How to Save $900 Billion Annually in American Healthcare

How to Save $900 Billion Annually in American Healthcare

Joe|October 29, 2018

The American health care industry wastes $1T by some estimates,[1] and possibly as much as 30% of health care spending by others.[2] US health care expenditures are twice the OECD average — for instance, we spend twice what the UK does on health care (as a percentage of GDP) — and American health care costs are growing at 5% a year.[3][4]

Notes: GDP refers to gross domestic product. Dutch and Swiss data are for current spending only, and exclude spending on capital formation of health care providers. Source: OECD Health Data

Healthcare presents one of the greatest policy challenges for our country because profit incentives and care for the patient are often misaligned. It’s clear that the government is going to play some role in making sure the least well-off Americans have access to medicine, but we need healthcare policies that incentivize providers and payors to educate patients to make informed, data-driven choices. Only intelligent consumer choice will stimulate functioning, competitive markets in insurance, patient care, the pharmaceutical industry, and elsewhere. Today, pharmaceutical companies, health providers, electronic health record (EHR) systems, and other actors often have misaligned incentives and fail to enable more efficient solutions that do more for the patient per dollar — indeed, often the winners in these areas are those that unnecessarily charge more. Aligning incentives will spur top technology startups to develop innovative healthcare solutions, bring down costs, and deliver superior outcomes to American patients. Here are a few necessary reforms:

1) Medical Schools

Experts project a total physician shortfall of between 42,600 and 121,300 by 2030.[5][6]* We need more medical schools fast, but the Liaison Committee on Medical Education accreditation process takes 8 years on average and most states require new medical schools to obtain a “certificate of need” before beginning construction.[7] In addition, medical schools are required to sustain the high overhead of medical research rather than focusing exclusively on training doctors, and inflexible requirements prevent medical schools from experimenting with new curricula. Organic chemistry and other undergraduate prerequisites are completely irrelevant to becoming a good practicing doctor, and should be optional.[8]

High medical school costs force students to become high-earning specialists, e.g. plastic and orthopedic surgeons, when our country really needs more primary care physicians (PCPs). Primary care physicians, nurse practitioners, and physician’s assistants are far cheaper than specialists, but limited medical school and residency supply as well as occupational licensing concerns keep them out of the market. In addition, foreign doctors are almost always required to complete a full residency before being allowed to practice in the United States.[9] Given a current skills gap of 30,000 doctors, adding 30,000 new PCPs, nurse practitioners, or physicians assistants could save $2.3B, $5.1B, or $6B in salary costs alone relative to the current mix of specialists and primary care doctors.[10][11][12]

In addition, primary care doctors achieve better health outcomes for patients than specialists by engaging in long-term counselling, tracking, and preventive care.[13] Scholars estimate that replacing specialists with primary care physicians at a density of 1 per 10,000 population could save $931 per beneficiary a year.[14][15] Adding a supply of 30,000 primary care physicians would save our country about $150–200B a year.[16]

*If implemented correctly, data-driven telemedicine can ameliorate demand for physicians somewhat. Doctors should be able to digitally prescribe most drugs, and data from increasingly sophisticated wearables will enable physicians to swiftly and efficiently diagnose patients.

2) Reform PBMs

In 2017 the Centers for Medicare and Medicaid Services (CMS) spent $175B on prescription drugs alone, and there are curr\ently shortages of vital drugs across the country.[17][18] An oligopoly of Pharmacy Benefit Managers (PBMs) generates $200B a year in revenue by forcing drug manufacturers to pay rebates and other kickbacks in order for the PBM to place their drug on the “formulary”, or list of insurable drugs.[19][20] Securing a place on the formulary is a matter of life and death for manufacturers, and by one estimate the current value of rebates and other price concessions from manufacturers to PBMs increased from $59B in 2012 to $127B in 2016.[21]

After speaking extensively with politicians on both sides, we were thrilled to see the Senate recently outlaw PBM “gag-orders” on pharmacies by a 98–2 vote. We are encouraged to see that Alex Azar’s Department of Health and Human Services (HHS) is planning to subject PBM rebates to anti-kickback law, but we would go further and require full price transparency on PBM contracts in the style of Colorado HB 1260.[22] Although some rebate money flows to insurers, we estimate that reforming the space could save America on the order of $50B.

3) End of Life Palliative Care

Although discredited by hyperbolic language about “death panels”, counselling patients at end-of-life is both cost-effective and humane. 30% of Medicare expenditures are attributable to 5% of beneficiaries who die each year, and acute care in the final 30 days of life accounts for 78% of the costs incurred in the final year of life.[23] While acute-care for the dying should obviously be available to those who want it, our country must shift to a model of counselling and palliative care at the end of life.

Just having an end of life discussion with the cancer patient reduces medical costs by 35.7% on average, and given that there are roughly 600,000 cancer deaths in the United States a year, would have saved $687M a year for cancer patients in the last week of life alone! In addition accountable care organizations (ACOs) have saved $12,000 per patient during the final three months of life by implementing home-based palliative care. If extended to all cancer, end stage renal disease, and congestive heart failure patients this program could save the country $11.7B a year.[24]

We all agree that we must treat families of the dying with delicacy and compassion. But introducing a program by which families will share in Medicare/Medicaid savings from palliative care would help families and patients factor the overall social cost of end-of-life care into their decision calculus. We estimate that extending proven programs and testing different incentives structures could save our country $30–50B a year.

4) FDA Reform

Clinical trials are an arduous multi-year process and have become drastically more costly in the last 30 years.[25] Phase II and III efficacy trials cost roughly $400M per new drug, which severely limits the number of drugs that make it to the final stage of Food and Drug Administration (FDA) approval.[26] A “progressive approval” approach would allow drugs to be repurposed for other uses and possibly sold after passing Phase I safety trials, which establish that a drug has a favorable risk balance and qualifies as value-based care.[27]Drug companies could gradually establish efficacy by logging the effects the drug has on each person who opts to use it over the next several years.

The extreme costs of clinical trials and FDA approval not only stymie drug development and the application of treatments to new indications, they effectively privilege Big Pharma over other innovators, inhibiting innovation and medical progress. While ramping up the number of drugs approved may not save our healthcare system money on net, a framework which encourages innovation will positively impact millions of lives by improving quality of care.

5) Give Medicare Negotiating Power

To pass the Affordable Care Act (ACA), the Obama Administration made a critical concession: Medicare would not be able to negotiate the price of drugs by controlling which drugs make it onto Medicare’s formulary. As a consequence, our federal government is a “price taker” that must blindly accept whatever prices drug companies demand, and the American government winds up subsidizing drug development costs for the rest of the world. Drug prices at home are extremely high, representing 10% of total healthcare expenditures, and about $144B of federal healthcare spending.[28]

In many other developed countries, governments use their monopsony or near-monopsony buying power to force pharmaceutical companies to sell drugs at much cheaper rates. For instance, Canada spends 70% of what the US spends on brand name drugs, the UK 40% of what we spend, and Denmark only 35%.[29] If the US federal government used its considerably larger “countervailing power” to negotiate reduced drug prices — whether on a case by case basis or by pegging the value of a Quality Adjusted Life Year at a generous but fixed rate — savings could be in the range of $30–40B, possibly even as high as $90B a year.[30]

Pharmaceutical industry lobbyists (PhRMA) argue that high drug prices are necessary to stimulate R&D which generates many new life saving drugs every year. But in fact, median R&D spending on new cancer drugs — the most difficult to develop — is only around 40% of total revenue.[31][32] In addition, most R&D is funded by American universities, and manufacturers of silver-bullet specialty drugs could continue to charge high prices to a federal payor.[33] Giving government negotiating power isn’t a novel solution, but it’s one of the correct solutions to driving down drug costs for Americans.

6) Tort Law

The threat of malpractice lawsuits forces doctors to engage in costly defensive medicine. Although the current administration has made some progress on tort reform (making arbitration legal for federal contractors and nursing homes), Congress must insist on Texas-style reforms including capped punitive and noneconomic damages from healthcare providers, eliminating contingency fees for speculative tort lawyers, reinforced federal preemption doctrine for food and drug products, and more. [34][35][36] Unfortunately the trial lawyers lobby — one of the biggest political donors in the country — will fight reform at every step of the way.

