Surviving Digital Health: How to Build Sustainable Tech-Enabled Service Companies — Part 1: Unit Economics for Care Delivery
Author:
Dan Gebremedhin is a Partner at Flare Capital Partners, a Healthcare Technology and Services focused VC Firm. He was a practicing physician at the Massachusetts General Hospital, previously served as a Medical Director at the Harvard Pilgrim Health Plan and spent time as an entrepreneur in the health IT industry.
Special thanks to Stephen Grinich for his contributions to the article. Stephen was a member of the 2022 Flare Capital Partners Scholar program during his graduate studies in the UC Berkeley and UC San Francisco Master of Translational Medicine program.
Table of Contents
Introduction: Navigating the Opportunities and Challenges in Digital Health
Unit Economics for Care Delivery
- Measuring a Unit of Care
- Start with Gross Margin, End with Contribution Margin
- Capacity Utilization and its Impact on Unit Economics
- Strategies for Optimizing Capacity Utilization
a. Tracking and Incentivizing Clinician Productivity
b. Utilizing 1099 and W-2 Clinicians
c. Extending Capacity with non-clinicians and Technology
Balancing Growth and Profitability
- Tracking Burn Multiple and Free Cash Flow Margin
- Accounting for Cash and the importance of RCM
- Pacing Operating Expenses with Growth
- Leveraging Customer Cohort Analysis for Sustainable Expansion
- Navigating Patient Acquisition and Enhancing Lifetime Value
Achieving Key Outcomes
- Patient Engagement and Activation Outcomes
- Clinical Outcomes through Evidence-Based Practice
- Economic Outcomes: Cost Avoidance, Cost Savings, and Return on Investment
Conclusion: A Path to Sustainable Success
Navigating the Opportunities and Challenges in Digital Health
The digital health sector has experienced significant growth in the last decade, fueled by a surge in funding and the emergence of innovative, tech-enabled care delivery models. These tech-enabled services offer groundbreaking opportunities for disruptive innovation and scalable care across a broad range of categories and conditions.
In the last quarter, there has been tangible excitement about the S1 filings and potential IPOs of breakout companies Hinge Health and Omada Health. The hope is that these success stories can provide validation for the broader digital health and tech enabled services industry. While these companies have achieved impressive topline growth and improving profitability, they are realizing their prior market valuations will require a reset of up to 50% as they go public. This market reset has seen more extreme reverberations with several recent failures and premature mergers and acquisitions among tech enabled services startups, combined with a broader slowdown in venture capital investment in the market broadly, but specifically lower investment rates into tech enabled services companies.
According to data from Rock Health’s Digital Health Venture Funding Database, investment for digital health companies in tech-enabled services categories declined at a compound annual growth rate (CAGR) of 9% from 2020 to 2024. In contrast, investment for SaaS-aligned categories of clinical and non-clinical workflow increased at CAGRs of 5% and 8% annually, respectively, over the same period¹.
Despite these headwinds, we believe with strategic assessments and proper planning, tech-enabled healthcare services can achieve significant impact and sustainable growth. In our review, we believe the success of early-stage tech-enabled service companies will depend on effectively managing several key drivers of performance: unit economics, growth strategies, and achieving crucial outcomes. We’ve canvassed perspectives from leading entrepreneurs, operators and investors to compile this playbook which outlines foundational strategies and a path to success in today’s evolving market.
In Part 1, we’ll review how tech enabled services businesses should define their unit economic and margin cost structure, and the impact clinician staffing and technology utilization can have on margin structure.
Unit Economics for Care Delivery
Understanding the unit economics of a care delivery model is essential for assessing the profitability and sustainability of a tech-enabled service company. In our experience, early-stage companies marketing a new service model may obtain customers and growth, without a strong understanding of their unit economics. In the following sections, we’ll discuss our approach to understanding, measuring, and then optimizing a company’s unit economics.
Measuring a Unit of Care
A “unit of care” is a quantifiable and discrete episode of care that generates revenue for the business. This could be a single clinical visit or a set of care activities. It could also be an entire clinical entity, like a free-standing clinic, where care is reimbursed at a standard, repeatable rate.
