Does Health Care Need a New Startup Model?

The traditional Silicon Valley model for startups, notably venture capital and private equity, may not work well when it comes to innovation in health care services, says James Stanford. He thinks the innovative ideas he ran across in the industry could best be developed by creating a new business model. That led him to launch Fitzroy Health Holdings, where he is managing director. Fitzroy scouts for promising health care-related ideas within universities, hospitals and elsewhere, negotiates an equity position while proving crucial leadership, and then brings them to a scalable level before taking a backseat. Stanford, who formerly was with McKinsey, discussed his business model with Knowledge at Wharton. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation appears below.

Knowledge at Wharton: Fitzroy Health seeks to unlock latent value for health systems by unearthing internal assets that can be turned into high-growth businesses. What inspired you to start the business, and how did you see the market opportunity?

James Stanford: We believe there is a massive opportunity to improve quality and satisfaction in health care, while also eliminating $600 billion of waste. Fitzroy Health exists to build businesses that we think can achieve those goals.

Knowledge at Wharton: You don’t develop drugs or devices, so what kind of assets have you found within the health systems to turn them into companies? Can you give any examples of the innovations you’ve been able to bring about?

Stanford: Traditionally, when people think about companies in health care, they think about drugs and devices. There’s a long-standing approach to commercializing those assets that tech transfer offices have been developed to manage. Those companies or those assets tend to be based on very air-tight IP (intellectual property) and very strong clinical research. So naturally, the people that populate the tech transfer offices come from a life sciences background, and they tend to have PhDs in chemical engineering and those sorts of backgrounds.

“There is a massive opportunity to improve quality and satisfaction in health care, while also eliminating $600 billion of waste.”

What we’re interested in, though, are not the drugs and the devices, but the tech-enabled health care services businesses that typically don’t have strong patents or clinical research – at least at the level that you’d expect of a pharmaceutical [company]. What they do have is operational excellence and the ability to reduce the inefficiencies and improve quality and satisfaction. They succeed by doing what they do extremely well and getting traction in the market, and specifically getting commercial contracts that have long-standing value and represent a satisfied customer, ultimately.

We work both in clinical and non-clinical businesses. There are two trends that we’re addressing in each of those. The first trend is what we see as a once-in-a-generation movement to outsource assets from health care organizations and delivery companies into new companies that can stand on their own, be more efficient, and serve a specific need at scale. In that realm, we help find those assets and then spin them out in ways that they create value for the original health system, but also can be sold to other hospitals, health plans, physician groups, etc.

An example is Flex Health, a company we launched recently that is looking to disrupt the typical health care staffing agency model and to improve workforce management across the health care value chain. Another is Salute Safety, a company we spun out of Weill Cornell Medicine (the biomedical research unit and medical school at Cornell University). They are leaders in environmental health and safety, managing risk associated with hazardous materials and facilities risks, [such as] employee slips and falls. We’ve turned that into a business that can scale nationally to help these large organizations manage what is a massive amount of risk that exists in their facilities every day.

Knowledge at Wharton: Is what you do similar to what consulting firms do? How is it different?

Stanford: From the beginning, we wanted to differentiate from a number of the different models that were out there, that we thought were ill-suited to the opportunity. When I was with McKinsey and Co. as a consultant, I worked with hospitals and health systems in identifying these new assets that they’d developed to manage these changes in health care

Obamacare and other changes led to health care providers taking on risk for populations; and [therefore] they had to develop entirely new systems of care and care models. In doing so, they invented things that I knew other clients of mine would like to buy, rather than build themselves or certainly reinvent the wheel.

What that took was for us to be able to first find the asset, but then actually build and operate it. As a consultant, I couldn’t do that. And consultants can’t do that. It takes someone who has an ownership stake in the business to go do that.

So, for us to be able to make that work, we formed an operating holding company that takes ownership positions in these new assets and then operates them as subsidiaries of Fitzroy Health. That allows us, then, to be waking up every day thinking about how to make this business succeed, which a consultant could never do. We’re also different from a fund. A lot of people ask us, “Why aren’t you a venture capital fund?”

We’re business builders. We’re not investors. We work with investors, but we want to be aligned with the people who have invented the innovation – be on the same side of the table as they are, and build the business together.

So we had to create a new model – at least as has been applied in this industry – to be able to work with our partners to find the assets, to turn them into something that might be commercial today but is definitely not investable, in the sense of something that a venture capital company could put money into. We’ll bring management teams. We’ll secure commercial contracts. We’ll form capital from outside parties and define a strategy for a company so that it can be spun out into an investable asset.