Some studies estimate that reducing physician malpractice fears to “somewhat concerned” about malpractice would decrease costs by 14%, saving the country $100B a year. Others argue that medical liability reform could save our country up to $210B a year.[37] Congress must protect our doctors from being attacked by unscrupulous prosecutors in order to reduce the cost of healthcare for American citizens. We all agree that we must insist on protecting patients, but unchecked tort lawsuits just punish American patients and taxpayers with an unaffordable system.

7) Data Interoperability

The ACA’s “meaningful use” requirements did little to make healthcare data accessible. As of 2015, only 6% of health care providers could share patient data with other clinicians who use an EHR system different from their own. Although 21st Century Cures Act made “information blocking” illegal, big EHR vendors routinely prevent their competitors from importing patient data by disclosing health records in garbled, incoherent formats.[38][39] As a result, physicians are unable to make fully informed decisions about their patients.

Judy Faulkner, CEO of EPIC, famously condescended then Vice-President Biden, “Why do you want your medical records? They’re a thousand pages of which you understand 10.” The answer is that only real, semantic interoperability which makes health data available to third parties via and open application programming interface (API) will allow an innovation ecosystem of apps, medical devices, and novel insurance plans to flourish. Granular, transparent healthcare data will allow entrepreneurs — whether college students or IBM executives — to invent new solutions from the bottom up and swiftly incorporate best practices into their businesses. In addition, direct service-to-service comparisons will allow consumers to make informed decisions about how to stay healthy, stimulating market competition for their dollars.

[40]

We have been excited to see CMS’s Blue Button 2.0 API program formalize the Fast Healthcare Interoperability Resources (FHIR) standard for health records, which includes programmer resources, a complete API, and gives beneficiaries full control over their data — but EHR providers are refusing to use it.[41] While any EHR system should ensure compliance with the Health Insurance Portability and Accountability Act (HIPAA) by storing protected health information on secure servers, we need to make interoperability truly mandatory.

If patients could easily share their medical records with new providers and selectively reveal their data to health apps, fitness devices, diagnostic companies, insurers, and academic researchers, our entire healthcare industry would become hugely more affordable and effective. Reliable, real-time information about which treatments work, which failed, and what they cost will enable hospitals to identify and minimize cost centers as they strive to produce care more cheaply than federal benchmarks and share in the savings.

8) Financing Reform

Overtreatment and poor physician incentives may be the main driver of health care costs.[42] Most hospital networks are local monopolies with limited incentives to innovate or save money. Replacing this broken system with value-based care models will immediately save over $100B in total, and should grow steadily over time to $200–300B as doctors harness digital technology interventions and other new techniques to make care cheaper and more effective. We break down a few potential sources of savings below:

Bundled Payments

The Bundled Payment Care Initiative (“BPCI”) introduced in 2013 shows serious promise in making acute care clinical workflows more efficient, particularly in orthopedic care and oncology. Results continue to improve as providers adapt to the program.

After adopting a bundled payment model, the NYU Medical center reduced costs to Medicare by 10% and reduced patient stays by 25% for total hip arthroplasty procedures, and a private practice joint arthroplasty generated 20% savings for CMS per episode while decreasing readmissions.[43][44]The Congressional Budget Office estimates that a voluntary bundled payments system could save Medicare $6.6B a year.[45] If CMS makes bundled payments mandatory for both Medicare and Medicaid, achieves health record interoperability, and allows the ecosystem to iterate on data-driven incentives, we expect savings to surpass $100B.

Accountable Care Organizations

ACOs are widely seen as the Affordable Care Act’s main instrument to rein in health care spending, and ultimately we expect that bundled payments will be folded into a broader ACO model.[46][47] To date ACOs have generated modest savings on average, but some, such as the Memorial-Hermann ACO, have generated 11% savings for Medicare.[48][49] ACO contracts are more efficient if they involve two-sided risk (rewards for savings, penalties for overages), but studies have shown that even early versions of upside-risk only ACOs are associated with a 3% reduction in Medicare reimbursement.[50] In addition, Medicare ACOs have improved quality measures across the board, despite their elderly populations.[51]

Provider networks are still adjusting to the ACO model, and returns will increase in the future. Projecting savings at 5–10% and assuming that all Medicare beneficiaries are enrolled in ACO providers, ACOs would save Medicare $30–60B a year.[52] If extended to Medicare and Medicaid, full ACO enrollment could generate between $56–112B a year.[53]

Preventive Medicine

The ACA now mandates coverage for all evidence-based prevention in non-grandfathered plans, so preventative screening and vaccinations have increased since the advent of Obamacare.[54] However we need to drastically increase the scope of preventive medicine under the aegis of value-based care. Preventable chronic diseases are 7 of 10 top causes of death in the country, and account for 75% of health care costs.[55] Half of American adults have chronic disease, and surprisingly, chronic illness among those younger than 65 years accounts for 67% of total medical spending.[56] 70% of American adults are overweight, and 1 in 3 American kids and teens is overweight or obese.[57] Prevalence of obesity has tripled since 1971.[58]

Some of the most cost-effective, successful preventive health interventions include childhood immunization, youth and adult tobacco counselling, alcoholism interventions, aspirin use for people with heart disease, and screenings for common cancers, STDs, and chronic conditions like hypertension.[59] Evidence suggests that many other preventive health interventions are cost-neutral or increase long-term medical costs (because they extend lifespans). However critics often miss the fact that preventive health measures will extend the working careers of Americans, and pay for themselves in the long-run.

In kidney care, for example, the federal government subsidizes extremely costly dialysis treatments for end stage renal disease patients but has not crafted incentives to perform preventative treatments before a patient advances to this critical, debilitating condition. Rather than fill the coffers of the corrupt duopoly that runs the dialysis industry, we should give providers incentives to halt the progression of kidney disease in its tracks. As a country we spend $42B on hemodialysis. Just getting prevention right here could save our system north of $10B a year.

Conclusion

Fixing our sprawling, tangled healthcare system is one of our nation’s greatest policy challenges. In the coming years, America should move swiftly to embrace value-based care models which align market incentives to produce a wealth of patient data and an ecosystem of new information technologies geared at preventive treatment. At the same time, we must address specific areas where poor incentives have throttled the production and delivery of medical services. Replacing bureaucratic mandates with proven Western values of entrepreneurial innovation and educated individual decision-making will yield better patient experiences and results for Americans from every walk of life while saving our country $600-$900B annually — a transformative amount of money for the well-being of our nation.

This paper is a work in progress and we intend to publish new versions of our recommendations as we continue to talk to practitioners and refine our views on healthcare policy. This is the latest version of our views as of October 15, 2018. American healthcare is a complicated space, and we would appreciate any feedback or suggestions.

Joe Lonsdale
Partner, 8VC


8VC is a San Francisco based venture capital firm investing in industry-transforming companies. For more information, or to sign up for our newsletter visit www.8vc.com

Endnotes

[1] Sahni, Nikhil et al. “How the U.S. Can Reduce Waste in Health Care Spending by $1 Trillion.” Harvard Business Review, 2015.

[2] Blumenthal, David et al. “Health Care Spending — A Giant Slain or Sleeping?” New England Journal of Medicine, December 2013.

[3] Squires, David and Chloe Anderson. “U.S. Health Care from a Global Perspective.” The Commonwealth Fund, 2015.

[4]“Average Annual Percent Growth in Health Care Expenditures per Capita by State of Residence.” Kaiser Family Foundation, 2014.

[5] Moses et al, ibid.

[6] “The Complexities of Physician Supply and Demand: Projections from 2016 to 2030: 2018 Update.” Association of American Medical Colleges, HIS Markit Ltd. March 2018.

[7] Stark, Roger. “The Looming Doctor Shortage.” Washington Policy Center, November 2011.