The cost to deliver a unit of care is influenced by several factors. The type and number of clinicians involved, the extent of technology use, related operational expenses, and the chosen reimbursement model are all important to consider.
Measuring a unit of care is straightforward for synchronous care, which is the widely accepted and reimbursed standard. Companies like One Medical and Carbon Health benefit from established fee-for-service and in-network payer models, where a unit of care directly correlates to an individual patient-clinician encounter. However, while synchronous care is more readily reimbursed and quantifiable as a care unit, it faces significant challenges. Synchronous care often incurs high operational costs related to workflow and infrastructure and may struggle to meet the diverse needs of specific patient groups.
Tom X. Lee, co-founder of Epocrates, founder of One Medical and now CEO of Galileo, relates, “Many entrepreneurs and investors in digital health businesses can get enamored by the technology, whereas the actual asset of importance should be labor. One has to truly understand labor costs in a dynamic environment, particularly if clinical services are a component of your care stack. Granted, cost accounting for labor can be complex as you are often not just producing repeatable widgets — but when we created One Medical, we found ways to abstract and simplify labor into common vectors. For example, what is the cost of delivery to specific patient populations? What are the available visit types and timeslots in any given day? The goal is to deliver high-quality care with durable margins across these vectors.”
The demand for asynchronous care is surging in today’s healthcare landscape, driven by its ability to expand clinical capabilities and accessibility. These models offer cost-effective and flexible engagement options that enhance the efficiency of care delivery. Nonetheless, defining a unit of care for asynchronous models requires a more nuanced approach than synchronous care.
Historically, payers have failed to reimburse asynchronous care in a standard fee-for-service model, forcing tech-enabled providers to innovate their reimbursement strategies. These providers have had to forge partnerships with self-insured employers and insurance plans to utilize episode-of-care or per-engaged-member-per-month (PEMPM) reimbursement models. Business model innovation around payment has been crucial for success in tech-enabled care models: collaborating with payers to fund high-value interventions that traditional reimbursement frameworks have consistently overlooked.
Eden Health, a former Flare Capital Company, now part of Centivo, combined synchronous and asynchronous care for employers to create a hybrid model that leveraged the strengths of both. With this new capability, Centivo can cater to a wide range of patient needs, complexities, and preferences while optimizing both cost efficiency and clinical efficacy. The company works with self-insured employers to reimburse high-value asynchronous care, while using traditional reimbursement rails for in-person and virtual care that payers already cover.
Start with Gross Margin, continue with Contribution Margin
Gross margins are defined as the profit generated from a unit of care, after subtracting the cost to deliver that unit (known as Cost of Goods Sold or COGS).
In the context of tech-enabled services, COGS refers to the costs directly incurred when delivering a unit of care. These costs primarily consist of variable expenses directly attributed to care delivery, such as clinical and administrative labor and technology costs, and scale proportionally with the volume of care provided.
While COGS is a well-defined concept, the specific cost inputs that should populate the COGS calculation is not addressed in any detail in generally accepted accounting principles (GAAP). Further, there is no standard accounting format or formula for COGS for early-stage tech-enabled services businesses, leading to significant variability in industry practices. Some companies adopt overly optimistic practices, presenting gross margins as if they are already at steady-state, optimized utilization ratios, which can be misleading. In reality, early-stage companies typically experience low or even negative gross margins due to the need to staff up clinician capacity in anticipation of future patient volumes and limited initial reimbursement.
Many companies exclude administrative time from clinician compensation, unutilized clinician capacity, or reclassify onboarding and ramp-up costs as operating expenses below the gross margin line to present a stronger gross margin. These practices can obscure the true profitability and sustainability of the business if not properly accounted for in COGS.
Matt Bogle, Managing Director leading the healthcare vertical at transaction advisory firm Intrinsic, notes that “Many early-stage companies prioritize scaling over generating EBITDA, often optimizing their gross margin calculations while overlooking the costs that scale linearly with their business. This can create a misleading gross margin profile, complicating both internal management decisions and investor evaluations. For example, if each new clinic, practice, or business line requires an additional scheduler or care coordinator, these costs should be classified under Cost of Revenue rather than Corporate overhead, which is typically considered more fixed in nature.”
