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.

A new way to fund drug discovery?

In the past decade, two failings of the modern drug discovery have become apparent. First, the major pharma companies are unable to develop new drugs as successful as the ones going off patent.

This has been a major theme of Derek Lowe in various posts in his blog “In the Pipeline”. For example, in a November 2010 posting, he lists the commonly know problems: “lower rates of success in discovery, higher costs, patent expirations, etc.”

The other is that the biotech startup model is beginning to fizzle out. Whether or not the current science will make commercially successful biologics, the idea of creating a new company to develop a few compounds — ending with a successful IPO — hasn’t worked for many years. (It doesn’t help that the IPO market has closed overall for bio and non-bio startups alike.)

Into the breach steps Duane Roth, onetime industry executive and entrepreneur who now heads San Diego-based Connect. Roth gave a webinar April 27 where he discussed the problem and some ideas of how to solve it.

Roth’s suggestions were based on a paper he did with former Warner Lambert executive Pedro Cuatrecasas that was sponsored by the Kauffman Foundation and summarized in Roth’s op-ed last year in Xconomy San Diego.

Roth was pessimistic about the prospects for both traditional pharma and the newer biotech model. He said that the IPO market “is never coming back for pre-revenue companies,” stretching out the return for startups and their investors. Today, only one major biotech startup remains independent — Amgen — while both Genentech and Genzyme have become subsidiaries of big pharma.

Instead of the traditional vertically integrated model, Roth argues that the industry needs to separate out a new role in the value chain: a product definition company. In this model, the federally funded research institute (i.e. a university) would license discoveries to the PDC, which would prescreen these for the product development companies (which might also have the distribution channels to bring these products to market).
In this division of labor, the product definition company spends $3-5 million per discovery to characterize it and attempt to develop a prototype. The drug development companies are the ones that do the clinical trial and hope to bring it to market.

The difference in this new model is that the PDC quickly studies the possible compounds and then sells them. There are no 10 year waits for IPOs — quick exits for the winners and returning the compounds to the universities for the losers.

From his vantage point at Connect, he’s watched the mobile industry (led by Qualcomm) make a similar dis-integration between chip designers, contract fabricators and handset makers.

As a longtime strategy professor, I can think of few examples where industries naturally changed themselves and many where industry inertia prevent long-needed reforms. (Think of the record industry.) Thus my question to Roth was: how do we get there from here?

Roth thinks big pharma will invest in and support such companies. He also hopes that angels could fund some companies, given the relatively small capital needs and quick returns.

I feel more pessimistic. This sort of model requires creating a market — buyers, sellers, price and quality measures — and it seems like today’s market is spotty at best. I can imagine that CROs could try to do this product definition, but be unable to get a fair price from potential buyers. Or they might get to greedy, hoping for a later sale at a higher price rather than handing off the compound to a firm that can bear the cost and risk of clinical trials.

Still, there’s no denying the cracks in the current model. During its heyday, US firms were the winners in both big pharma and most notably for biotech startups. The industry — and universities and the country — need to find a 21st century model that will take advantage of our home court advantages: university science, risk capital, and a large affluent domestic market.