[8] https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3824759/

[9] https://www.statnews.com/2017/05/15/missouri-doctor-dearth/

[10] The average yearly salary of a doctor (given current percentages of specialists vs. PCPs) is $300k, see Kane, Leslie. “Medscape Physician Compensation Report 2018.” April 11, 2018.

[11] The average yearly cost of a Nurse Practitioners and Physicians Assistants is about $100,000 a year. See https://nurse.org/articles/nurse-practitioner-ranks-2nd-US-2017/ and https://money.usnews.com/careers/best-jobs/physician-assistant/salary

[12] Physicians Assistants can handle 86% of the diagnoses seen in outpatient primary care settings. See Eibner et al. “Controlling Health Care Spending in Massachusetts: An Analysis of Options.” Rand, 2009.

[13] Starfield et al. “The Effects of Specialist Supply on Population’s’ Health.” Health Affairs, 2005.

[14] American College of Physicians. “How is a Shortage of Primary Care Physicians Affecting the Quality and Cost of Medical Care?” 2008.

[15] Adjusted for inflation. See: Baicker, Katherine and Amitabh Chandra. “Medicare Spending, The Physician Workforce, And Beneficiaries’ Quality of Care.” Health Affairs, 2004.

[16] Our current physician skills gap is currently around 30,000 doctors, see: “The Complexities of Physician Supply and Demand.” Since the current physician workforce composition is 2/3rds specialists and 1/3rd PCPs, a base case for solving the skills gap would be to create 20,000 more specialists and 10,000 more PCPs. Replacing 20,000 specialists with PCPs would generate savings of $931 * 20,000 doctors * 10,000 beneficiaries per doctor, or $186B a year.

[17] https://www.kff.org/infographic/10-essential-facts-about-medicare-and-prescription-drug-spending/

[18] “Urgent Call to Action!” Physicians Against Drug Shortages,

[19] Neeraj Sood, Dana Goldman & Karen Van Nuys, Follow the Money to Understand How Drug Profits Flow, STAT (Dec. 15, 2017)

[20] “Amber Rainey, Christina Kollmeyer, and Lisa Vogel v. Mylan Specialty L.P.” United States District Court, Western District of Washington at Seattle. 2018.

[21] Fein, Adam. “New Data Show the Gross-to-Net Rebate Bubble Growing Even Bigger.” Drug Channels, June 14, 2017.

[22] https://www.reuters.com/article/us-usa-healthcare-kickbacks/trump-administration-proposes-altering-rule-on-drug-rebates-idUSKBN1K92ON

[23] Zhang et al. “Health Care Costs in the Last Week of Life.” Arch Intern Med, 2009.

[24] 600,000 cancer mortalities + 287,000 congestive heart failure mortalities + 89,000 ESRD mortalities yields 976,000 mortalities a year that could be addressed with palliative care. For ACO savings, see: Lustbader et al. “The Impact of a Home-Based Palliative Care Program in an Accountable Care Organization.” Journal of Palliative Medicine, 2017.

[25] Berndt, Ernst and Iain Cockburn. “Price Indexes for Clinical Trial Research: A Feasibility Study.” 2014.

[26] Adjusted for inflation. See: DiMasi et al. “Innovation in the Pharmaceutical Industry: New Estimates of R&D Costs.” Journal of Health Economics, 2016.

[27] Caplan, Arnold and Michael West. “Progressive Approval: A Proposal for a New Regulatory Pathway for Regenerative Medicine.” Stem Cells Translational Medicine, 2014.

[28] https://www.kff.org/infographic/10-essential-facts-about-medicare-and-prescription-drug-spending/

[29] Woo, Nicole and Dean Baker. “State Savings with an Efficient Medicare Prescription Drug Benefit.” CEPR, March 2013.

[30] The USFG spends $144B on prescription drugs a year.

[31] https://www.washingtonpost.com/news/wonk/wp/2015/02/11/big-pharmaceutical-companies-are-spending-far-more-on-marketing-than-research/?utm_term=.828fb80bac8a

[32] Prasad, Vinay and Sham Mailankody. “Research and Development Spending to Bring a Single Cancer Drug to Market and Revenues After Approval.” JAMA, 2017.

[33] Kirkwood, John. “Buyer Power and Healthcare Prices.” Washington Law Review, 2015.

[34] Carter, Terry. “Tort Reform Texas Style.” ABA Journal, 2006.

[35] https://www.law360.com/articles/906301/trump-kills-government-contractor-blacklisting-rule

[36] http://thehill.com/policy/finance/358297-trump-repeals-consumer-bureau-arbitration-rule-joined-by-heads-of-banking

[37] 2016 data from CMS indicates that America spent $665B on physicians; 665*.14 = $93B, and it’s certainly higher today. Reschovsky and Cynthia B. Saointz-Martinez. “Malpractice Claim Fears and the Costs of Treating Medicare Patients: A New Approach to Estimating the Costs of Defensive Medicine.” Health Services Research, 2018.

[38] Reisman, Miriam. “EHRs: The Challenge of Making Electronic Data Usable and Interoperable.” Pharmacy and Therapeutics, 2017.

[39] Adler-Milstein, Julia and Eric Pfiefer. “Information Blocking: Is it Occurring and What Policy Strategies Can Address It?” The Milbank Quarterly, 2017.

[40] Feldman et al. “The State of Data in Healthcare: Path Towards Standardization.” Manuscript, 2018.

[41]https://en.wikipedia.org/wiki/Fast_Healthcare_Interoperability_Resources

[42] Gawande, Atul. “The Cost Conundrum.” The New Yorker, 2009.

[43] Iorio et al. “Early Results of Medicare’s Bundled Payment Initiative for a 90-day Total Joint Arthroplasty Episode of Care.” The Journal of Arthroplasty, 2016.

[44] Preston et al. “Bundled Payments for Care Improvement in the Private Sector: A Win for Everyone.” The Journal of Arthroplasty, March 2018.

[45] http://www.cbo.gov/sites/default/files/cbofiles/attachments/44761-Wharton.pdf

[46] Barnes, Andrew et al. “Accountable Care Organizations in the USA: Types, Developments and Challenges.” Health Policy, 2014.

[47] Colla, ibid.

[48] Colla, Carrie and Elliott Fisher. “Moving Forward with Accountable Care Organizations: Some Answers, More Questions.” JAMA Internal Medicine, April 2017.

[49] Kim et al. “A Direct Experience in New Accountable Care Organization: Results, Challenges, and the Role of the Neurosurgeon.” N13% of health care expenditures eurosurgery, April 2017.

[50] McWilliams, J. Michael. “Changes in Medicare Shared Savings Program Savings from 2013 to 2014.” JAMA, October 25, 2016.

[51] Bleser et al. “ACO Quality Over Time.” The American Journal of Accountable Care, March 2018.

[52] Total Medicare expenditures in 2017 were $702; excluding part D prescription drug payments yields $602B. See: Cubanski, Juliette and Tricia Neuman. “The Facts on Medicare Spending and Financing.” KFF, Jun 22, 2018.

[53] Non-drug Medicaid spending in 2017 was around $520B. See: “Rudowitz, Robin and Allison Valentine. “Medicaid Enrollment and Spending Growth: FY 2017 & 2018.” KFF, Oct 19, 2017.

[54] Maciosek et al. “Updated Priorities Among Effective Clinical Preventive Services.” Annals of Family Medicine, 2017.

[55] Chatterjee et al. “Checkup Time: Chronic Disease and Wellness in America.” Milken Institute, 2014.

[56] Moses et al., ibid.

[57] https://www.cdc.gov/nchs/fastats/obesity-overweight.htm

[58]http://www.heart.org/HEARTORG/HealthyLiving/HealthyKids/ChildhoodObesity/Overweight-in-Children_UCM_304054_Article.jsp#.W5s5i-hKibg

[59] Maciosek, ibid.

For-Profit College Incomes Should Mirror Student Outcomes

For-Profit College Incomes Should Mirror Student Outcomes

Joe|October 29, 2018

Many for-profit colleges, like many publicly funded community colleges, are failing American students. The best way to improve higher education is to harness entrepreneurial innovation, aligning incentives so that for-profit colleges earn financial rewards only if they help students succeed in the American economy.

