Why is health care so damn expensive?

Never has there been more talk of innovation and yet more disappointment in the future than in the health care industry. AngelList shows almost a thousand startups just in the digital health space alone, and VCs invested $3.5 billion in digital health startups in just the first half of 2017 according to Rock Health’s industry analysis. There are dozens of health innovation conferences hosted in the United States every year, with participants chattering, chattering, chattering about this or that “innovation.”

All of that innovation has done practically nothing though to fix the single worst problem of modern American health care: it’s cost. Health care in the United States has never been more expensive. The United States is spending about $3.5 trillion a year on health care expenses, an increase of 12,300% since 1960. In that timeframe, health care spending increased from 5% of U.S. GDP to about 17.5% of GDP.

Despite all of that spending, the age-adjusted mortality rate for Americans has only slowly declined every year since 1980. Even worse, life expectancy for Americans — among the most typical metrics for measuring broad health and wellness outcomes for a country — declined for the second year in a row in 2017.

It’s Juicero innovation at its finest. We’re paying more, way more, than we used to, and yet our outcomes have never been worse.

This is the problem known as “cost disease” — the rapidly escalating costs of basic human services like health care, housing, education, construction, and infrastructure. It’s a problem that plagues the developed world, but none more so than in the United States. Scott Alexander, who blogs at Slate Star Codex, wrote a masterful summary of the problem a year ago that’s worth reading for how this pattern seems to emerge across all of these industries.

It is one thing though to identify the pattern, and it’s another to start to tease out the reasons why costs have spiraled 123x in just a few decades. The pithy answer is that there is no pithy answer: industries like construction and healthcare are simply too complicated to have a simple response to the question of cost disease. It’s literally all the answers and none of them at the same time.

There is a slowly growing understanding in policy circles that cost is the fundamental challenge to improving America’s human services and infrastructure. The tradeoffs required in American medicine — offering better care or offering more care to more people would simply be moot if the overall cost of health care was 9% of GDP instead of 17.5% — the median percentage in the OECD group of industrialized countries.

Call me cynical, but having talked with dozens of digital health startups over the past few years, this basic fact so rarely seems to register with founders. Entrepreneurs are trying to digitalize medical records, or improve operating room efficiency through better analytics, or create a new (and expensive!) robotic medical device. These innovations are important, but they are a bit like rearranging the deck chairs on the Titanic to try to right-size the ship: actions far too small to make a difference.

This problem is thankfully starting to be addressed by startups head on. One startup is Avant-garde Health, which publicly announced a $4 million seed round led by General Catalyst, Tectonic Ventures, and Founders Collective this week (the round was closed mid-last year).

I chatted with Derek Haas, who is the founder and CEO of the company and who has spent the last few years completely immersed in the challenges of controlling the rampant cost disease in American hospitals.

If you are wondering what one of the main drivers of cost disease in health care is, it likely starts with the fact that few hospitals and providers actually know what their costs are except for aggregated numbers. We can cue a facepalm emoji, but the reality is that it is really hard to do this sort of analysis with existing management systems.

The company’s solution is to use a technique called “activity-based costing” and apply it to the health industry. The idea is to try to accurately assign every expense of an organization to the exact activity that created that cost. In the healthcare context, Avant-garde uses “time-driven” costing to assign expenses to treatment. The goal, Haas explained, is “to understand for each patient what care is delivered, who delivered that care, and how much time did it take to deliver that care.”

So, for instance, every health professional that sees a surgery patient needs to assign exactly their time to that patient so that the true cost of that surgery can be calculated and analyzed. A nurse who spends 20 minutes in the room needs to assign one third of their hourly rate to the patient.

Now, this sort of costing can sound like an MBA’s godsend or a patient’s worst nightmare (let alone the providers who need to input their timecards). However, Haas’ data from the last few years though shows that the tradeoff between quality of care and cost often doesn’t have to be made. “What we frequently observe is that the biggest drivers of cost and delivery of care is the volume of care,” he explained. In other words, surgeons who conduct more surgeries both have more experience — improving outcomes — while also cutting the cost of each surgery by amortizing their income across more patients.

In addition to volume, standardized treatment is also key. “When you look at organizations with more standardization in how care is delivered, those organizations are getting better outcomes and are often more cost-effective” to boot Haas said.

For example, Avant-garde worked with the Penn State Hershey Medical Center to improve the efficiency of Total Hip Arthroplasty surgery (i.e. a hip replacement). What the hospital found is that different surgeons were using different hip components at different rates, increasing the total supply cost of the surgery. With improved analytics and physician education, the hospital was able to save $842 per surgery with minimal change to outcomes.

Today, Avant-garde is focused on just collecting and analyzing cost data. Its long-term goal though is to attach those costs to actual patient outcomes so that administrators can understand when additional spending is helping patients, and when it doesn’t. “People are often making decisions based on perceived quality, rather than actual outcomes,” Haas said. By getting better outcomes data, hospitals can start to help consumers get better treatment at lower expense.

Avant-garde is not a panacea to our healthcare cost disease. But it is a step in the right direction. By quantifying aspects of the healthcare business that are today opaque, management is being given the tools to actually make the right decisions on behalf of patients and payers.

That in many ways is the story of cost disease in every industry. What looks like a tradeoff can often be recast as a win-win situation. Lowering infrastructure costs can suddenly mean not choosing between three subway routes, but doing all of them. We suddenly don’t have to choose between new technology in classrooms and lower class sizes. And we don’t need to choose between limiting treatment and offering insurance to more people. For founders thinking about making an impact, there’s a trillion dollar idea right here.