Reversal of Fortune
On the Web a company can change its direction almost as easily as its founder can change his or her mind about what the company should be
"With 52 employees, here's where we would have died."
Jim Kean stood before the remaining 34 employees of his Internet-based start-up, Sapient Health Network (SHN), and pointed to the month of August on the calendar projected on the wall by his PowerPoint presentation software. It was already mid-June 1997. Kean, the company's president, had spent the morning laying off workers--18 of them--in groups of twos and threes. He'd downed two stiff scotches at lunch and then returned to face the shell-shocked survivors. Now he had to make them understand that what he'd done was amputate a limb to save a life. "Because we've done these layoffs," he told them, "the venture capitalists on the board will be encouraged by the fact that our burn rate is lower, which will help us with our next round of financing."
Things hadn't always been so bleak. From the moment it began operations, SHN, which is based in Portland, Oreg., had had no trouble raising more than enough cash. In fact, within 12 months of its founding, in November 1995, it had more than $5 million in venture capital in its coffers, raised in its first two rounds of financing. But when the health-care-information subscription service failed to generate significant revenues in its first year of operations, the once-enthusiastic supporters began to back off. "In May we were down to a point where we would run out of cash by the end of August," Kean, 36, says now. "You could almost feel this thing ticking. It's like you're a sick patient who's been told you have nine months to live, and you'd better figure something out between now and then."
In the real world, triage would have been pointless. SHN's crisis would have been followed by a series of cash-flow crunches and then an accelerating death spiral. But SHN doesn't live in the real world; it lives in cyberspace. And cyberspace has spawned a more resilient type of business. As SHN's story illustrates, sans physical plant and inventory--and even preconceived notions about what form it should take--a Web-based company can reinvent itself in midflight in a matter of weeks. And so, on the same June day that Jim Kean announced the layoffs to his demoralized staff, he also introduced them to a new business model and a restructuring of the organization. On the Web, he says, you can be whatever you want to be whenever you want to be it: "It's like a map of the world from the 15th century. There's all this unknown space."
SHN's original business model--a subscription service providing health-care information to people in virtual communities set up along disease lines--collapsed. Yet Kean knew that even in its death throes, the company had two things going for it: it had created a valuable piece of technology ("expert system" software called intelligent profiling engine, or IPE, and intelligent query engine, or IQE), and it was in a burgeoning market (medical informatics, the analysis of health-care data for the purpose of measuring costs and quality of care). Instead of giving up, he and his partners refocused that technology to go after a completely different customer--pharmaceutical houses and other health-care companies. In retrospect, the changes the company made seem to have been part of a natural evolution, says SHN board member Susan Clymer, but actually the company's executives backed into it. "There was a lot of scrambling around trying to figure out how we could wring value out of what we'd already accomplished," she says.
SHN was founded with the idea of creating communities of Internet users with specific chronic illnesses. Through its expert system it would provide members with personally tailored news and information about their diseases, and through message boards and chat groups it would give them the ability to interact on-line with others suffering from the same condition as well as with health experts, who would make guest appearances. Users would pay $10 a month for the service. SHN also planned to earn revenues from banner advertising and sponsorships by drug companies and other health-care players.
SHN's business plan was nothing if not optimistic. Kean and his cofounders, Bill Kelly and Kris Nybakken, projected the company could pull in $6.3 million in 1997 and more than $42 million in 1998. The three men, all former managers of Creative Multimedia Inc., a Portland-based CD-ROM development company, were undaunted by the fact that other than the Wall Street Journal and certain pornographic sites, they knew of no examples of successful Web-based subscription businesses. "Everyone knows health care is going to be consumerized," Kean explains. "It seemed like something people would spend money for--to get detailed information. There weren't a lot of examples out there, but I think it's fair to say that somebody is going to make some type of subscription business work. You just don't know when it's going to be. So being optimistic entrepreneurs, we thought it was going to be us."
The partners' revenue assumptions were based on a model that took into account several variables: how many patients in the United States had a specific disease; of those, how many had Internet access; what percentage of those SHN could reach through its own banner ads; and what percentage of that group would sign up for the service. "In direct marketing, 2% is great," says Kelly, SHN's 34 -year-old executive vice-president. "If we got a 2% 'click-through' to our site, and then got just 15% to 20% of those people to sign up, that would be significant revenue."
Kean and Kelly, both Ivy League M.B.A.'s, did a fair amount of market research before launching the business. They contacted support groups such as the Arthritis Foundation and studied patient-spending habits in their efforts to decide which diseases to target first. They chose breast cancer, prostate cancer, and fibromyalgia, a painful and debilitating rheumatic disorder. Their research for fibromyalgia alone showed that the several million Americans with the disease each spend between $700 and $800 a year on educational materials, newsletters, and seminars.
