Barriers to Innovation in US Healthcare

This week I’m at #WOIC2015 (World Open Innovation Conference 2015) in Santa Clara. I am program chair for this the second annual conference, which was organized by the Garwood Center at the Haas School of Business at UC Berkeley.

This morning, the opening panel for the second day was on open innovation in healthcare within (and across) ecosystems.

• Sangita Reddy, Co-Managing Director, Apollo Hospitals Group
• Amir Dan Rubin, President and CEO, Stanford Healthcare
• William Bonfield, CMO, OptumHealth division of UnitedHealthcare
• Pramod John, CEO and Co-Founder of Oration

Pramod John, William Bonfield, Amir Rubin, Sangita Reddy

The session opened with a keynote by Reddy, daughter of cardiologist Prathap Reddy (who founded the chain in 1983). The company has 57 hospitals (7 with US accreditation), 2,500 pharmacies and numerous doctors and outpatient clinics.

She talked about how the company used frugal innovation to provide solutions both to India’s middle class and poor. For example, the company has created a national telemedicine program that has touched 36 million patients. To support that, it’s created a device for remote testing of vital signs, and is working on a device for diagnosing malaria (and other parasite) infections.

Perhaps the best example was open heart surgery. Apollo has done 150,000 surgeries with a 99.3% success rate — and an average cost of $4,000. Yes, compared to the US it has lower labor and pharma costs. However, the clinicians pioneered a process (and clamp) to allow 89% of the surgeries be done as beating heart surgery — saving the machine that oxygenates the heart, the process (and risk) of starting/stopping the heart, and the longer recovery period.

Several speakers noted that the U.S. is still the gold standard for the newest, most advanced, most complicated cases. As Reddy said, “Advanced healthcare in the United States guides advanced healthcare in the rest of the world,” and speakers expressed concern about any changes that would eliminate the spillover values that provides for global medicine.

The U.S. problems are both in the incentives and the inefficiencies (including rent-seeking) in the current system. (Rubin faces specific challenges of real estate and labor costs in Silicon Valley, with nurses drawing $160k/year vs. $50k nationwide). As Bonfield remarked, the success of the system keeping people alive longer means there are more patients living with (expensive) chronic conditions.

On the inefficiencies, John argues that the biggest opportunity is in pharmaceutical distribution. Drug prices are rising while medical procedures are relatively flat. He estimated that 20% of the $400b annual pharma costs are wasted in the distribution channels, through pharmacy benefit manager (PBMs) and retailers. Using the website GoodRx.com, he offered examples of the same (generic) statin drug having more than a 5x range of retail pricing in a specific local neighborhood.

Not surprisingly, John has a tool to facilitate search for lower drug prices. Although it could be used by the uninsured or those with high deductible plans, their target is medium-sized firms that self-insure their pharmaceutical expenditures.

As the person who (successfully) pushed for KGI’s healthcare economics and drug pricing classes, I asked about the incentives. It’s great if I can save drug costs, but if it doesn’t budget my monthly premiums, I’m not going to bother. As one speaker notes, Singapore spends less than almost any developed country on healthcare (4.6% in 2013) through high deductibles and incentives for consumers to reduce their own costs (as you would on any other good).

Still, it was good to see suggestions of bottom-up innovation that have a real chance to bend the cost curve in a way that top down mandates cannot.

Accelerating life science startups

On Thursday, I attended the Indie Bio SF Demo Day, a coming out party for 12 companies in its San Francisco accelerator.

SOSVentures, the sponsor of Indie Bio (which has a second site in Cork, Ireland) believes this is one of the first life science accelerators.

As with a life science incubator, the accelerator requires provide startups with shared wet lab space. However, following the accelerator model pioneered by Y Combinator, the accelerator provides mentorship with a fixed term of residency.

The 12 companies applied in January, joined in February and marked their coming out Thursday with a pitch and exhibition to the press and potential investors. The 12 companies are:

• ABioBot (Raghu Machiraju, CEO): lower cost, higher reliability lab automation
• Affinity Wulfrun (Anil Bagha, CEO): improved column for manufacturing monoclonal antibodies
• Arcturus BioCloud (Jamie Sotomayo, CEO): cloud hosted recombinant DNA experiments
• ArkReactor aka Sensa.io: inexpensive bioreactors
• BioLoom (Jennifer Kaehms, CEO): biomaterials for skin repair
• Blue Turtle Bio (Adham Aljahmi, CEO): oral administration of enzyme replacement therapy
• Clara Foods (Arturo Elizondo, CEO): synthetic egg whites
• Extem Bioscience (Mardonn Chua, CEO): high throughput stem cell production
• Orphidia (Aron Rachamim, CEO): point-of-care lab-quality assays from a single drop of blood
• Pembient (Matthew Markus, CEO): synthetic rhino horn to supplant poaching
• Ranomics (Cathy Tie, CEO): genomic database for oncology diagnostics
• ZymoChem (Harshal Chokhawala, CEO): higher yield synthetic petrochemicals

TechCrunch profiled 11 of the 12 companies in their report of the demo event, while three of the companies were profiled when Co.Exist toured the IndieBio lab in April.

Talking to the entrepreneurs, all were indoctrinated in the "lean startup" philosophy. At least one of the companies has already done a “pivot.”

Consistent with that, each of the firms was trying to get to market with the minimum possible cash. Several of the companies have revenues already, and at least two hope to be cash flow positive within the next year. Several of these are tools companies — a business model that is quick to cash flow positive — while the one therapeutics company is targeting orphan diseases which offer a quicker and less expensive regulatory pathway.

No incentives, no innovation

I have been teaching innovation management for more than 15 years at three different schools. In most cases, I kick off the course with a discussion of the incentives for innovation, a topic of particular interest to Berkeley economists such as David Teece and the late Suzanne Scotchmer.

