first biotechnology/rational drug design (in the 90s), then genomics (in the 00s), and most recently proteomics and personalized medicine have been promoted as the force that will change this, and lots of money was raised, but the productivity curve has not turned up. And, when I talk with sophisticated professional investors in venture funds, they say that health care VC is proving unproductive, and they will be allocating capital elsewhere going forward.

Chart via Frost & Sullivan****

Highly valuable technologies have come out of pharmaceutical research, e.g. Lipitor and similar statins that manage high cholesterol cheaply and effectively, and from biotechnology, e.g. erythropoietin (“EPO”), a godsend for patients with cancer and blood diseases. And effective drug treatments, even if very expensive, can be far more cost-effective than surgery or hospitalization. But, the return on investment in these products is clearly declining, for the nation and for investors.

I believe there are great opportunities for public and private investment in health care. From a public health perspective, investment in more intensive primary care and reduction of life-style diseases has huge savings potential (see a previous post). For venture capital investors, investment in businesses that streamline health care business processes and disrupt the numerous market distortions (i.e., honey pots) offers handsome returns, often with less capital need than product businesses, and will contribute to curing the fiscal cancer that health care has become.


*, NVCA Yearbook for 2011, figure 3.4

**McKinsey Global Institute, Accounting For The Cost Of U.S. Health Care, January 2007, pp 40-48.

*** Nature

**** Frost & Sullivan

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