The ‘giant sucking sound’ of digital health consolidation

Ross Perot may have popularized the term during his unsuccessful presidential bid in the nineties as a reference to the adverse effects of NAFTA on American jobs, but “giant sucking sound” may be an apt metaphor today for the rapid consolidation of digital health companies.

Recent reports indicate explosive growth in venture capital funding for digital health startups, around $15 billion for the first half of 2021, with no slowdown in sight. The story from the other side is that these same startups are exiting through liquidity events at an equally fast clip.

Amwell’s announcement of the acquisition of two digital health companies is the latest in a series of M&A moves that have continued to accelerate since Teladoc and Livongo merged last year in an $ 18.5 billion deal.

On the face of it, the two companies are in unrelated spaces. Silver Cloud is a behavioural health company that has developed digital care models equivalent to face-to-face encounters. Conversa is a chatbot technology company that uses conversational interfaces for digital pathways to support a wide range of clinical needs – from pre-admission patient education and preparedness to post-acute monitoring and chronic care management.

The unusual deal announcement indicates that the two companies, with combined revenues of less than $15 million were acquired for a combined value of more than $300 million.

The deal announcement confirms a consolidation trend underway in the digital health space. We are seeing digital health startups merge or get acquired by larger tech firms to achieve this goal. An example of the former is the merger of Grand Rounds and Doctor-on-Demand for a combined value of $2 billion. An example of the latter is Microsoft’s $8 billion acquisition of Nuance. The Amwell acquisitions are small in comparison. However, these deal values may be the norm as we see an increased pace of M & A in digital health.

The ongoing consolidation makes sense for startups (and their VC backers). There has been a proliferation of chatbot-based tools and virtual behavioural health companies. The bottom line for startups is how to achieve scale and profitability in this highly competitive landscape. Many will be tempted to exit in the current environment of unlimited funds and attractive valuations rather than grind it out for the long term.

What does this consolidation wave mean for their customers, i.e. healthcare enterprises?

The digital health solutions landscape is highly fragmented today. The health system CIOs and CDOs that my firm works with are struggling to make strategic bets on partnerships in this confusing landscape. Digital leaders in health systems realize that selecting a promising startup for a strategic partnership may have the perverse effect of putting the startup in play for a possible acquisition just based on acquiring a marquee name as a client. 

On the flip side, many of the more mature digital health solution providers are acquiring smaller startups with complementary offerings to expand their “surface area” – a term that is now trending among digital health VCs. This complicates vendor governance and management even further for health systems executives.

If a health system is on the Teladoc platform and uses Conversa chatbots, they may soon have Amwell knocking on their doors to gain entry as the new owners of Conversa. Over the long term, the number of incompatible vendor relationships is bound to increase and will require CIOs and CDOs to architect their solutions stack with loose coupling and to write contracts that provide exit options with minimal penalties and separation costs.

Many health systems are joining the party, making investments in startups that they bring in, mitigating risk, and capitalizing on the opportunity to cash in if the startup finds a profitable exit. One of Conversa’s lead investors is Northwell Health in New York. Other health systems, notably Providence Health, have actively invested in startups and have seen significant gains from successful exits.

There is no question that M&A has become a necessity to grow and scale for digital health startups and larger firms. As big tech firms such as Microsoft and Amazon move aggressively into the telehealth and virtual care space, standalone firms such as Amwell and Teladoc are using M&A to get to scale and remain solid contenders for leadership in the emerging digital health landscape.

Smaller digital health startups are also finding out that the extended sales cycles and slow decision-making in healthcare organizations make new client acquisitions increasingly challenging. Their best bet to avoid going out of business is to hitch their wagons to an incumbent vendor with a substantial footprint in the market. Notably, even the larger firms in the telehealth space are not profitable today.

For Amwell, Teladoc and others, acquiring smaller firms is really about strategic positioning for market share growth and profitability in the long term. In the short term, they can exploit synergies between the acquired companies (Conversa chatbots can complement Silver Cloud’s virtual care model for behavioural health) to increase organic growth opportunities.

In the long term – well, who knows? The party is only getting started. Hang on tight for the wild ride ahead.

Paddy Padmanabhan is the author of Healthcare Digital Transformation – How Consumerism, Technology and Pandemic Are Accelerating the Future. He is the founder and CEO of Damo Consulting.