The concept of medical contribution, or simply contribution margin, acts as a safeguard for companies that opt for a more aggressive gross margin calculation. This is because contribution margin calculations include all care delivery costs, in particular the variable costs that are often left out of gross margin calculation.
By definition, contribution margin separates such variable costs from fixed costs. For tech-enabled services, variable costs typically include those utilized in delivering care or producing revenue, such as clinical labor and patient support services. Fixed costs, on the other hand, usually cover non-clinical parts of the business, such as corporate administrative overhead and R&D technology expenses. The medical contribution margin reflects the actual profit margin generated from the entire clinical revenue-producing entity, which can then be allocated to cover fixed costs. In essence, it represents the portion of revenue that not only covers fixed expenses and drives the profitability of the company.
Organizations must understand the fixed and variable costs of their care model, and how these scale over time to achieve sustainable, profitable margins. Failure to do so undermines financial stability. Once the cost model is understood and fixed, organizations must ensure consistent patient demand and implement revenue models that optimize how clinical resources are utilized. Ignoring these fundamental steps jeopardizes long-term viability and growth.
Once established, top-tier tech-enabled service models can attain gross margins of up to 60% and contribution margins well above 20% by effectively leveraging key drivers that fine-tune the unit economics of care delivery. In the following sections, we’ll review several tactics that have proven effective in managing unit costs to achieve these margins.
Capacity Utilization and its Impact on Unit Economics
Managing the cost of clinician time is the most important lever in optimizing unit costs for care delivery. Clinicians are often the costliest resource within a tech-enabled services company, requiring compensation requisite for the years of extensive education, training, and clinical certification. Additionally, significant time is needed to onboard and train clinicians in compliance with quality and ethical standards in new, digital-first, rapidly scaling clinical models. Given the high cost of clinical labor, not closely tying utilization of this asset to revenue production is a serious error.
Measuring clinician utilization requires analyzing the proportion of time spent on direct patient care compared to administrative, non-clinical tasks, or other non-revenue producing activities. This metric, known as capacity utilization, is calculated by the ratio of billable hours to total working / compensated hours. High utilization rates usually reflect efficient use of clinician time. However, excessively high rates may indicate overwork, risk of burnout, and potentially poor patient satisfaction. Finding an optimal balance is essential to maintain both clinician well-being, quality of service, and service efficiency.
Due to the complexities of clinician staffing, companies may overstaff, leading to an average capacity utilization of about 50% across their provider base — effectively paying clinicians for idle time. Companies must consider adding clinician capacity only when there is clear and confirmed demand to avoid such inefficiencies. In our experience, clinicians should ideally operate at 80–90% capacity utilization, as 100% utilization is not realistic given no-shows and last-minute schedule changes. Companies should initially staff according to their lowest demand projections and increase staffing levels as demand grows and clinicians approach the 80–90% utilization threshold.
It bears repeating — paying clinicians for time that does not generate revenue is unsustainable. All work performed by clinicians should be reimbursable by either payers or patients. Companies may consider re-purposing any excess clinician capacity to IP creation or administrative activities that may generate revenue in the future, but this can be misleading given the lack of straight-line to positive unit economics.
Strategies for Optimizing Capacity Utilization
Clinicians have traditionally been burdened with administrative duties and patient-facing care coordination without corresponding reimbursement. This inefficient use of highly trained professionals is financially detrimental. The most effective tech-enabled service companies optimize operations by ensuring clinicians work at the top of their licenses, thereby minimizing time spent on unreimbursed activities.
Tracking and Incentivizing Clinician Productivity
Tech-enabled services companies striving for profitability must develop robust capacity utilization views segmented by clinician and empower managers to utilize this data when growing and curating their clinical workforce. Variation in performance and productivity among individual clinicians is inevitable with a large clinical workforce. Managers must have visibility into this clinician-level data and employ strategies to understand the variations and take corrective action where needed. Overlooking these variations when evaluating company-wide care costs and efficiency can lead to tactical mistakes creating stubborn model inefficiency.