Our Western framework of property rights and other freedoms rewards entrepreneurs who succeed in bringing people together to execute clever ideas about how to serve others. The way to harness entrepreneur-driven innovation at the college level — a major step towards broader education reform — is to ensure that for-profit colleges have their profit incentives aligned with students’ success. If we carefully tethered for-profit college profits to the future salaries of students, higher-education entrepreneurs with students’ interest in mind would be allowed in to compete and revolutionize education, resulting in more high-paying jobs and greater career success for millions of students.[1]

American for-profit colleges (FPCs) have an abysmal record of preparing students for successful careers. Lured into enrolling by flashy billboard advertisements and cheap loans, FPC graduates are less likely to be employed and face lower earnings than their public-school counterparts.[2] As a consequence, 52% of FPC students buckle under the weight of their student loans (vs. 13% of public school students).[3] Meanwhile, 2.5 million STEM jobs will go unfilled in 2018, and millions of students are being steered into frivolous Bachelor’s and Associates of Arts degrees instead of trade schools and vocational training programs.[4][5][6]

Federal government student loans account for at least 70%, and often up to 90% of for-profit college revenues, but our government does little to ensure that FPC executives are motivated to do what’s best for the country. [7][8] In fact, the federal government often richly rewards FPCs that underperform their peers. Take, for example, the following pair of for-profit colleges:

Data collected from 2018 10K statements and New York Times Upshot data on student outcomes*

Although Grand Canyon University was extraordinarily more profitable than Strayer University on a per student basis, its students earned only marginally higher salaries and were less upwardly mobile than lower-income students at Strayer University. This is a completely unacceptable outcome. Instead, Secretary DeVos should combine the best features of free markets and Obama-era gainful employment regulations in the form of a scalar rewards policy in which FPC profits increase in lock-step with the real salaries of their graduates.

One strategy for aligning for-profit colleges with the career success of their students is to introduce what we call a “synthetic income share agreement”. Whereas in a traditional “income share agreement”, the government would loan money to students in return for a stake in their future income, we propose that the federal government grant money to FPCs proportionate to the salaries of their past graduates.

A grant to an average FPC could be around 105% of the last year’s outlay. Assuming a normal distribution, a school whose graduates perform a standard deviation above the mean would receive 139% of last year’s funding; a school whose graduates perform two standard deviations below the mean would receive 57.5% of last year’s funding, etcetera.

A scalar rewards model would unleash all the positive forces of capitalism, forcing board members, administrators, and educators to focus on producing high-earning students. Top financial analysts and investors would intensely scrutinize emerging signs and data to determine what coursework is working and help successful schools grow much more rapidly than they could as government sponsored or non-profit entities. Finance can be enormously destructive when at odds with the interests of our communities, but aligning brilliant financial minds towards the career success of our young people will advance education in ways that we can scarcely imagine.

In this new, competitive system, schools like Grand Canyon and Strayer would have to innovate rapidly or die. They would try out various approaches such as:

· Addressing quantified skills gaps by focusing on professions such as vocational nursing, K-12 education, and construction — and teaching work-ready skills.

· Partnering with large corporations in need of new recruits; using industry certification programs to communicate with potential employers instead of traditional credentials; developing databases of regional businesses and their hiring needs. [9] Most mid-to-large companies would love dedicated recruiting programs, but do not currently have them.

· Offering classes in the evenings when continuing-education students such as single moms and full time workers can actually attend them. Today, 30% of undergraduates in America are over the age of 25, and 25% of full-time college students are also working full-time.[10]

· Tinkering with the ratio of online educational material to focused physical classroom time or 1-on-1 mentorship sessions; conducting prior learning assessments; concentrating classes into 8-week vs. 16-week terms and seeing what gets results and is profitable for all involved.

Schools would independently test which strategies work for them, with marketplace competition determining what scales and succeeds. As in any other capitalist system, solutions for particular student demographics and geographical regions will vary, and the blend of educational techniques employed will fluctuate in real-time in response to changing labor market conditions. Private sector educational institutions, which are more nimble and adaptable than public schools, are ideally situated to swiftly respond to the automation of inefficient industries and the introduction of new forms of labor.

One objection to our proposal is that colleges and universities will naturally be incentivized to cherry-pick students from wealthy families, who are more likely to earn higher salaries after college. Policymakers could adjust for these types of effects by adjusting funding to schools with a regression that accounts for parental income in cases where students’ parents are socio-economically challenged. Thus, in the example above, adjusting median graduate income for the median family income of students would likely make Strayer University more profitable per student than Grand Canyon University. Policymakers will have to refine their funding calculus to account for this objection and others as they strive to implement a fair, bipartisan education policy.

Education in America will continue to be suboptimal until it reinforces the pillars of liberty, open innovation, and good profit upon which Western Civilization rests. The only major education reforms worth supporting are those that enable entrepreneurial educators to compete, experiment, and innovate to better prepare students to succeed in the labor market — scaling the ideas that work and eliminating the schools that do not. To address the shortcomings of our education system we must hew to the liberal, bottom-up policy frameworks that make our country great, and reforming for-profit colleges is one obvious place to start.

Joe Lonsdale
Partner, 8VC


8VC is a San Francisco based venture capital firm investing in industry-transforming companies. For more information, or to sign up for our newsletter visit www.8vc.com


Grand Canyon University recently converted to a non-profit, but was a for-profit college at the time of 10k filing.

[1] Approximately 2.5 million STEM jobs will go unfilled in 2018. See: Smith, Lamar. “To fill STEM jobs, federal programs need to focus on results.” Committee on Science, Space, & Technology. December 20, 2017.

[2] Cellini, Stephanie and Nicholas Turner. “Gainfully Employed? Assessing the employment and earnings of for-profit college students using administrative data.” NBER, 2018.

[3] Scott-Clayton, Judith. “What Accounts for Gaps in Student Loan Default, and What Happens After.” Brookings, June 21, 2018.

[4] Smith, Lamar. “To fill STEM jobs, federal programs need to focus on results.” Committee on Science, Space, & Technology. December 20, 2017.

[5] Schneider, Mark and Matthew Sigelman. “Saving the Associate of Arts Degree.” AEI,

[6] McCarthy, Pat. “Leading Practices for the State’s Secondary Career and Technical Education Programs.” Office of the Washington State Auditor. December 19, 2017.

[7] Kelchen, Robert. “How much do for-profit colleges rely on federal funds?” Brookings, 2017.

[8] Cellini, Stephanie Riegg. “For-profit higher education: an assessment of costs and benefits.” National Tax Journal, March 2012.

[9] Monroe Community College in Rochester, NY has begun using this database model. See: Alvarez, Joshua. “The Twelve Most Innovative Colleges for Adult Learners.” Washington Monthly, October 2017.

[10] Kelly, ibid.

The Dialysis Industry is Failing America

The Dialysis Industry is Failing America

Joe|October 29, 2018

End-Stage Renal Disease (ESRD), or kidney failure, afflicts more than 660,000 Americans a year and is growing at an annual rate of 5%.[1][2]While waiting for a transplant or living indefinitely without one, nearly half a million patients are on dialysis, an onerous treatment that siphons blood from the patient, filters it in an external machine, and then cycles it back into the patient’s body. Dialysis is an unpleasant, emotionally exhausting process, which typically involves three separate 4-hour visits to a clinic every week. At a government-negotiated price of $232.37 per treatment and a private-payor price of over $4,000 per treatment, it is also extremely costly.[3] Medicare spends nearly $35B per year on dialysis treatments alone, representing fully 7% of total Medicare expenditures.[4],[5]

The American dialysis industry hit an inflection point in 1972, when President Nixon signed a law that required Medicare to cover dialysis treatment for any American suffering from kidney failure, regardless of their insurance coverage. In the 1970s and 1980s the dialysis market consisted exclusively of small, privately-owned nephrology clinics. However, in the 1990s, two companies — DaVita and Fresenius — began packaging kidney drugs such as Venofer and Zemplar in unnecessarily large quantities, pushing doctors to overprescribe kidney medicine that was often thrown away, and thus overbill Medicare.[6]

Ultimately the government issued a warning to patients asking them to double-check prescription amounts with their physicians. A storm of negative PR forced DaVita and Fresenius to discontinue their fraud (DaVita later paid $450 million to settle a whistleblower lawsuit), and prescription quantities fell by a full 75%.[7] Bruised but not beaten or deterred, DaVita and Fresenius used their ill-gotten cashflow to launch a wave of consolidation, buying up many dialysis clinics in the country. Market dominance allowed the two giants to dictate the prices of inputs such as medical devices and buy out major manufacturers of dialysis machines.

