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House Calls

Can Buddy Systems Inc. convince doctors, insurers, and patients to accept its new home monitoring device?
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Can Buddy Systems Inc. persuade doctors, insurers, and patients to accept its new home monitoring device?

Northbrook, Ill., is a Chicago suburb that is in most respects as blandly middle-American as Wonder Bread -- not a place where many folks know when Chinese New Year begins, let alone celebrate it. But at the headquarters of Buddy Systems Inc., in a Northbrook industrial park, the frigid February day when the Year of the Dragon ended and the Year of the Snake began was the occasion for a festive stir-fried lunch party, where most of the guests -- including several Buddy Systems engineers and the company's founder and president, Thomas Manning -- chatted in Mandarin. Of the six technical staffers at Buddy Systems, four are Chinese immigrants. "Their academic qualifications are excellent," explains Manning, who began learning to speak Chinese during a stint in Taiwan in his junior year of college. "But beyond that, they've made some really impressive sacrifices to come to the States and be educated here and get established here. So they are highly motivated people who have something to prove to themselves and to their families. If you can find someone with something to prove, hire them."

It's an apt remark. Buddy Systems, which Manning started in early 1985, is a company with something to prove -- namely, that its product can dramatically cut the cost of caring for patients with congestive heart failure and other serious chronic illnesses without compromising the quality of the care those patients get. The company's product is a computer system, sold to doctors' groups and home-care agencies, that allows health-care professionals to monitor the vital signs of patients who have been sent home from the hospital but are still in need of observation. The system in effect delivers an electronic house call. The patient uses a computer console, chummily known as "Buddy," to measure and record his or her own blood pressure, weight, heart rate, electrocardiogram, and other data, which are then transmitted to the doctor's office and the home-care agency via telephone hookup and printed out for evaluation by doctors and nurses.

The only such machine commercially available now, Buddy is designed to let people go home from the hospital sooner, at a savings of hundreds of dollars a day. And by taking care of routine testing that would otherwise be done by a visiting nurse, Buddy greatly reduces the number and length of nurses' calls -- another significant savings, since each runs $60 or $70. In contrast, depending on the use each doctor and patient make of it, Buddy costs between $17 and $30 a day.

The idea of developing a cost-effective home monitoring system occurred to Tom Manning -- a Harvard graduate with an M.B.A. from Stanford -- during the five years he spent as a consultant in the Chicago office of McKinsey & Co. Manning's clients were companies in the health-care industry, where cutting costs is nothing short of an obsession. In 1983 Medicare and Medicaid, by far the biggest health insurers in the United States, began to crack down on the ever-soaring cost of medical care, which had reached a colossal 10% of the gross national product. Instead of paying hospitals and doctors on a cost-plus basis -- which meant reimbursing whatever the medicos saw fit to spend and then some, no questions asked -- the feds set strict ceilings on the fees they would henceforth shell out for any given treatment. So in order to keep their doors open, hospitals had to start thinking and acting like businesses. They scrambled to find ways to cut costs while they rustled up new sources of revenues, including new departments that oversee the care of patients in their homes. Manning observed that one result of all this upheaval was a tendency to release patients, in the rather flippant phrase some industry insiders use, "quicker and sicker" -- and more in need of clinical supervision.

Moreover, partly because of the aging of the U.S. population, health-care costs seemed likely to keep right on climbing. They've risen more than $140 billion since 1983. Health-insurance companies have been hard-pressed to make ends meet: the Blue Cross and Blue Shield Associations reported a net loss of about $1.1 billion in 1988, which was an improvement over their $1.9-billion deficit the year before. Nor does relief seem near. According to figures released by the U.S. Health Care Financing Administration and analyzed by Sanford C. Bernstein & Co., in New York City, the nation's medical bills rose an average of 8.6% a year between 1982 and 1987 -- but from 1988 through 1992, the cost of getting well is expected to go up at a 12% annual clip. A product that could help cut medical costs without compromising quality, Manning reasoned, should be an answer to a health insurer's prayer.

The idea for Buddy Systems gradually took shape as Manning advised McKinsey clients on how to survive in the harsher and less forgiving world Washington's new cost-consciousness had wrought. "One pattern that emerged right away was the tremendous movement of patients from high-cost sites like hospitals to low-cost, decentralized locations," he recalls. "Home care was growing fast. The main issue, which nobody was looking at in any systematic way, was how doctors could keep tabs on their patients who'd been sent home." Medical technology, meanwhile, had spread from hospitals to doctors' offices, and consumers were becoming less leery of electronic gadgetry. A home computer that would be easy for patients to operate by themselves and would instantly provide doctors and nurses with essential medical information seemed logical.

