How To Assess Current and Prospective Network Effects, Marketplaces and Platforms in Healthcare
Four out of the top five most highly valued companies in the world are platform companies that utilize network effects to help them grow larger, faster, and more profitably than their competition. 70% of value creation from technology over the past 25 years is driven by network effects.
For angel investors and venture capitalists, spotting the prospects of network effects and platform potential early is key. By the time platforms reach Series C financing, they start to realize a valuation premium of 2.4X compared to their non-platform technology peers. This valuation premium effect persists into maturity, as publicly traded platform companies trade at 2.5x their technology peers without network effects.
So identifying companies with exciting network effects prospects early can offer huge payoffs for early investors.
It’s not enough to spot the opportunity, either; diligence is needed to separate out the wheat from the chaff. This is especially important given that platforms and marketplace companies tend to have different growth profiles (especially at the early stages) than their “pipeline” peers. Further, platform and marketplace companies face different problems from pipeline companies, such as building multiple go-to-markets at the time same. And building platforms and marketplaces in healthcare requires navigating and overcoming different (and often more complex) challenges. By way of just one example, many of the market opportunities for network effects in healthcare are B2B; combined with healthcare being highly regulated, this can place limits on the type of ‘viral’ growth and product-led growth (PLG) opportunities that exist for in other industries, especially those B2C marketplaces that are familiar to many (e.g., Uber).
Which raises the question: how should early stage investors in digital health evaluate the prospects of network effects-driven marketplaces and platforms in healthcare?
Here’s how we think about it at Summit Health.
Scoring Network Effects And Platform Potential
Applying a scoring rubric to a complex and abstract concept is difficult, but can yield tremendous value. The score itself is one piece, but the real value is the journey to get there: breaking down the complex into parts and analyzing parts against benchmarks can yield insights.
Andrew Chen, author of ‘The Cold Start’, describes three types of network effects: the Customer Acquisition Effect, the Engagement Effect, and the Monetization Effect. We think these are good starting points, but they tend to relate to effects at a moment in time; early stage investors must evaluate current performance, future trajectory, market opportunity, the ability of the founding team to execute on its plan, and the degree to which the business is or becomes defensible.
Accordingly, at Summit Health we focus on Chen’s three areas of focus, but with a different lens.
Strength of Network Effects - we begin here because it is most often overlooked by early stage investors. By ‘strength of network effects’, we mean both the classic definition of Metcalfe’s Law (the value of the network increases with more users) and the degree to which that value is unique, robust, and defensible. In healthcare specifically for instance, we look to understand the different sides (e.g., doctors and pharmacies), interaction patterns between the two, and other factors such as the degree of workflow embeddedness.
Increasing Returns to Scale - the most exciting platforms benefit from both supply-side and demand-side economies of scale. That is, as they grow they can simultaneously benefit from reducing their per unit costs as well as increasing their revenue and margin on a per unit basis. Understanding healthcare markets, economics, reimbursement and incentives is key here.
Flywheel Growth Effect - many platforms are able to tap into their existing user base to efficiently acquire or attract new users and grow. For instance, the classic example of Uber was that demand would attract new drivers, which would decrease pickup time and improve geographic coverage, which in turn would yield increased demand. As described above, leveraging network effects for growth in healthcare can be difficult, so we look for opportunities to tap into existing operational relationships between stakeholders and whether those can be harnessed to drive adoption.
The framework is helpful, but applying analytical rigor to assess the prospects of each in a healthcare context is where the rubber meets the road.
For instance, when evaluating the strength of network effects, is a network that connects doctors and pharmacies for e-prescribing intrinsically worth more, less or the same when compared with a network that connects doctors and PBMs for eligibility transactions? Or, is it realistic for a platform building a payer-provider network to tap into network effects to help it grow faster, and if so, how?
Additionally, there are more nuances to consider:
Which effect matters the most? When scoring, how should each category be weighted?
What are the component parts that make up each effect?
What’s the reference point, and how should scoring work?
Answering these questions should help not just answer questions about the attractiveness of a certain investment, but inform hypothesis and strategy development with the founding team itself. Further, thinking critically about these questions can help to drive strategic alignment between company and investor.
About Summit Health And Network Effects
At Summit Health, we go deep on network effects, marketplaces and platforms in healthcare because we believe in the power of platforms to have a profound and positive impact.
To learn more about Summit Health’s approach to assessing and measuring network effects and marketplace/platform opportunities in healthcare, contact us or schedule time with us.