The fundamental idea is that innovation is risky in many ways: the innovator doesn't know if the technology will work (technological uncertainty), whether the market will value it (market uncertainty) or whether the innovator will be able to hold off imitators and other competitors long enough to make a profit (appropriability and ompetitive uncertainty).

As with any other gamble — whether investing early-stage companies or lottery tickets — the innovation winners have to pay above-normal returns to cover the partial or total losses from the losers. Business is an experiment, and if you don’t compensate for the risk, then entrepreneurs, managers and investors will avoid risk. (We can debate the magnitude or the approach to providing incentives — as Scotchmer and others have done—without denying the inexorable need for such incentives).

Of course, outsiders only see the winners of the lottery or the IPO jackpots. They don’t see the dry wells, the failed companies or the other investments that fail to pan out. So the big success of blockbuster drugs attracts attention (and populist attacks) from those who don’t factor in the cost of failures. In many cases, this is due to economic ignorance — innovation costs or economics more generally — and in some cases this ignorance is willful.

Forbes columnist (and former Pfizer R&D head) John LaMattina attacks such ignorance in his February 3 column “New York Times Op-Eds Misleading Regarding The Biopharmaceutical Industry.” The column is balanced and thoughtful, allowing for the basis of most of the criticisms while decrying the economic ignorance (willful or otherwise) beyond the criticism.

In the category of willful ignorance has to be that of economics Nobel Laureate Joseph Stiglitz, a “frequent” critic of the pharma industry (and, IMHO, capitalism more broadly). Let me briefly except LaMattina’s comments on the Stiglitz op-ed:

1) “In generics friendly India, for example, Gilead Sciences, which makes an effective hepatitis C drug, recently announced that it would sell the drug for a little more than 1% of the $84,000 it charges here.” – Actually, “generics friendly India” really means that India has its own rules when it comes to intellectual property (IP) and often refuses to recognize legitimate IP positions.
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2) “Overly restrictive intellectual property rights actually slow new discoveries by making it more difficult for scientists to build on the research of others and by choking off the exchange of ideas that is critical to innovation.” – This is a stunning misrepresentation of the R&D process in the biopharmaceutical industry. For any investment to be made in R&D, be it the 3 person start-up company or a Big Pharma, the promise of a financial return must exist. An absolute requirement for these investments is having sufficient IP to justify that a project, if successful, will provide such a financial return.
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3) “As it is, most of the important innovations come out of our universities and research centers, like the NIH, funded by governments and foundations”. – As I have said in the past, these contributions are very important in the search for new medicines. But Stiglitz, like many other critics, is either ignorant of the amount of R&D carried out by the biopharmaceutical industry or chooses to minimize that the industry’s applied research is what converts nascent ideas and discoveries to the breakthrough medicines that are continually generated by the industry.

I would be naturally sympathetic to LaMattina’s criticisms due to my free market bias, which stems both from my first experience as an entrepreneur, what I’ve learned studying technological innovation for the past 20 years, and of course what I’ve also learned teaching students how to run innovation-related businesses.

However, his three criticisms have particular salience now that I’ve co-founded a new (pharmaceutical) startup that is a spinoff of my current employer. It is (as he says) a 3-person startup, bootstrap funded for now, trying to bring a breakthrough therapy to market.

My two co-founders and I are working nights and weekends — alongside our regular jobs — to raise funds, validate the science, and try to get something approved by the FDA. We wouldn’t be working so hard (#2) unless there was some possibility of a big return at the end: hypothetically, if we’re each putting $10,000 worth of effort into it each year, then if we have a 10% chance of success then we’d each want a $100k+/p.a. return (actually more given due known entrepreneurial optimism biases).

Of course, we wouldn’t have started down this path without IP. We have to talk to the government, CROs, CMOs, potential investors, industry execs and others to make our idea feasible. We are a tiny company with no full-time employees and minuscule resources: almost anyone we talk to is better equipped to bring this to market than we do. All we have is an idea, a vision and the (patent pending) IP that we hope will allow us an exclusive to bring this to market (if we can overcome all the uncertainties).

Finally, we have thought long and hard about commercialization. Even if every NIH or other government grant goes our way, we’ll have certain regulatory, manufacturing, distribution and (yes) IP costs that won’t be covered by government grants. These costs are far beyond what we can bear personally, so unless the potential returns are attractive enough, we won’t get the equity investment necessary to bring this therapy to market.

The Stiglitz ignorance (or misrepresentation) is depressing but utterly commonplace, particularly among economic populists. But sometimes these populists can see the light.

In the 1970s, there was no more outspoken populist among national political figures than George McGovern (1922-2012), the South Dakota senator and 1972 Democratic presidential nominee. After retiring from the senate, he opened a hotel in Connecticut and found out firsthand how little politicians know about business risks.

As McGovern wrote in a June 1, 1992 Wall Street Journal op-ed (quoted in a 2011 Forbes article):

In retrospect, I wish I had known more about the hazards and difficulties of such a business, especially during a recession of the kind that hit New England just as I was acquiring the inn’s 43-year leasehold. I also wish that during the years I was in public office, I had had this firsthand experience about the difficulties business people face every day. That knowledge would have made me a better U.S. senator and a more understanding presidential contender.
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We intuitively know that to create job opportunities we need entrepreneurs who will risk their capital against an expected payoff. Too often, however, public policy does not consider whether we are choking off those opportunities.

So there is hope for intelligent people who get out of the Ivory Tower (or the Beltway) to try to make a living in the real world. McGovern was a man of modest means — a modern-day Harry Truman — trying to put away money for retirement. Millionaire politicians and academics are unlikely to leave their comfort zones, but there’s still a chance for skeptics to experience this epiphany.