By late 1984 Manning, then 29, had made up his mind to start a venture that would develop and market such a system. But first, just to make sure it was workable, he took two weeks of vacation from his job and interviewed dozens of doctors and computer technicians. What kinds of data did doctors need to assess the condition of a patient, sight unseen? And could a computer be designed that could measure and transmit the right stuff? Manning got a crash course in both medicine and electronics. "Then I got some good advice from a colleague at McKinsey," he says. "He told me not to overanalyze it, or I'd lose the excitement that could make it work."

With that in mind, in December 1984 Manning quit the consulting business. He set up shop in the basement of his house, living on his savings, scrounging $25,000 in seed capital from friends, and huddling with engineers to come up with a viable product. From the outset, Manning concentrated on meeting the needs of the growing number of health-care agencies and doctors who were trying to treat patients at home. Those customers' biggest concerns: how to cope with a shortage of nurses and how to gain a competitive advantage over other home-care providers, for-profit and non-profit alike. If his product could satisfy those needs, Manning figured, he could sell the system to home-care providers who would then amortize or absorb the initial cost, as they were already doing with other types of medical equipment.

Throughout the spring of 1985 Manning and two technical consultants toiled in the basement and came up with a working prototype for a system that would be cost effective and easy for patients to use without professional help. At the same time, Manning wrote up a long-term strategy for his new company and set out to pitch it to potential investors.

An early encounter with venture capitalists taught him what he now wryly calls the Rule of Halves. After a frustrating six-hour meeting on a Sunday afternoon in New York City -- a get-together he had hoped would yield $50,000 in working capital -- Manning flew home empty-handed and crestfallen. "But a few days later I decided not to take no for an answer, and I called them back. They gave me $25,000, half of what I'd asked for," he says. "When you have a totally new, untried product -- where there are no competitors to compare it with, and you're really trying to invent a market that doesn't exist yet except as a hypothesis -- venture capitalists tend to give you half of whatever you say you need." The Rule of Halves.

The venture capitalists' initial hesitation was understandable. Not only was Buddy Systems pioneering a whole new market, it was doing so in a business that demands more patience than most. Any new medical device must win approval from the Food and Drug Administration before it can be sold. With equipment such as Buddy, gaining that crucial green light could take at least a couple of years of testing, paperwork, and clinical trials, all while operating costs are mounting and before a single sale is made.

To some investors, Buddy has seemed worth the wait. In all, the company's total capitalization reached $4 million as of April 1989. In mid-1986, while Buddy was still in the R&D stage, a couple of investors forked over $100,000 each, and Buddy Systems moved out of Manning's basement and into a real office. Manning even hired a few full-time employees. But like the cash-strapped hospitals that inspired his venture, Manning ran a tight ship. The company's walls are decorated with colorful crayon art commissioned from a local class of second-graders. The furniture was bought at auction secondhand -- "which was eerie," Manning notes, "because these auctions were held at the sites of businesses that had failed, so you had these intimations of mortality" -- and employees hauled their own desks and chairs back to the office in a rented truck. To save still more nickels and dimes, employees doubled as janitors; they took turns cleaning the bathrooms and taking out the trash.

Like many infant electronics companies, Buddy Systems has kept its labor force and capital expenditures small by building its machines from parts made by outside suppliers. In Buddy's case, that is more cost-effective than it might seem. The computer consoles have thus far been manufactured in such tiny volumes -- by the dozen, not the thousand -- that the cost of producing its own basic components would be too high for Buddy Systems to bear. Although Manning wants to be able to do more manufacturing in-house as the company grows, he has concentrated up to now on doing meticulous final assembly, testing, and quality control.

"In medical products, for obvious reasons, quality is absolutely crucial," Manning says, "so we want to keep close control over that. And the biggest challenge was finding the right people to do prototypes for us. You need a component maker who's willing to do top-quality work in very small volumes and who'll be patient with you while you keep modifying and refining the design." Noting that manufacturing has rolled along with only minor glitches, Manning adds, "One thing we've learned is that it's important to diversify. If you rely too much on any one vendor, and it has a period when it's overloaded with demand, that sets you back. When it gets behind, you get behind. So it's crucial to have an alternate supplier lined up."

By late 1987 Buddy Systems computer consoles were doing well in clinical trials with the cardiology and home-care departments of Chicago's Rush Presbyterian St. Luke's Medical Center. With FDA approval just around the corner at last, Manning was getting ready to start selling Buddy to large, well-established home-care agencies and doctors' groups around the country. For the long-awaited marketing phase of his strategy, he had planned to ask his backers for a new round of financing. So on October 1, 1987, Manning once again began calling on venture capitalists, hat in hand. Then came the crash on October 19. "Overnight, investors who had been encouraging us were suddenly behaving like commercial banks," Manning says. "They wanted low risk. And they wanted to make loans, not take on equity investments."