Knowledge at Wharton: In that sense, are you more similar to, say, a private equity firm or an accelerator? Or is there a difference there, as well?

Stanford: It’s a good question, and honestly one of the challenges that we’ve had over the life of the company has been being able to define what we are with relation to what we aren’t. A lot of people say, “Well, it sounds like consulting,” [but] we take the ownership position. Others will say, “Well, it sounds like you’re a fund that’s investing in these assets.”

“We had to create a new model to be able to work with our partners to find the assets, to turn them into something that might be commercial today but is definitely not investable … something a venture capital company could put money into.”

The truth is, what we’re investing is our time and energy and strategy to build out these companies themselves. So we are closer to an accelerator, except accelerators typically work by having companies come to them. They take a slug of equity – 6% to 10% – and provide support for a short period of time, typically. Whereas, we consider these subsidiaries [to be] our companies. We only want to do one to two a year that we can invest all of ourselves into and really consider it our effort.

Knowledge at Wharton: How do you find these opportunities? Has it been easy or difficult to find these opportunities within the health systems that you can invest in and turn into fast-growing startups?

Stanford: One of the great aspects of the last, say, five to 10 years in health care is that there has been just an explosion of innovation. So finding opportunities [in] itself is not hard. What’s hard is finding an innovation that we think can be successful and scaled successfully and is a good fit for our model. Conversely, that is something the originating institution can actually transact on.

It can be very difficult for these organizations. They’re typically not-for-profit organizations, with a very different perspective on how they view growth and how they view their own internal assets. So it takes a huge amount of relationship building and trust building to help these organizations that have multiple missions. They exist to take care of a population. They exist to do research. They exist to teach. And then they have to turn a profit to be able to do all those things.

So it’s a lot of missions to manage, and we spend a great deal of time with each institution – whether it’s NYU (New York University) or Weill Cornell or many of our other partners – understanding what it will take for this to be successful [for them to be able] to say five or 10 years from now, “Yes, we’re glad we did this. This is delivering what we need it to do.”

Knowledge at Wharton: What have been some of the biggest obstacles you have found in dealing with the health systems, and how have you overcome them?

Stanford: The biggest obstacles have to do with the amount of time it takes to get to a decision – that’s probably the single greatest. A typical startup needs to move quickly, and that’s something that simply doesn’t happen inside of a typical health system, academic medical center or health plan – you name it.

Knowledge at Wharton: It doesn’t happen quickly in any bureaucracy.

Stanford: That’s right. And we’re talking about some of the largest bureaucracies. If you look at the board of a typical major institution, it’ will have a lot more [members] than your typical for-profit corporate board. What that means is that getting to a decision can take years. And sales cycles in the forms of years is typically, I guess, the death knell for a startup. So we’ve had to manage our own business to fit within that cycle.

That led us to a portfolio approach, where we will have multiple companies as subsidiaries that will need time and patience, and we need to give that to them in order to succeed. We have to do it in a way that makes sense from a sustainable financial position, which is why the typical Silicon Valley venture model doesn’t work very well in health care services. You haven’t seen too many successes [in health care services] come out of that world. What they’re looking for from those companies are typically very fast growth and hockey-stick projections, which typically doesn’t happen when you’re talking about hospitals, physicians and clinical sales cycles.

Knowledge at Wharton: What exactly is your business model? Do you retain equity in the startups and share in the risks? And how does the health system benefit from the relationship?

Stanford: The way that we get compensated is that when we form a company, we earn founder’s equity in that company, and we share that founder’s equity with the clinical partners – whether that be the physicians or the hospital or the health plan. What that means is that we are going at risk to develop that company and to earn that equity. So it’s that alignment of interests with the different stakeholders that allows everyone to feel like ‘We’re in this together,’ as opposed to, say, a consultant who’s taking fees along the way or an investor relationship that’s looking for a specific return with a specific type of mandate from an LP (limited partnership) fund, for example.

“Our biggest learning was that we need as Fitzroy Health Holdings, the parent company, to get out of the way of the business as soon as we can.”

Knowledge at Wharton: If a health system believes that it has under-utilized assets and would like to work with Fitzroy Health, what is the process? How would they go about it?

Stanford: The way it works is typically we get a referral from someone who says this organization has something that’s really pretty spectacular and is a center of excellence. What we’ll always do is provide our perspective as one company on what we think the opportunity is for that to scale, either nationally or internationally. If the organization likes our perspective, then we will work together to determine what a business plan could look like and ultimately make a proposal for a partnership.