In the 2000s DaVita and Fresenius embarked on a series of illegal schemes to boost their earnings including charging the government for unnecessary blood tests and paying kickbacks to physician groups for patient referrals.[8][9] Most recently, the duopoly used one of the largest nonprofit groups in the nation, the American Kidney Fund, to cover premiums for privately insured payers and encourage low-income patients to switch from government provided healthcare to private insurance.[10][11] Since private insurance is 17x as profitable as public reimbursement, analysts estimate that this scam was responsible for 30–45% of the giants’ annual pre-tax income.[12]

Today DaVita and Fresenius control 70% of the dialysis market, roughly 35% each.[13] DaVita has experienced truly explosive growth over the past two decades, climbing from a market cap of $724M to over $12.6B today.[14]Together, these corporations received $11.4B Medicare dollars last year, and did nearly $2B in after-tax profit.[15][16]

Of the remaining $22.6B paid out by Medicare last year, we estimate that roughly $5B went to DaVita and Fresenius’ smaller competitors, and the remaining $17.6B went to hospitals and other healthcare providers that typically own stakes in dialysis clinics and provide healthcare services.[17]The provider half of the market is extremely fragmented and regionalized, but DaVita and Fresenius’ unsavory maneuvers enable hospital and nephrology clinic partners to profit as well.

The cost of a broken dialysis industry is measured not merely in payor dollars but in human lives. DaVita and Fresenius have little incentive to introduce cheaper, more effective treatments, and consequently the United States has one of the highest kidney failure mortality rates of any industrialized country.[18] Mega-chain dialysis centers have far higher mortality rates than nonprofit dialysis centers — 19% higher at Fresenius facilities, and 24% higher at DaVita facilities, respectively.[19] Patients routinely complain about filthy dialysis facilities, and incompetent nursing staff. As many as 47% of dialysis patients are depressed or suicidal, which is orders of magnitude larger than CKD patients who are not on dialysis.[20][21]

America needs to drastically rework the incentives structure for CKD healthcare providers so that DaVita and Fresenius are encouraged to innovate and deliver cheaper services. We are optimistic about the introduction of “bundled payments” — capitated payments for complete treatment of a condition rather than for each individual service — which force dialysis clinics and drug manufacturers to internalize costs. To save money, providers are now using cheaper drugs such as Triferic (an iron booster) instead of Erythropoiesis Stimulating Agents (hormonal drugs which cause bone marrow to produce more red blood cells).[22] The jury is still out, but value-based care may decrease Medicare expenditures by incentivizing mega-chains to build holistic, preventative treatments around personalized medical data.

We need to fundamentally realign economic incentives so that CKD healthcare providers are rewarded for screening at-risk patients and intervening to prevent progression towards ESRD. Currently, the medical definition of “pre-dialysis screening” is any screening at least 3 months in advance of a dialysis treatment.[23] This is an absurd benchmark. Real preventative treatment such as weight loss, dietary changes, and the introduction of angiotensin-inhibitor medication must take place years in advance to make a difference. Today only 25% of patients have been followed by a nephrologist for at least a year before they reach end-stage disease.[24]

Universal coverage of dialysis treatment creates moral hazard by dis-incentivizing healthcare providers from attempting preventative treatments. Only by rewarding providers for prevention can we bring about real clinical change. One exciting model for preventative treatment is Medicare’s Diabetes Prevention Program (DPP), which reimburses providers for lifestyle interventions that meet certain criteria (education, coaching, check-ins) and achieve weight loss in patients at risk for diabetes. DPP programs have achieved an average of 5% weight loss for participants, directly reducing their chance of developing diabetes and saving Medicare $2650 per patient per 15 months.[25] Reimbursements are available to traditional health care providers or more innovative programs on mobile health apps.

Finally, Medicare must revise policy so that providers treating chronic kidney disease are similarly incentivized to engage in real preventative care. In this mold, Kaiser Permanent conducted an experiment which assigned nephrologists to give physicians advice on how to test and advise Hawaiian patients with early-stage CKD. Kaiser’s experiment successfully reduced the number of patients who progressed to more advanced stages of the disease.[26]

Of course, preventative treatment isn’t a complete panacea. In the case that a patient progresses to ESRD and needs dialysis to stay alive, insurers and healthcare providers should encourage patients to pursue in-home dialysis over in-clinic dialysis at DaVita or Fresenius. Successful in-home dialysis requires that providers carefully teach patients how to self-administer treatment, a network of nurses to visit these patients, and tools for patients to report statistics on their blood composition. But in-home dialysis possesses many advantages over in-clinic dialysis: it is up to 5 times cheaper, is favored by most nephrologists, and is less stressful for patients.[27] In addition, haemodialysis nurses report higher job satisfaction and lower burnout rates in an in-home environment.[28] As you might expect, DaVita and Fresenius strongly discourage patients from pursuing this cheaper option.

We must shift market incentives so that payors and healthcare providers make money by experimenting with new strategies and technologies for treating chronic kidney disease rather than by allowing patients to accelerate to a government-covered terminal condition. Only a framework in which the best ideas win and spread through market forces — in which the market is aligned to lower costs and better outcomes with solutions such as value-based care — will ensure that Americans are able to secure the kidney care they need. In the case of chronic kidney disease, cheap, effective care is quite literally a matter of life and death.

Joe Lonsdale
Partner, 8VC


8VC is a San Francisco based venture capital firm investing in industry-transforming companies. For more information, or to sign up for our newsletter visit www.8vc.com


[1] “End Stage Renal Disease in the United States.” National Kidney Foundation, 2015.

[2] “Statistics” The Kidney Project, UCSF Department of Bioengineering and Therapeutic Sciences2014.

[3] This is standard Medicare reimbursement; the figure is much higher for private insurers.

[4] https://www.usrds.org/2017/view/v2_09.aspx

[5] Brenoff, ibid.

[6] Pollack, Andrew. “Lawsuit Says Drugs Were Wasted to Buoy Profit.” New York Times, July 25, 2011.

[7] “DaVita to Pay $450 Million to Resolve Allegations That it Sought Reimbursement for Unnecessary Drug Wastage.” Department of Justice, June 24, 2015.

[8] Freudenheim, Milt. “Dialysis Provider to Pay $486 Million to Settle Charges.” New York Times, Jan. 20, 2000.

[9] Osher, Christopher. “DaVita to Pay $389 Million to Settle Anti-Kickback Investigations.” Denver Post, October 22, 2014.

[10] Thomas, Katie and Reed Abelson. “Kidney Fund Seen Insisting on Donations, Contrary to Government Deal.” The New York Times, December 25, 2016.

[11] Alpert, Bill. “Insurers Press Dialysis Claims.” Barrons, September 2, 2017.

[12] Rexaline, Shanthi. “American Kidney Fund Legal Issues A Major Overhang for DaVita Shares.” Benzinga, October 09, 2017.

[13] Neumann, Mark. “The Largest Dialysis Providers in 2017: More Jump on Integrated Care Bandwagon.” Nephrology News, July 17, 2017.

[14] Data from Ycharts.com

[15] See Fresenius Form 20-F for year ending in December 31, 2017, and DaVita 10-K for year ending in December 31, 2017.

[16] Shinkman, Ron. “The Big Business of Dialysis Care.” New England Journal of Medicine, June 9, 2016.

[17] Extrapolating from the fact that DaVita and Fresenius control only 70% of their market, the other 30% controlled by their smaller competitors would proportionally receive about $5B. Then, $34B minus $16.4B yields $17.6B.