Those were dark days in Northbrook. As Buddy Systems's bank accounts dwindled, marketing took a back seat to scratching around for capital -- which finally came in February 1988, when a team of investors led by pharmaceutical giant Johnson & Johnson put up $1.2 million. Manning's contract with J & J prohibits him from discussing the terms of the deal, but when huge medical-products companies back start-ups, they usually have an option to buy part or all of the business. The closest Manning will come to explaining why he waited so long to approach companies like J & J for money is to say, "Corporate backers, generally, have other expectations than the purely financial, and there's more potential for conflict." In his particular deal, though, he claims that "J & J brought very little baggage."

In any case, by the time J & J rode to the rescue, Manning had been forced to lay off 11 employees, their departure marked by a tearful staff meeting, and morale was badly bruised. "We had done very careful -- and, up to then, very accurate -- projections of our cash flow. But in the wake of the Crash, it was clear we hadn't left ourselves enough slack," Manning says now. "We had to pick ourselves up off the floor and focus on a very limited set of objectives. We're just now getting back on our feet. The main task was, and is, to learn the best ways to reach the customer and get market acceptance for the product."

The effort to make Buddy as user-friendly and as salable as possible has already led to some changes in the computer system's design. For one thing, there's the name Buddy. Early on, Manning called his company Biometrix Inc. But a focus group of nurses, asked to comment on the machine while it was still being developed, said that when people are ill, frightened, and newly released from the hospital, they need friendly reassurance, not high-tech dazzle. Manning's wife, Ellen, who has worked extensively with chronically ill children at the Rehabilitation Institute of Chicago, suggested renaming the company Buddy Systems.

The computer's name in turn shaped its -- pardon the expression -- personality. The data-entry key on the console's simple four-button keyboard is labeled BUDDY. Each time a patient is supposed to enter information, the instructions on the screen direct him or her to TOUCH BUDDY. Patients seem genuinely to like Buddy -- especially now that it's taken to speaking plain English. In the beginning, the computer was programmed to ask patients to enter yes or no for such symptoms as edema and palpitations. Buddy now inquires about swelling and heart flutters instead.

So far, Buddy has been used by 64 patients -- most of whom are suffering from heart problems -- under the care of 22 different doctors, for a total of 24,216 operating hours. The prognosis is good: the system not only won FDA approval and a U.S. patent, but users are impressed with its performance. Patrick Smith, a cofounder and president of New England Critical Care Inc., a rapidly growing national home-care company, began experimenting with Buddy in the summer of 1988. The company now has a dozen doctors using Buddy to monitor patients, and Smith expects to add more networks. "The biggest difficulty is hesitation from doctors, not over the system itself, but over whether cardiac patients ought to be treated at home at all," Smith says. "The medical community traditionally is slow to accept new modes of treatment. But once that acceptance is there, rapid growth can follow."

Buddy's ultimate success also depends in part on whether insurance companies will agree to cover its cost. If not, home-care agencies may be reluctant to install the system. Over the long run, Buddy is cheaper than any alternative at about $20 per day for each patient, but the initial investment that home-care providers must lay out -- up to $90,000 for a system that can handle 10 patients simultaneously -- may prove unappealing if insurers turn thumbs down.

"Insurance reimbursement is a big hurdle for any venture in health care these days," Paul Judy observes. A former CEO of the securities firm A. G. Becker & Co., Judy was Buddy's first major backer and now sits on the company's board of directors. "The key is to get yourself wired in with the big, reputable home-care organizations that are already submitting a lot of insurance claims and whose judgment the insurers trust. And the fact that Buddy is designed to reduce costs, at a time when that is so critical, is a real advantage."

Getting wired into the claims system isn't simple, and it takes time -- anywhere from six months to two years, depending on whose estimates you believe. But Buddy Systems's quest for widespread acceptance, and the insurance dollars that will come with it, is picking up speed. With more than 5,500 separate home-care agencies and about 15,000 doctors' groups in the United States, the company can't hope to make its pitch to every one. Instead, Manning is aiming to get national distribution by forging contracts with large regional customers who will buy and use hundreds of systems in dozens of states as part of their existing treatment programs. That plan has two advantages: it obviates the need for Buddy Systems to hire a big in-house sales force, and it will disseminate the product in enough places, with enough established claims-filing groups, to grab insurers' attention. Manning is now negotiating with 12 such megacustomers. He predicts that at least 3 of them will sign on by the end of 1989. To date, though, he has sold only two of the $90,000 systems.