So it’s a straight-forward process where we can provide, I think, value immediately in the form of a third-party outside perspective, given our reach across the market and the number of deals that we see to be able to help an organization that is necessarily internally focused to put some sort of value on what they have.

Knowledge at Wharton: How many deals have you closed so far, and how many pitches have you considered?

Stanford: The first question is easy. There are five Fitzroy Health assets that we’ve closed. We look at 200 to 400 ideas a year.

We’ve had to develop our own internal software to help us manage that process, and to quickly get to perspectives on where we can add the most value. Once we’ve come to a decision, [we look at] what the fastest route to market is for that opportunity.

Knowledge at Wharton: How are those five startups doing, and how do you measure their success?

Stanford: How we measure their success has to do with the valuation the companies get from outside investors. That’s the ultimate proof of how valuable they are – what someone is willing to pay for them. Right now we have three companies that are, I think, doing very well. We have one that has not done well and in many ways was a victim of the confusion or at least the lack of clarity around what’s happening with the national health care debate. But the other three that are focused more on business process outsourcing have been doing very well. Two of them are profitable. One will be profitable in about a year’s time. We’re very happy with their progress.

Knowledge at Wharton: I understand you are focusing on three areas. You’ve already mentioned business process outsourcing, but you also focus on care model innovation and reinventing education. Why did you choose these three areas?

Stanford: Those three areas are where we can do the most good and create the most value with that initial recognition of the opportunities for improving quality, satisfaction and efficiency in health care. In business process outsourcing, there is this very large trend where hospitals even 10 years ago wanted to hold everything internal – all of their operations. Now they’re recognizing what every other industry has, which is that non-core assets can often be better managed outside of the corporate realm, and they need someone who can create the scale necessary to run that optimally.

Care model innovation has to do with this generational shift towards value-based care. [While] the fee-for-service model is predominant and has been, increasingly there are risk components being added to contracts to say that you’re going to guarantee some level of outcome or quality, in addition to the services that you’re offering. Those changes are making dramatic demands on the care models that exist today. We’re interested in the innovations that work there. A couple of examples from the Fitzroy portfolio: One is DosedDaily, a micro-learning platform [that ties] educational interventions to improving quality. Another is AgeWell, a company that’s devoted to helping older people stay in their homes longer and more healthfully.

Knowledge at Wharton: Do you plan to expand the number of areas you focus on, or will you continue to focus on those three?

Stanford: Our efforts are to focus more [on those three areas] – as much as possible – rather than expand. There’s so much opportunity in all three of those channels that our goal is to be creating two to three companies per year, max – and trying to have a relatively even distribution across those verticals.

Knowledge at Wharton: When you’re trying to incubate startups, the risk of failure is always very high. What have you learned so far in managing this process about how to manage those risks? And how have you changed your strategy as a result of what you’ve learned?

Stanford: Our biggest learning was that we need as Fitzroy Health Holdings, the parent company, to get out of the way of the business as soon as we can. Our job is to find the opportunity, create the strategy, hire the management team, and then let them run with it. Early on we made the mistake of thinking that we could operate it for a longer period of time and create value ourselves. That wasn’t doing anyone any favors.

More recently, [we’ve had] a couple of great examples. For DosedDaily, we hired a CEO named Rolla Couchman, who spent his career with Elsevier and with Kaplan Medical, developing innovative products for health care education. Or Rob Bender, the CEO of Salute Safety, who had been the successful builder, and ultimately seller, of a fintech company that brings the types of data analytics and risk management expertise that he brings to that company. [Those examples] show us how important it is for us to get out of the way quickly.

Knowledge at Wharton: If you look to the future, where do you see Fitzroy Health going in the next three years in the U.S., as well as globally? What opportunities do you see today that you’ll be working on tomorrow?

Stanford: It’s hard to imagine what will happen in three years. I think if you had asked me three years ago what would happen with things like Obamacare, I would have given you an answer that would have looked very different from what exists today.

But with respect to Fitzroy itself, I think that what you’ll see is a company that continues growing its portfolio, potentially has exited some of the positions that it’s in and has created value for our investors, and increasingly is playing a role in identifying large scale opportunities for creating value within those three verticals of care model innovation, business process outsourcing, and reinventing education.

My hope is that what I’m doing in three years or five years is not terribly different from what I’m doing today, and that we just have gone down the road that much farther.