Kelly remembers sitting in a focus group with fibromyalgia patients. After playing with SHN's software for a while, one woman looked off in a contemplative mode. When asked what she was thinking, she replied, "Well, I collect antiques. And I was just adding up the antiques I would have to sell in order to buy a computer so that I could get on-line and get Sapient Health Network."
"I thought: Bingo. Defining moment!" Kelly recalls. "Who would be more voracious consumers of information than people who are faced with life-changing, life-threatening illnesses, who need information in order to make the best decisions?" Their market research complete, in September 1996 Kean and Kelly, along with staff members, established three beta-test groups--one for each of the three diseases they had targeted. Each beta group had 300 members who had been recruited through focus groups and banner advertisements on the Web.
The lack of a successful Web-subscription model didn't deter SHN's investors, either. "The idea behind SHN was very appealing to me," said Philippe Chambon, a partner in the Sprout Group, which, like its fellow Silicon Valley firm, Asset Management Group, gave the company $2 million in venture capital right off the bat. "Patients are becoming more involved in their own care, and this seemed like it could be a very good channel for that."
SHN used its $5 million in venture financing to begin development of a robust Web site, centered on the expert-system technology. The staff grew quickly to 52 people as Kean hired editors and writers to produce up-to-the-minute research reports on topics related to specific conditions. Users would also have access to medical dictionaries, databases such as Medline and MDX Health Digest, and news services such as Reuters Medical News.
But the site's biggest selling point was the expert system that vice-president of technology Nybakken and his team had designed. The software, for which SHN is seeking two patents, kicked in when subscribers first registered by asking them to fill out a profile relating their experience with their particular disease. It then employed Web-crawling agents to explore the company's database--which included articles written by the SHN staff, material licensed from drug databases and medical dictionaries, and contributions from subscribers picked up in, say, newsgroup postings--for the information most relevant to the individual. "It says to the user, 'Based on your profile, here's the sort of stuff you should be reading," explains the 29-year-old Nybakken. "For example, if you're post-diagnosis but pre-treatment, you're going to be interested in treatment options: Where are good care centers? What are the side effects going to be? Whereas if you're post-treatment, you're not interested in those things. If you're already on chemo, the system will offer articles on how to deal with dehydration from the methotrexate side effects."
The company also began collecting aggregate data about the subscribers gleaned from the patient profiles. "We did that to point us in directions where there were holes in our content, to drive our acquisition of content," Kean explains. For instance, many patients across all three disease groups rated highly the need for advice on how to deal with their doctors. And prostate patients were eager for information on how their prostate-specific antigen scores compared with the average in the group.
Throughout the four months of beta testing, subscriber feedback was encouraging: the patients particularly liked the customized information that the expert system provided. But in January 1997, when SHN tried to convert its trial subscribers into paying ones, it had few takers. "Lower than 5%," says Kelly in describing the conversion rate--a far cry from the 15% needed for the "significant revenue" of his projections. SHN had discovered the hard way that most people think of health care as an entitlement. "We had lots of people saying, 'Can you get my HMO to pay for this?" Kean recalls. "But their HMOs are not going to pay for this. They are earning a dollar per person per month in net profit."
Shocked by the low conversion rate, the team decided to solicit some marketing expertise. They found it in the person of Paul Sonnenschein, to whom they gave the title of vice-president of marketing. Sonnenschein, 41, had years of experience building consumer-based businesses, including the Book-of-the-Month Club, at Time Inc. More recently he'd been at Children's Television Workshop, where he'd managed consumer marketing and overseen book-licensing activities. He had also helped with the planning of the Children's Television Workshop's on-line service. But Sonnenschein was to express serious doubts about the subscription model soon after he made the leap from Big Bird to breast cancer.
The first thing Sonnenschein did was bring in scores of trial subscribers, whom he attracted to the site by placing ads on frequently searched pages. Then, under his direction, the partners began experimenting with different types of payment plans, offering one-month, 6-month, and 12-month deals as well as a "charter," or lifetime, membership for $200. "At one point we had twice as many charters as we had monthly subscribers," Kelly says. SHN tried giving users additional weeks of free service before converting them to paying customers. But it didn't matter how the company tweaked its assumptions or offerings. After three months of campaigning, the network had only 500 paying customers. SHN was burning through $400,000 a month and had less than $10,000 in revenues to show for it. Says Sonnenschein, "I didn't see us raising the trial-to-member conversion rate anywhere near high enough to make the business work."
Meanwhile, life inside the company was heating up as well. A rift had developed between the editorial and the marketing departments. The writers chafed at being told what type of stories to write by the company's executives and by the marketing staff, who had the most direct contact with patients. Employees in different departments weren't talking to one another. "We needed to have a series of protracted negotiations to get any work done," Kean says with a hint of exasperation. The partners were near their wits' end. "We all freaked out at one point or another," Nybakken admits. "We were just lucky that it wasn't simultaneously."