Further down the road, Manning anticipates other as yet unexplored uses for Buddy's technology. One possible market is drug manufacturers, who could use a Buddylike system to keep track of patients in clinical trials of new drugs. Another potential customer base is nursing homes, where Buddy could reduce the need for costly nursing staff by helping residents do routine tests themselves.

In Manning's view, tapping such potential will require a twofold effort. "We need to keep listening to our customers' reactions and suggestions," he says. "And we need to respond by continuing to innovate. If we can refine Buddy and perhaps come up with new versions of the system to meet different needs, we can remain the leader in the field even after new competitors come in."

For a man who still has a lot to prove and whose own projections don't show Buddy turning a profit until 1990, Manning has lost none of the excitement that made him quit McKinsey. It's contagious, too. Walter McNerney, a past president of Blue Cross/Blue Shield and currently professor of health policy at Northwestern University, has advised Manning since Buddy Systems's birth. "Tom really believes in what he's doing, and his energy and enthusiasm have gotten this thing as far as it is now," McNerney says. "If it keeps passing muster with the medical community, as it has so far, it's got a good chance of succeeding." Once McNerney's former employers and their ilk agree to foot the bill, Buddy could be a $200-million baby.

For an update on this company, see Anatomy of a Start-Up Revisited: Laying the Groundwork

Anne B. Fisher is a business writer based in New York City.

Research assistance was provided by Leslie Brokaw.


EXECUTIVE SUMMARY

THE COMPANY
Buddy Systems Inc., Northbrook, Ill.
Concept:
Make and sell a computer monitoring system that delivers an "electronic house call," enabling doctors to keep track of the patients whom hospitals are being forced, by a financial crunch, to send home sooner than they used to

Projections: A 1989 loss of $400,000 but profits each year thereafter, with 1991 sales of $9.6 million yielding aftertax income of $902,000

Hurdles: Getting doctors to use a device that involves no direct observation of patients and that may raise liability concerns; getting major insurers to routinely reimburse for use of the system; sustaining operations over what may be a longer than anticipated product-acceptance and sales cycle


THE FOUNDER
Thomas J. Manning, 34, CEO
When Tom Manning started Buddy Systems in 1984, he was in effect moving from an ivory tower into the trenches. Since 1979 he had been a consultant in the Chicago office of Mc-Kinsey & Co., advising top management of health-care companies about how to adapt to a fast-changing business environment. It was in the course of that work that Manning spotted the trend he is attempting to exploit with Buddy Systems: the shift from costly hospital care toward treating more patients in their homes.

Before he joined McKinsey, Manning worked his way through Harvard, where he received a B.A. with honors in East Asian Studies in 1977, and earned an M.B.A. from Stanford in 1979. While at Harvard he helped run the $1-million-a-year Harvard Student Corp., an undergraduate-run business that provides a variety of services to students and publishes the Let's Go series of bargain-travel guides. "That experience was the root of my interest in someday starting and running a business of my own," Manning says. He is founder of a newly formed network of entrepreneurs in the Chicago area. The group, whose 18 members are founders and CEOs, meets every six weeks to talk about the issues and problems facing growing businesses.

(continued)


FINANCIALS

Buddy Systems Inc. Operating Statement

($ thousands) 1989 1990 1991

Revenues

System sales $0 $4,667 $7,486

Recurring (parts, maintenance) 0 1,024 2,158

Total Revenues 750 5,690 9,644

Cost of Goods Sold 400 2,584 4,480

Gross Profit 350 3,106 5,164

% gross profit 47% 55% 54%

Operating Costs

Sales & marketing $0 $1,073 $1,859

General & administrative 0 838 1,071

Research & development 0 567 744

Depreciation 0 64 102

Total operating costs 750 2,543 3,776

Operating costs as % of sales 100% 45% 39%

Operating Income (400) 563 1,388

Income tax 0 197 486

Net Income (400) 366 902

Net income as % of sales 0% 6% 9%


WHAT THE EXPERTS SAY

FINANCIER
PETER SANTEUSANIO

Partner at Hambro International Venture Fund, a $150-million Boston venture capital firm; has been on boards of three companies selling to doctors and hospitals

I think Buddy Systems has a next-to-impossible task in selling to doctors. Consider the question of liability. If patients stay in the hospital, then the liabilities are shared by the nurses and the hospitals; if they go home, potentially more of the liability falls onto the doctor. And the last thing in the world doctors want is more liability.