[18] Fields, Robin. “God Help You. You’re On Dialysis.” The Atlantic with ProPublica, December 2010.

[19] Shinkman, ibid.

[20] Fields, ibid.

[21] Jong et al. “Prevalence of depression and suicidal ideation increases proportionally with renal function decline, beginning from early stages of chronic kidney disease.” Medicine, November 3, 2017.

[22] Charnow, Jody. “How ‘Bundling’ Changed Dialysis Care.” Renal and Urology News, March 2, 2017.

[23] Quaglia et al. “Early Nephrology Referral: How Early is Early Enough?” Archives of Internal Medicine, 2011.

[24] Lee et al. “Effects of proactive population-based nephrologist oversight on progression of chronic kidney disease: a retrospective control analysis.” BMC Health Services Research, 2012.

[25] Bresnick, Jennifer. “CMS Expands Promising Medicare Diabetes Prevention Program.” HealthIT Analytics, November 6, 2017.

[26] Lee et al. “Effects of proactive population-based nephrologist oversight on progression of chronic kidney disease: a retrospective control analysis.” BMC Health Services Research, 2012.

[27] McFarlane et al. “Cost savings of home nocturnal versus conventional in-center hemodialysis.” Kidney International, 2002.

[28] Hayes et al. “Work environment, job satisfaction, stress and burnout among haemodialysis nurses.” Journal of Nursing Management, 23.5, 2013.

Align Incentives to Solve Recidivism

Align Incentives to Solve Recidivism

Joe|May 15, 2018

With a prison population of 2.3 million inmates, the United States has the highest incarceration rate of any country in the industrialized world. On the face of it, housing one quarter of the world’s prison population costs America $80 billion a year.[1][2] But in fact America’s incarceration nightmare represents a true opportunity cost of hundreds of billions of dollars a year, and unnecessarily devastates many of our most vulnerable communities. A major problem is that prisons are incentivized to “warehouse” prisoners rather than provably reintegrate them into society. A competitive, market-based rewards system for private prisons would encourage talented entrepreneurs to help convicts into society in compassionate, effective ways and allow the very best rehabilitation strategies to spread.

The US incarceration rate multiplied by 700% between the 1970s and the present as America abandoned rehabilitative models of criminal justice for more punitive responses. This surge in convictions was partially precipitated by a global crime wave in the 1980s. But the incarceration rate has remained extraordinarily high even though the crime rate has decreased 45% since the early 1990s.[3][4][5]

 

[6]
To tackle prison overpopulation our country must address a host of issues including aggressive public prosecution, the failure of the war on drugs, exorbitant sentencing guidelines, and the fact that 94–97%[7] of charged criminals opt for plea bargaining over a jury trial. But one obvious strategy for decarceration is to reduce the recidivism rate, or the rate at which criminals reoffend and wind up back in prison. We need to shift from a “custody” model of detention to a “treatment” model. Private prisons, properly incentivized, may be the answer.

Today 8% of U.S. prisoners are currently detained in private prisons (though disproportionate press coverage would lead one to believe that the figure is much larger).[8] The largest private prison operations today are CoreCivic (formerly the Corrections Corporation of America) and the Geo Group, which have achieved a duopoly over the private prison market.

Private prisons gained a poor reputation as early as the late 19th century for subjecting prisoners to barbaric treatment and lax security, but today private prisons are roughly as humane as public prisons.[9] Evidence as to whether private prisons are better than public prisons at reducing recidivism is inconclusive, and a meta-analysis found that private prisons even cost about the same as their public counterparts.[10][11][12] The central problem is that private prisons, like public prisons, are payed on a per-diem/per-prisoner basis. Under this statutory regime, “privatization can come to resemble an exercise in who can better pretend to be a public prison.”[13]

We propose that private prison contracts tie financial incentives to performance measures such as reducing inmate recidivism. If entrepreneurs were given clear lanes to erect new private prison businesses and explicitly incentivized to reduce recidivism, they would experiment with new modes of rehabilitation to find the best ways to reintegrate convicts into society. Operating in a more competitive, transparent environment would force private prisons to rapidly innovate and develop new techniques for rehabilitating the maximum number of prisoners. Private prisons could escape their legacy of mediocrity and brutality by embracing this new mandate.

The first country to experiment with this model was the United Kingdom, which raised a social impact bond in 2010 to fund a rehabilitative program for short-term inmates at a private prison in Peterborough.[14] On this model, investors in the bond were rewarded on the condition that Peterborough Prison reduced the frequency of reconviction events by more than 10% relative to a public prison control group. Investors partnered with the prison to supply paid caseworkers, specialist practitioners, gym volunteers from nonprofit organizations such as the YMCA, and other 3rd parties. These workers engaged in a pragmatic, flexible style of relationship-based therapy, and successfully reduced the recidivism frequency by 11% even while recidivism frequency rose 10% in the control group (2010–2014). Similar programs have been piloted in Massachusetts, New York, Australia, and New Zealand.[15][16][17] These projects are only the beginning — in an evolving market framework the most refined, effective prisoner rehabilitation programs could eventually scale to deliver recidivism reductions on the order of 50% or more.

There are a variety of ways to set up an incentive structure aimed at reducing recidivism. We favor rewarding private prisons with a combination of financial payouts and new inmates to replace the old inmates who will not return to prison. The contract could replace traditional per-diem/per-prisoner rewards with scalar incentive payments that vary with the percentage of the inmate population that doesn’t reoffend over some period (e.g. 2 years). Another possibility is to reward the prison with a flat bonus such as $11,000 per rehabilitated prisoner,[18] or to make upside for prison staff contingent on running successful programs and spreading ideas that work.[19] Many state legislatures explicitly encourage pay-for-success models, and these states should begin experimenting immediately.[20]

Private prisons should only house inmates who will be released in a relatively short time period (e.g. <5–10 years). Prisoners sentenced to life or virtual life would not be eligible for rehabilitation, and it would be unfair to force a private prison to house a convict for whom they have no expected financial upside.[21] Each private prison’s population should be compared against a representative, comparable population in a private prison, or against historical re-offense rates. As a safeguard against mistreatment, prisoners could be allowed to opt out of the private prison and into public prison every 6 months, and would be able to express their grievances in public fora.

Operating in a more competitive, transparent environment would force private prisons to rapidly innovate and develop new techniques for rehabilitating the maximum number of prisoners. Private prisons could escape their legacy of mediocrity and brutality by embracing this new mandate.

 

Strategies for reducing recidivism are virtually endless — the challenge is to create incentives to make sure the best ideas are documented and spread. We strongly believe in the value of prison-work programs where inmates receive either pecuniary or in-kind rewards — for instance better food, more time in the prison yard, better access to books, and more.[22] Educational programming, employment programming, cognitive behavioral therapy (CBT), chemical dependency treatment, sex offender treatment, mental health interventions, domestic violence/family life programming, and prisoner re-entry programs are all time-honored methods for helping convicts reintegrate into normal American life. [23][24][25]

One successful example is the Texas Prison Entrepreneurship Program (PEP), a selective MBA-style educational program for inmates who demonstrate work ethic and a desire to take charge of their own lives.[26] Another is “Code.7370,” a 6-month program at San Quentin Prison which teaches eligible inmates how to develop websites.[27] Graduates of these programs have recidivism rates of only 7%![28]

Programs with no selection bias have also been highly successful. In Saskatoon, Canada a sexual offender treatment program used cognitive behavioral therapy to treat male sexual offenders between 1981 and 1996. In a comparison of 296 treated and 283 untreated offenders, only 14.5% of the treated group reoffended vs 33.2% in the control group.[29] In Hillsborough County, Florida, 18,000 domestic violence offenders were subjected to a tiered treatment program from 1995–2004. The program reduced domestic violence recidivism to 8.4% vs 21.2% in the control group.[30]

As these examples illustrate, the main challenge is not discovering what the best ideas are, it is crafting a market mechanism that rewards innovators for iterating on different holistic treatment regimes until they achieve the lowest possible recidivism rates. The fundamental problem with American criminal justice is not a lack of good ideas, it’s the system itself. We need to literally create a marketplace of ideas — a bottom-up, competitive arena in which the best ideas win. If we reward innovations which demonstrably reduce America’s prison population, bright entrepreneurs will deploy their talents to fix our broken prison system.

