A Caution for Would-be Digital Health Entrepreneurs

This is a perspective from Halle Tecco, founder and managing director of digital health venture fund Rock Health.

One of the biggest mistakes would-be digital health entrepreneurs make is building a product based on what they think needs to be fixed in healthcare, irrespective of what the industry is willing to buy.

Investment in digital health surpassed $4.1 billion in 2014, nearly the total of the past three years combined. But many of the most promising startups are failing to get off the ground.

Too few entrepreneurs have grasped the distinction between a product that a physician would love to use and a product that is so critical to the business that a hospital is willing to pay for it.

Defining a 'Death by Pilot'

It’s not all that difficult for “nice-to-have” digital health products to land pilots in today’s spaghetti-against-the-wall environment. Pilots are essentially test-runs of a product, for which the potential customer or partner often doesn't pay.

In fact, entire units are being established at hospitals just to test new startup concepts. Some hospitals even flip the customer relationship and charge the startup cash or equity to conduct a pilot.

Many of these startups never scale beyond the initial pilot. Digital health investors often refer to this as "death by pilot."

If you're a digital health entrepreneur or thinking of starting a company, here are some questions to ask yourself to avoid falling victim to this scenario:

Why are you Piloting Your Product?

A "proof of concept" or "validation" pilot is a provisional agreement to test the technical capabilities and value proposition of a product in a controlled manner.

In academic medical settings, these pilots are often used in research. Some academic medical centers have standard “unfunded research collaboration” agreements, where a Principal Investigator (or "PI") at the university agrees to collaborate on a short-term research project with a startup. In exchange for the time and effort of that researcher, he or she is given the rights to publish any findings.

A validation pilot is often critical for a company introducing a new technology. Validation pilots reduce the technology risk for investors and future customers. The results of a pilot are sometimes valuable for marketing purposes. But a validation pilot should not be confused for a real customer relationship.

Do you Really Know Your Customer?

It's very important to make sure you are working with someone at your target customer organization who is invested in and capable of taking your product as far as possible. I suggest finding a champion who is directly responsible for implementing new technologies which can reduce administrative overhead or improve the patient experience.

The ideal person is someone who has business and finance responsibilities, and views pilots as just the first phase of a larger partnership. Try to talk to department-heads or executives, like a chief executive or chief medical officer. Avoid groups that are solely focused on research, IT, or worse yet -- departments with the entire business model to make money off startups.

I also recommend asking questions early on about which departmental budget you will be paid from, so there's no confusion later down the line. Realize that you'll be working with slow, bureaucratic organizations. To grow quickly, reduce the number of staff-members that need to sign off on your product.

Take Kit Check, a digital health company that specializes in helping hospitals manage inventory in an internal pharmacy. Their product has three components: RFID tags for each medication, a scanning machine, and cloud-based software.

[Editors' Note: Kit Check is a Rock Health portfolio company. The author is a cofounder of Rock Health.]

Originally, the Kit Check team sold the scanning machine which required the approval and budgets of procurement, IT, and the Head of Pharmacy. They quickly switched to giving the scanning machine away for free and only charging for the RFID tags, which only requires approval from the Head of Pharmacy. By making this shift, Kit Check has been able to scale to almost 200 hospitals in less than three years.

Are You Getting Paid?

Only pursue deals where both parties are willing to invest the time and resources to succeed.  If a hospital is unwilling to pay, then they are either the wrong customer or you’re selling the wrong product. It’s not sustainable for any company to work on projects without compensation. Additionally, if another potential customer finds out you’ve worked for free, they could demand the same.

Remind yourself that if the customer really values your product, they should be paying you and not the other way around. At Rock Health, we’ve been seeing more of these so-called pilots, where startups are actually paying organizations to pilot their product.  I’d suggest limiting your free pilots to one. If you do a complimentary pilot, make sure you are getting paid in other tangible ways, such as having the rights to use that hospital’s name and validation results on your sales materials, or having them make introductions to other customers and serving as a reference.

If a hospital truly doesn’t have money to compensate your company for a valuable service or product, they are probably not a good target and you should move on.

Is Your Deal an Opt-Out or Opt-In Contract?

If you have no other option than to offer an unpaid pilot, structure the pilot as part of a multiphase agreement with clearly defined milestones leading to a paid customer agreement.

Multi-phased, definitive sales contracts are up-front agreements that give each partner in the deal the choice to opt-out if certain milestones are not met. These contracts align the business goals of both parties. It’s a larger upfront commitment from the customer, but it also ensures that a startup will get paid if the product works as promised. These agreements also help startups focus on the product and implementation itself, rather than the sales process.

I'm optimistic about startups’ ability to get their foot in the door at large hospitals in today’s innovation-positive climate. But entrepreneurs should always consider the long-term sustainability and scalability of pilots before signing on the dotted line. Validation from a top-tier medical center is impressive, but a list of multiple, unpaid pilots on a fundraising deck is a "death by pilot" waiting to happen.  When going to market and working in the healthcare industry, make sure both sides are aligned and ready to scale.

Thanks to Rock Health entrepreneurs Chris DeNoia, Tim Kress-Spatz, Christine Lemke, and Ian Shakhil for sharing ideas for this article.