The managers weren't the only ones freaking out. The board members had known from the beginning that there was widespread skepticism in the Internet community about the subscription model, because Web users are used to getting information free. But the SHN board had been willing to suspend disbelief. "It turns out there was a basis for that skepticism," says board member Clymer, a business consultant to the biotechnology industry. The venture capitalists on the board were getting antsy, too. "We were right that patients were interested in becoming more involved in their own care," says the Sprout Group's Chambon, "but we were wrong in that they were not willing to pay for it."
By February 1997, while still trying to convert trial members to paying ones, Kean and company tried to come up with new ways to bring in cash. Kean had agreed to give a talk about the Internet to the market-research arm of a huge East Coast health-care conglomerate. (For reasons of competition, officials of the company asked that its name not be used.) The conglomerate's research showed that an increasing number of women in need of certain gynecological surgery were researching the treatment options themselves and telling their doctors which ones they preferred. The patients were driving the surgical choices. The company wanted to know both how women went about acquiring such information and how they used it to make decisions.
In the conglomerate's immaculate conference room, Kean flicked on his PowerPoint presentation software and set up a live link to SHN's Web site. He could almost see his audience nodding off. "They were pretty glassy-eyed during most of it," he says about the presentation. "They were thinking, 'God, this is boring. Isn't it great that the company always brings doughnuts to these things?' "
Then Kean pulled up SHN's statistics on its breast-cancer group--showing members' aggregate responses to questions ranging from tumor size to treatment choice to how long ago they'd been diagnosed --and flashed the responses on the wall. The room came alive. "The stats came up, and all of a sudden the consumer-marketing people sat up and were saying, 'Hey, that question 5 is really interesting. You have a high percentage who say they considered surgery over radiation," notes Kean. "They started realizing this profile could be pretty valuable as a market-research tool."
Suddenly, Kean had hope. When he returned to Portland, he began researching the viability of dropping the subscription fee altogether and refocusing the business on selling aggregate market-research data on SHN group members to pharmaceutical houses and other health-care companies--everything from details about the experiences of women at specific stages of breast-cancer treatment to patient testimonies about the effectiveness of interferon administration for hepatitis C. SHN could even build new disease-specific sites at the request of sponsors. To supplement its market-research services, the company would run advertisements for its customers on its Web pages. SHN's original business plan had mentioned that there might be a market for aggregate data about patient populations collected through the Web site. "But it was always talking point four or five," Nybakken says, a strategy aimed at filling in gaps in the company's store of knowledge. Could it now become the company's raison d'etre?
Before SHN could find out, the partners knew they'd need more expert direction. With the board's strong urging, Kean began searching for an interim CEO with experience in health care to guide the company's transition from one business model to the other. Through contacts, Kean found Craig Davenport, a 25-year veteran of the health-care industry. "They needed a tremendous amount of help," says Davenport, whose company, the D.W. Group, specializes in providing management expertise to early-stage medical-device and health-care-service companies. "They didn't have any experience in health care. It would be like me trying to fly the space shuttle."
In May 1997 Davenport joined SHN's board and agreed to become interim CEO. His first move as chief executive was to help the cofounders plan the cuts in staff, specifically among the editors and the writers. The amount of original material the editorial staff had been generating, he says, was just too expensive to maintain. "I thought we could make the sites rich and rewarding for patients without trying to win an Oscar for each disease site," he says.
Then Davenport set out to plan operations around the company's new agenda: to continue to build thriving on-line communities, whose members would now receive the company's customized reports and interact with one another on-line for free; and to figure out how to package and sell data about those communities to SHN's new customers. On June 24, 1997, Sapient Health Network was "relaunched" in its new guise, and all subscription revenues collected to that point--about $10,000--were returned to the members.
SHN's concept wasn't the only thing that had to change for it to switch from a company that processed subscriptions to one that sold market research; its technology had to be revamped as well. Originally, after exploring several vendors' solutions, Nybakken and his programming staff had written the code for all the company's publishing and billing mechanisms. "Whenever I would look at those build-versus-buy decisions, it ended up on the build side," Nybakken says. "We built our content-management solution for three-quarters of the price of Netscape's consulting estimate alone--never mind licensing fees."
But now the billing scripts had to be yanked. And the company wanted to change its database software, from Informix to IBM's DB2, in order to boost the speed of keyword searches by subscribers and to improve its "data mining"--the capability to massage the aggregate data about its membership.