Regulators should supercharge this new competitive market by lowering regulatory barriers to entry, which will force CoreCivic and the GEO group to innovate just as intensely as their nimbler competitors. Relationships with state legislatures and regulatory bodies should not be enough for these giant corporations to win procurement contracts. In the medium-term, we hope that the industry will evolve to become more diverse and competitive. In the long-run, we envision a system where transparent, compassionate private prisons have become so successful at rehabilitation that they have replaced public prisons as the dominant mode of incarceration in the United States, and would continue to compete to successfully reintegrate former prisoners into their communities.

Though we’re excited by the prospects of rewiring the private prison market to solve America’s incarceration problem, we recognize that challenges for American criminal justice remain. In his seminal essay on the “prison-industrial complex”, Eric Schlosser wrote that we are fighting an establishment

…composed of politicians, both liberal and conservative, who have used the fear of crime to gain votes; impoverished rural areas where prisons have become a cornerstone of economic development; private companies that regard the roughly $35 billion spent each year on corrections not as a burden on American taxpayers but as a lucrative market; and government officials whose fiefdoms have expanded along with the inmate population.[31]

Dismantling this complex of special interests — which also includes prison guard unions and aggressive, careerist public prosecutors — will be difficult. Fortunately, prison reform is one of the few truly bipartisan issues in our nation today. Harnessing America’s brightest entrepreneurial talent to heal inmates and reduce recidivism could be a powerful antidote to America’s prison crisis.

Joe Lonsdale
Partner, 8VC

A Note for Startup CEOs on Budget Chats

A Note for Startup CEOs on Budget Chats

Joe|January 23, 2018

CEOs shouldn’t worry about their budget all the time — on a day-to-day basis they should work on managing their company, building an awesome product, developing key relationships, identifying distribution channels, etc. But CEOs should carefully review their company’s financial numbers at least once a quarter, even when there is plenty of funding in the tank.

The reason we have so much talent in Silicon Valley building and investing in for-profit technology companies is that markets richly reward successful ideas, no matter who invents them. But to remain competitive in a free market, companies must exercise discipline to meet quantitative goals, and eventually become cashflow positive. As we have written elsewhere, metrics synthesize a huge volume of information about how efficiently and effectively you are accomplishing your mission. A clear budget and a comparison of spending to revenue reveals whether your project is being sustainably managed, and whether it will add value to our economy in the long term.

A common mistake among new entrepreneurs who have raised large rounds is that they have essentially infinite resources. As a new entrepreneur who is extremely confident in the product you are building, you may wonder: why waste time on precise budgeting and defining goals? But building an intuition for how your burn-to-output ratio is evolving is important for any CEO.

A good place to start is your monthly spend. Any CEO who doesn’t know to within 5% error how much they spent in the last few months and how much they will spend in the next few months is not doing their job. A reasonably mature company must track both expenditures and, on the other side of the equation, incoming cashflow (not bookings — cashflow).

Engineering is the art of managing scarcity — it’s easy to design and build a massive bridge that will last forever if cost is not an issue. Similarly, to build a new company you must manage scarce resources. Almost any company would be easy for talented people to build if you could spend an infinite amount of money to get to where you want to go. The challenge is to keep your monthly burn at a sustainable level, and punctually achieve your milestones.

Before you meet with a board member or senior advisor who is going to talk to you about your budget, you should familiarize yourself with the following data points:

· Current cash in bank (not projected cash, actual cash). If the cash hasn’t hit your bank account, don’t count it — that’s tantamount to lying to your investors. You should also note any large expected near term changes such as money you hope hits soon, or major payments due.

· Monthly gross expenditures, gross receipts, net burn over past several months, and projected monthly burn in near-term and a year from now. For businesses with high volatility in their monthly numbers, quarterly numbers may make more sense.

· How much you plan to spend over the next year. At your current pace, how many months do you have left before you are out of cash, if you don’t raise more? If you plan to raise, how many months will the new round last you?

To illustrate the point, let’s take an unnamed startup in December 2017, and see what the CEO knows:

· Annual recurring revenue (ARR) is $25M at the end of ’17, with contracts paid annually upfront. This figure will grow to at least $42M next year.

· Cash receipts have been about $2.5M a month in the past 3 months, and are trending upward

· Monthly spend has been about $5M a month, burn has been about 2.5M a month.

· With hiring targets, spend will reach $6.5M a month by the end of ’18. Given current goals, burn will stay around $2.5M net.

· The goal for December ’19 is to get to $65M ARR, and only raise spend to $7.5M a month, meaning that at the current rate of closing deals, the burn should actually fall to $1.5M a month by the end of the year.

· The goal for December ’20 is to reach $90M ARR, with an annual burn of $12M and a near-breakeven run rate at the end of the year.

As an investor and an advisor, I might respond to this information by noting that this burn rate and hiring plan is slightly, but not unacceptably high for current ARR. This looks like a platform-esque company, not a lean enterprise solution, but the fact that the CEO has a handle on ’18, ’19, and ’20 makes this burn manageable.

With $35M in the bank from a $50M round in mid-2017, this company has about 14 months left, and is going to need to raise a big round in the middle to late part of the coming year. For a good CEO, 9 months is yellow alert, 6 months is red alert, and 3 months means you screwed something up and may need to start looking at other options like selling or merging your company. This CEO should start thinking seriously about the next round, and what she’ll achieve in the next six months, to convince investors that her plans for the next three years make sense and that her company is valuable.

The CEO originally intended to raise spend to $7M a month, but after mapping out how spend and burn would evolve in the coming years, agreed it was prudent to keep it at $6.5M maximum (and hopefully a bit lower). According to the current plan, another $50M round should be enough to take the company to profitability and an IPO in ’21 or ’22. But if the price is good, I would advise this entrepreneur to raise a safe $75M just in case things don’t work out according to plan. If the entrepreneur wants to build a new division onto the company in the future, and chooses to raise spend again vs going to break-even, they will require a larger round and an investor who shares their vision.

It’s vital to get a sense of how burn and spend underpin the budget decisions which largely determine everything else in the business. A CEOs core responsibility is to ensure her company will succeed, and measuring these changing data points is the only way to stay informed.

Of course, this thought exercise has nothing to do with the most important parts of the business: the product strategy, the marketing strategy, the technology culture, the shifting competitive landscape, the leadership, vision, internal culture, etc. But in discussing all of those, it’s important to have the numbers as a backdrop.

Before you meet with your board, consider getting a sheet together of your cash-in-hand, spend, and monthly or quarterly revenue from year or two ago to a few years in the future. Learn the numbers and develop opinions about them! As with any business conversation, budget chats should be conducted with rigor.

Innocent Until Proven Guilty

Innocent Until Proven Guilty

Joe|January 3, 2018

Most of our generation lacks historical perspective on justice and persecution, so we’ve put together a brief paper on how these ideas have evolved in the context of Western Civilization.