I'm also concerned about barriers to entry. It's not clear what's patented here. The people at Buddy allude to patent protection, but I think the barriers are, at best, questionable. Much of their data -- blood pressure, weight -- can pretty easily be gathered in other ways. Maybe the EKG is the one thing that they could put some barriers around, although I'm not sure. It would seem that someone in the EKG business, a Hewlett-Packard or somebody -- and there's fierce competition in this industry -- could knock this thing off. And they have a whole lot more resources.

I question Buddy's ability to market without a large direct-sales force. I would say they're going to have to establish credibility and a reference base with doctors -- and that's expensive and takes a lot of time. You have to sell direct. The selling expense budgeted in the financial projection is not a particularly large percentage of sales, and I think that's unrealistic.

I think it's impossible to make money at this business in a year. Buddy Systems is going to have to put 50% to 100% of the top line into selling. In companies like this, sales costs are very high initially -- I don't see any way it can put money on the bottom line next year. Which is not bad; a venture capitalist is going to look at this and say there's no way they should be able to. But that they're showing they can ramp up that bottom line in a relatively short period of time suggests to me a significant . . . I don't know if the word is naïveté or ignorance or what. It calls into question whether they realize what has to happen to be able to sell to this market.

CUSTOMER

ARTHUR J. BERMAN

Director of medicine, Lawrence Hospital, Bronxville, N.Y.; past president, Westchester Academy of Medicine

What they've done well is simplify the procedure and recognize the market in terms of patients who may have difficulty even recalling when to take medications and who find any kind of machine or high-tech instrument threatening.

But would I recommend it be purchased? I don't know that I would. Physicians are conservative in that they make decisions based on judgment, and they may feel that judgment is interfered with by having just a few pieces of paper and bits of information to make decisions on. We need clinical information: whether the patient is short of breath or looks ashen, whether the lungs are clear. Doctors need to feel they know what the patient looks like. I'm not sure how big a hurdle this will create for Buddy Systems.

It's not the cost that might present a problem; for a hospital I think $90,000 is small potatoes. I just don't think general hospitals, especially given the question of physician confidence, will want to get involved with it unless they see it as a business venture they can profit from. It might do OK, but it wouldn't be anything I'd think every patient discharged with a cardiological problem would use.

CUSTOMER

KATHEEN DODD

Corporate director, home-care services, American Nursing Resources Inc., an Inc . 500 nursing-care company in Overland Park, Kans.

Providing another high-tech product in the home is creative and quite ingenious. I see the future of patient management moving from an acute-care setting into a home setting. But I wouldn't buy this system. I don't see that we would have any incentive whatsoever to put it in our agencies. They would either cut down the number of visits I would be able to charge to a payer for the nurse, or add to my costs for the person I've got to have in my office to call patients and process the information.

HMOs, however, could have a real need for this. They could determine the cost benefit of paying for a system to be put into a patient's house and then subcontracting a home-care agency like ours to monitor it. That way, the HMO would be paying for it, and we'd just help provide their services.

I can almost assure you Medicare is not going to pick up the bill for these systems. HMOs are much more sensitive than Medicare to the cost-containment arguments. Their livelihood depends on how judicious they are with their fiscal management. Medicare will see the systems as adding to the already high cost of managing the Medicare population. I think the cost-effectiveness argument has a lot of validity, but the federal government doesn't deal in reality. It's possible for Manning to get them to see the cost-savings benefits, but it's going to take a long time.

CUSTOMER

LAWRENCE I. SOSNOW

President, Patient Care Inc., a $23-million chain of home-care agencies based in New York City

Manning is way out in front in terms of timing. Other companies are beginning to develop systems like this -- AT&T is working on one -- but he has the advantage of getting there first. The second thing he did right was recognize the labor shortage home-care agencies are dealing with. This machine can save nurses' time, which helps spread the available labor over a larger number of patients.

But I'm concerned that insurers aren't reimbursing home-care providers for use of this system yet. To get Medicare or Medicaid reimbursement, you have to have generated a lot of convincing data; you must be able to prove that this will save money. For Manning to build a statistical track record, he may have to approach the insurers on a case-by-case basis at first. That is, go straight to an individual patient's carrier and say, "Here's proof that if this patient goes home from the hospital and uses this system, you'll save X number of dollars."

Making that case is partly a matter of getting the right personnel. Manning should hire somebody with a lot of experience working with insurers who really knows the reimbursement business. Manning himself doesn't have the background -- the credibility -- to approach insurers. He probably doesn't have the time, either. But it's essential. Without reimbursement a lot of potential customers won't make the purchase.

Last updated: Jul 1, 1989




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