For the rest of June and through July--while the staff built membership and Nybakken's engineering crew tweaked the technology--Kean and Sonnenschein contacted the market-research arms of large pharmaceutical companies in an attempt to land some pilot accounts. "Very early on during those interviews, it was clear there was value" in the kind of consumer access SHN could provide, says Davenport. The next question was, What would they be willing to pay for it?" SHN's executives are tight-lipped about the pricing schemes they developed, but they will reveal their method of attack. "We started with what pharmaceutical companies usually pay for market research," says Sonnenschein, "and then asked these questions: What's it worth to get the results in a fraction of the time? What's it worth to do quantitative research and then track those patients over time? Both are virtually impossible to do using conventional methods."
Traditional health-care market research can take up to 16 weeks to complete. To find subjects, researchers typically run ads in newspapers or intercept shoppers in malls. SHN could get much faster responses using E-mail. For instance, SmithKline, one of the company's first market-research customers, wanted to survey 700 women aged 45 to 65 who had some interest in Alzheimer's disease, osteoporosis, breast cancer, or cardiovascular disease. SHN had 700 of its members complete a 23-question survey, designed by the pharmaceutical giant, within a matter a weeks.
Or consider the case of Amgen, a biotechnology company in Thousand Oaks, Calif., that came on board in November 1997. Amgen hired SHN to build a hepatitis-C virtual community to coincide with the launch of its interferon drug to treat hepatitis C, called Infergen. It wanted to learn, among other things, about the side effects and the compliance problems patients might have with the medication. Amgen gave SHN three months to gather 500 users, but by placing banner ads on sites where users search for the word interferon, SHN was able to attract 500 hepatitis-C-group members within three weeks. "It totally blew Amgen away," says Kean with pride. Today SHN's group has nearly 10,000 hepatitis-C patients, and the company's goal is 27,000 by the end of 1998. With only 180,000 U.S. citizens diagnosed with the disease, that would give SHN 15% of the country's entire hepatitis-C population. "That all of a sudden becomes a very potent marketing force for anybody who wants to sell goods and services to the patient," says Kean.
Although Amgen sponsored the group originally and pays to be the exclusive advertiser on the hepatitis-C site, SHN, not Amgen, owns--and controls the use of--the data gathered there. Other drug companies with hepatitis-C treatments are free to ask SHN to do market research on the group's members if they wish. As for the members, they're told up front, in a terms-and-conditions clause that they must agree to before they register, that the information they provide will be used "in statistical aggregates" and perhaps "to develop research databases, articles, promotional and testimonial materials, and other things" SHN needs in its business. The members, in turn, reportedly appreciate the chance to interact with the companies that make the products that address their specific conditions, says Kean, and don't seem to mind receiving the commercial solicitations "as long as they're not disingenuously presented." Confidentiality, Kean stresses, is never an issue: though SHN uses information culled from member profiles and surveys at an aggregate level to provide insights into patient opinions, it is committed to maintaining its members' privacy. No personal data are ever revealed to any customer, and members receive no E-mail from companies unless they request it.
"We call what we do now 'real-time research," says Kean. "We're making research an impulse purchase. Knowing more about specific groups and then acting on that information through communication opportunities--that's our revenue domain."
And that revenue is soaring.
SHN should make $1.9 million in revenues in 1998, Kean says, and will hit $6 million in 1999. Those estimates are more conservative than the ones in its original business plan, but at least the company has a chance of reaching them. SHN now has 81,000 members, who participate in a variety of communities: for asthma, breast cancer, depression, diabetes, fibromyalgia, chronic fatigue syndrome, heart disease, prostate cancer, and several women's health conditions. Ten to 15 new groups will be launched in the next year. The company is seeking a permanent CEO to replace Davenport and is preparing to seek another round of financing--from $10 million to $12 million. "The technology is the power behind this company," says Davenport. "We've made the strategic changes necessary to leverage that in a different way. Now we're using the information to the advantage of large pharmaceutical companies, which never have had a direct link to the people who consume their products."
It's too early to say if SHN will be able to build a successful business out of doing market research on its members and providing an environment in which health-care companies can make their marketing pitches. The year and a half SHN spent struggling to find its niche may have shrunk its window of opportunity. Other, more-established health-care players--such as Kaiser Permanente--are starting to build disease-specific Web sites. But if the failure of SHN's original business plan gives some venture capitalists pause, its discovery of a secondary market for its technology platform may be a testimony to the resilience of Web-based businesses--and to the entrepreneurs building them.
"We're not tied up in a bunch of capital investments that can't be redeployed," says Kelly. "The Web so far has attracted people who are very flexible in their thinking. People don't survive if they're narrow-minded in how they view their job. The fact that the people here were already predisposed to changing made it easier to turn on a dime."
David Raths is a freelance writer based in Portland, Oreg.