“The law requires a double testimony to convict…the principal reason undoubtedly is to secure the subject from being sacrificed to fictitious conspiracies…”[1]
– William Blackstone, 1769

The cornerstone of Western criminal law is that the accused is presumed innocent until proven guilty beyond a reasonable doubt. The presumption of innocence (PoI) is justly regarded as “axiomatic and elementary,” a triumph of rationalism over arbitrary persecution.[2] Like all due process protections, the PoI took shape against the specter of tyrannical violence. In particular, history suggests that the PoI emerged as an antidote to the tyranny of mob violence against marginalized figures including “heretics, witches, and Jews” — and sometimes even kings themselves.[3]

Few have analyzed persecution as deeply as René Girard. Girard argues that communities routinely commit acts of insensate violence against innocent individuals. These victims of collective aggression are “scapegoats” — symbolically equivalent to the he-goats that the ancient Hebrews would slaughter to atone for their sins.[4] For Girard, social groups are driven by an intrinsic logic of “mimesis” — mimicry of other people’s desires. Because human beings absorb our values from others, we are prone to bandwagoning, herd instincts, the madness of crowds, and sometimes a “blind instinct for reprisals.” [5] This trait occasionally drives us to demonize others as monstrous scapegoats that must be ritually slain to restore peace to the community.[6]

Girard argues that Christ’s crucifixion permanently exposed the scapegoat’s “guilt” as a lie, inaugurating progress towards more rational criminal justice. Christ is perfectly innocent. Pilate can find no case against the “Lamb of God”, who cries out from the cross “Father forgive them, for they know not what they do” (John 1:29, Luke 23:24). This most famous miscarriage of justice reveals the entire practice of scapegoating to be morally bankrupt and forces humanity to reason about guilt prior to punishment. In this way, the synoptic gospels give birth to the rational criminal trial, due process, and, by extension, the presumption of innocence. In Girard’s phrase, “the invention of science is not the reason that there are no longer witch-hunts, but the fact that there are no longer witch-hunts is the reason that science has been invented.”[7]

As a matter of historical fact, variants on the PoI surfaced in the West well before the death of Christ. The principle that the burden of proof is on the plaintiff dates back to the Twelve Tables, and in Roman law the defendant’s guilt had to be as “clear as daylight” in order for the judge to convict.[8],[9] Well before Judeo-Christian thinking penetrated Rome, Emperor Trajan said “it is preferable that the crime of a guilty man should go unpunished than that an innocent man be condemned”. Furthermore, Judaism itself endorsed the principle that “at the mouth of two witnesses, or three witnesses, shall he that is worthy of death be put to death; but at the mouth of one witness he shall not be put to death” (Deuteronomy 17:6).[10]

It is nearer the truth to say that both church and state helped cement principles of due process in the West. After all, the Roman world had the most robust legal system of any classical civilization. But Girard may be right that Christianity helped to “rationalize” the Abrahamic tradition. It was the fusion of the two traditions — Roman law and Canon law — that ultimately produced modern due process protections. 1215 was a watershed year for criminal justice: in a span of months, the Magna Carta codified the rights of a free man to the “lawful judgment of his equals or by the law of the land,” and the Fourth Lateran Council overturned pre-rational modes of trial (combat, ordeal). In trial by ordeal, for instance, defendants burned themselves with molten iron, boiling water, or glowing coals, and then clerics assessed their guilt based on the pace at which their wounds healed.[11]. Under growing pressure from Scholastic thinkers, Pope Innocent III decreed that appeal to heavenly signs (combat, ordeal) was not adequate to determine guilt. Instead, guilt had to be assessed by using human reason to grapple with the facts of a case to the best of our ability.

Unfortunately, legal progress marches to the unsteady canto of two steps forward, one step back. While Pope Innocent’s reforms were a dramatic advance in Western criminal justice, atavisms persisted into the modern world. Inquisitorial trials were “generally permeated by a presumption of guilt in the guise of mala fama, a doctrine which allowed a person to be brought to trial if they were collectively presumed to be guilty.[12] In addition, torture was used as a mode of fact-finding and an unimpeachable form of proof as late as the 18th century. As a result, the medieval criminal trial was often little more than a formalized scapegoating ritual.

Eventually the Western world clawed its way to a moral high-ground, immortalizing the presumption of innocence as a central pillar of due process. Blackstone famously expanded Trajan’s principle to “it is better that ten guilty persons escape than that one innocent suffer.” The “beyond reasonable doubt” standard found first expression in the trials of redcoats after the Boston Massacre, and the phrase “presumption of innocence” first appeared in an American court opinion in 1850. Of course, it took many years for our country to extend the principle fairly and evenly to all men and women, black and white. In the middle of the 19th century, Frederick Douglass caustically noted that slave owners espoused a hideous variant of Blackstone’s principle.

“Mr. Gore acted fully up to the maxim laid down by slaveholders, — “It is better that a dozen slaves should suffer under the lash, than that the overseer should be convicted, in the presence of the slaves, of having been at fault.” No matter how innocent a slave might be — it availed him nothing, when accused by Mr. Gore of any misdemeanor. To be accused was to be convicted, and to be convicted was to be punished; the one always following the other with immutable certainty.”

But over the course of the 20th century, due process protections were gradually extended to all Americans. In 1970 the Supreme court elevated the “beyond a reasonable doubt principle” to the status of constitutional law.[13],[14] As the concept of the plaintiff’s evidentiary burden evolved from “clear as daylight” to “moral certainty” to “beyond a reasonable doubt”, courts continued to refine the ideas of “rationality” and “reasonability” which guide the criminal trial. Borrowing an idea from Hegel, one might say that the spirit of Western rationalism animating criminal law has become increasingly self-conscious.

Whether Girard is right about the causal link between the synoptic gospels and Western rationalism, he is certainly right that we are always in danger of relapse. Our highest court once ruled that unless the right to bail before trial was preserved, “the presumption of innocence secured only after centuries of struggle would lose its meaning.”[15] The Rehnquist court destroyed this protection in Bell v. Wolfish (1979), ruling that pre-trial detention of presumptively innocent parties is permissible. The extension of this precedent has eroded the rights of those accused of sexual crimes and justified “civil asset forfeiture,” or the blatant seizure of an innocent person’s property.[16]

James Thayer once argued that the PoI has the “peculiarly important function…of warning our untrained tribunal, the jury, against being misled by suspicion, conjecture, and mere appearances.”[17] Today, social media and search algorithms corral us into the kinds of ideological pens that make suspicion and knee-jerk reactions to “mere appearances” more probable. In 2017 we made real progress in resisting the predations of the powerful — inspiring people to stand up for themselves, and making it clear that certain behavior is unacceptable in our society. As we move into the new year, we would do well to remember our civilization’s foundational wisdom and find new ways to support the downtrodden. As we continue important conversations about justice and our identity as a people, we should ensure that we do not cast stones in new cycles of public scapegoating. As Girard reminds us, a core element of our Judeo-Christian heritage — and the crucifixion story itself — is the belief that no one should face persecution at the hands of a mob, and that the presumption of innocence is the soul of rational criminal justice.

[1] Blackstone, William. “Blackstone’s Commentaries” Abridged version, ed. William Sprague, 9th edition, 1915. p. 523

[2] Coffin v. U.S. Justice White’s majority opinion. 156 U.S. 432, 1895.

[3] Pennington, Kenneth. “Innocent Until Proven Guilty: The Origins of a Legal Maxim.” The Jurist, 2003.

[4] Leviticus 16:30

[5] Girard, 86.

[6] Girard’s theory of mimesis is that individuals competitively imitate each other until they become so similar that they are driven into a cycle of escalating violence which terminates in the cathartic, sacred murder of a “scapegoat.”

[7] Girard, ibid. p.96

[8] Mousourakis, George. “The Historical and Institutional Context of Roman Law.” Routledge, 2003.

[9] Cicero. “Against Verres” in Selected Works, Trans. Michael Grant. Penguin Classics, 1971.

[10] However Judaism is conflicted on the issue of PoI. When Abraham asks “wilt thou destroy the just with the wicked?” God replies that the entire population of Sodom and Gomorrah is presumptively guilty unless Abraham can find 50 innocent people therein (Genesis 18:20–26) — an inversion of the principle that “it is better that n-guilty people go free than 1 innocent person be punished.” …By contrast, one may interpret Adam’s demand that God punish Eve for tricking him into eating the apple as a demand for a fair adjudication of guilt.

[11] McAuley, Finbarr. “Canon Law and the End of the Ordeal.” Oxford Journal of Legal Studies, Vol. 26.3, 2006.

[12] Van Damme, ibid.

[13] Commonwealth vs. John W. Webster. 59 Mass. 295, 1850.

[14] In re Winship, 397 U.S. 358 (1970)

[15] Stack v. Boyle, 342 U.S. 1 (1951)

[16] Pernell, LeRoy. “The Reign of the Queen of Hearts.” Cleveland State L.R., 1989.

[17] Thayer, ibid.