In a competitive clinician hiring market, companies often feel pressured to hire clinicians on fixed W-2 employment agreements with fixed salaries, regardless of productivity. This approach quickly reveals its flaws as clinician productivity varies and is sometimes unrelated to patient demand. Successful companies have implemented variable compensation models, offering lower base salaries to meet minimum cost break-even levels and incentivizing higher productivity through bonus structures. Clinicians, like all employees, are focused on their total compensation and will adjust their behavior to reach desired levels. This strategy ensures that organizations pay clinicians based on their productivity while providing a basic level of security, avoiding the financial pitfalls of fixed salary agreements.
Utilizing 1099 and W-2 Clinicians
In the first wave of digital health tech-enabled services, companies looked at the clinician staffing model as black and white. More tech-focused telehealth companies chose to hire 1099 clinicians valuing lower overhead costs and agility. More value-based care-oriented digital providers were celebrated by having a solid W2 clinician workforce that differentiated on quality and consistency of provider services. Time and mixed results have shown that the issue of clinician staffing is not black and white but nuanced.
Striking the right balance between W-2 employees and 1099 contractors is crucial for profitability and care quality. W-2 employees, who receive benefits and have taxes deducted, are more integrated into the company’s protocols and culture. In contrast, 1099 contractors offer greater flexibility, including part-time work options, but may have less commitment to company-specific practices potentially leading to variability in care outcomes.
We believe tech-enabled service companies can optimize capacity and manage costs by employing a mix of 1099 independent contractors and W-2 employees. In their early stages, startups should consider hiring few clinicians as W2s and instead lean towards 1099 independent contractors to optimize costs and meet the demands of a small patient base. This approach is especially beneficial when securing contracts with national-scale partners such as payers and large employers, as it enables startups attempt to establish a “national network” and provide services across many states without the financial burden of full-time salaries and benefits. Ignoring this strategy can lead to excessive costs and inefficiencies that hamper growth and scalability.
Transitioning to W-2 employment becomes more viable as companies grow and secure stable patient acquisition patterns and reimbursement terms. This shift enhances care standardization, quality, staffing reliability, and reduces wait times, all of which improve the patient experience and strengthen the company’s position in negotiations with payers and enterprise partners.
Tracy Brubaker, COO at Flare Capital portfolio company Vita Health mentions “We’ve found value in strategically load balancing our W2 / 1099 mix. 70% of our clinical workforce are W2 clinicians focused on our high-demand markets. The remaining are 1099 contractors generally hired in our emerging markets. To better optimize capacity, we have instituted incentive pay for full-time W2 clinicians who achieve a targeted number of completed patient sessions. These targets tie back to clinician performance metrics shared with the clinicians when they join the company.”
Ben Robbins, General Partner at GV, states, “Our thinking on clinical staffing has evolved over time. There’s no inherent virtue in one model versus the other — what matters is the outcome. A well-managed contractor workforce can deliver the consistency, accountability, and community engagement expected of traditional full-time staff. Likewise, full-time clinicians can be incentivized to operate efficiently and match the productivity associated with contractors. What matters most is building a staffing model that aligns clinical capacity with patient demand, without compromising quality of care.”
For digital health companies that aim to grow profitability, the right approach to clinician staffing is likely to resemble a hybrid model. Combining a core team of W-2 employees for predictable patient volumes with 1099 contractors for less foreseeable demand offers a balanced approach, maintaining the benefits of full-time clinicians while allowing for scalable growth.
Extending Capacity with Non-clinicians and Technology
Instead of solely relying on hiring expensive specialists and clinicians, tech-enabled service companies like Omada Health, Lyra Health, and Hinge Health have effectively reduced costs by employing non-clinician members of the care team such as health coaches, navigators, and care coordinators. These professionals augment the clinical staff, guiding patients toward their health goals at a lower cost than a purely clinical staff model would entail. This approach is increasingly vital as the dwindling supply of healthcare providers drives up staffing costs. Moreover, health coaches offer greater scheduling flexibility and provide emotional support and navigation, enhancing patient adherence to clinician-prescribed care plans.
When incorporating non-clinicians to interact with patients, it’s crucial to ensure their time is reimbursed where possible, but more importantly, their costs are included in the cost of goods calculation. Often, these professionals are not reimbursed in a fee-for-service manner by traditional payers, so companies must ensure they are driving commensurate revenue at attractive margins when utilizing care extenders in their models. Delegating non-patient-facing tasks such as documentation, coding and billing optimization, care coordination, and chart review to non-clinicians can further enhance the optimization of unit costs and capacity utilization, preventing clinicians from being burdened by administrative duties and ensuring they focus on revenue-generating activities.
Brubaker notes, “At Vita Health, we preserve clinician time by utilizing support staff to manage the important tasks for strong reimbursement, including credentialing, licensing, scheduling, billing and quality monitoring. That frees our clinicians’ time to be optimized for reimbursable patient care. This administrative layer has also required significant iteration to yield efficiency gains. We’ve moved from outsourced to insourced call centers to electronic and automated scheduling and care coordination. This digital layer still requires humans in the loop and executive auditing to ensure high conversion rates and high-quality patient care.”
Tech-enabled service companies are beginning to experiment with how they can derive similar cost benefits through investments in digitally enabled workflows and automation. Generative AI tools have the potential to play an important role in reducing the administrative burden associated with care delivery tasks like documentation, Electronic Health Record (EHR) workflows, prior authorizations, patient intake and follow up, and medical coding. In addition to these administrative functions, AI enabled coaching will certainly be tested and early results show promise to effectively guide patients through their care journey. Once these technologies deliver sustainable efficacy and ROI, they will become a must-have in reducing operating costs.
In addition to front and back-office automation, technology can improve core clinical routing and operations. As discussed, clinical staff efficiency is essential to positive unit economics but can be logistically complex. The permutations of matching visible or anticipated patient demand with available clinical supply is a persistent need for every tech enabled services business. This can be done with thoughtful workflows and custom fitting off the shelf technology tools. But increasingly, tech-enabled services companies are building their own proprietary platforms to excel in this critical area.
Positive Development, a tech-enabled Autism Care Services provider and Flare Capital portfolio company, built a tech platform that matches the real-time availability of clinicians to patients needing care, reducing the wait time required for patients and their families to receive care while improving clinical efficiency. This multi-modal platform, known internally as “Stanley,” combines modules for clinician productivity, patient-provider matching, and quality outcome tracking and reporting.
Mike Suiters, CEO at Positive Development (PD), explains, “When we set out to build PD, our observation was that the best Autism care existed in pockets, but it was too hard to access and not standardized for quality and scale. As a result, measurable outcomes and profitability were inconsistent. Our Stanley platform was built to solve these problems. It has required significant investment but has shown the ability to achieve industry leading outcomes and margins at a fraction of the therapy hours of alternative programs.”
Conclusion
In summary, while the focus on generating and growing revenue is a primary concern for tech-enabled services businesses, optimizing cost structure is perhaps more important as the company strives for sustainable growth. This begins with accurately defining and optimizing unit economics and margin structure while aggressively managing clinician and operational costs through leveraging technology, monitoring and reporting. By honing cost structure, the business has more insight into accretive growth.
In Part 2, we’ll examine the trade-offs between growth and profitability and how tech-enabled services businesses can track performance and evaluate common dilemmas on the path to building a large sustainable enterprise. Read Part 2: Part 2: Balancing Growth & Profitability here.
Straight to the Source
To go a click deeper, we are convening these voices around the virtual table for our next expert roundtable webinar. Join us on June 10th at 12PM ET alongside this brilliant group of innovators, executives, and investors who will share their hard won lessons and tactical strategies. Register here.
Footnotes
[1] In Rock Health’s Digital Health Venture Funding database, digital health companies categorized as tech-enabled services are tagged with the value propositions “on-demand healthcare” or “treatment of disease.” The database includes U.S.-based digital health companies that have raised at least $2M in venture funding.
