Teladoc's Business Model and Implications

I’ll start with an short hypothesis of how Teladoc (TDOC) could play out to the upside (or else why bother right?) then analyze the business model, implications and options to change that model.

Summary Upside Case

• Continued organic revenue growth at 20-30% CAGR. Growth comes from both membership increases and price increases.
• Government expansion of telehealth coverage for Medicare Advantage plans beginning in 2020 should help membership increases
• Operating leverage kick in as TDOC drives utilization, proving its worth to clients, which in turn justifies price increases. Management expects EBITDA to inflect positive this year.

TDOC trades at 8x EV/revenue while still unprofitable, so buying it requires us to think 10 years+ forward and project sizeable revenue and margin increases. That calls for an understanding of Teladoc’s business model and its place in the healthcare value chain.

Business Model

For the most part, Teladoc gets revenue from payer clients (health insurance plans, self-insured employers), and not directly from patients/consumers. 

These clients pay TDOC recurring "subscription access fees", typically on a per-member-per-month basis.

Costs of revenue are essentially based on volume of visits:

Cost of revenue is driven primarily by the number of general medical visits, expert medical services and other specialty visits completed in each period. Many of the elements of the cost of revenue are relatively variable and semi-variable, and can be reduced in the near-term to offset any decline in our revenue

As far as value proposition and "jobs to be done", here's a line from TDOC's filings:

(Clients) purchase our solutions to reduce their healthcare spending, or to provide market differentiating services as either part of, or a complement to, their core set of consumer service offerings,

Cost savings is the most tangible benefit, and in my opinion the most important one, since telehealth itself will not be much of a differentiator for health plans given the proliferation of video technology. 

TDOC saves money for payers by "capitating" an otherwise fee-for-service cost. The typical health plan pays doctor each time patients visit. More visit means higher costs for the plan/insurer. But with TDOC, the insurer just pays TDOC a fixed fee regardless of how many times patients visits doctors in TDOC’s network.

Here's a very simplified diagram that illustrates how economics flow from payers to doctors through TDOC (right side of picture). Compare that to the world without Teladoc (left side of picture), note that TDOC basically injects another layer of physician network for the original insurer to outsource to, and turn a volume based variable cost into fixed cost.

Implications

TDOC’s business model has several implications:

1) This business model only makes sense in a non-integrated healthcare world where payers still pay doctors on fee-for-service basis. It makes no sense in a vertically integrated healthcare system like Kaiser, where doctors are salaried staff.

As mentioned earlier, in a typical non-integrated healthcare system (for example Blue Cross for example), the more you visit doctors, the higher the costs for Blue Cross. TDOC comes in and fixes that costs at some per-member-per-month, regardless of number of visits. But with Kaiser that cost is already fixed because doctors are employees, so TDOC can add little value there.

This implies an inherent limit to growth. But TDOC has a long way to go before it hits that limit since systems like Kaiser are relatively rare.

2) Ability to raise prices depends on how much payer clients are saving by using TDOC. That saving amount is based on telehealth utilization - and TDOC is incurring marketing costs to drive patient awareness and utilization.

That TDOC couldn’t pass that marketing cost along to payers, even as it directly benefit payers, shows the weak bargaining position that TDOC occupies in the value chain.

Unlike say, Uber, where both sides of the market place – drivers and riders – are both fragmented and politically weak, TDOC is a middleman between 2 powerful groups – payers and doctors.

This is why I would love to see TDOC go more of a direct-to-consumer route, like they’re already doing with behavioral health. Owning the customer relationship would give them more bargaining power vis-a-vis health plans.

3) Where will operating leverage come from in the future?

The problem with driving utilization higher to improve client ROI is that TDOC itself would have lower margins, since revenue is fixed based on number of members while costs goes up when visits are higher. 

TDOC can change its own costs structure though, by hiring doctors (which turns variable costs into fixed cost), or even use algorithms for simple prescriptions. They are in fact already exploring the former.

Having more of a fixed cost structure would further incentivize TDOC to continuously prove and improve ROI for payer clients. This would convince payers to offer Teladoc through more of their health plans (boosting membership), and allow TDOC to argue for higher access fees per member (boosting both revenue and margins)

4) Perhaps Teladoc can carve out a separate product for chronic care and using nurse practioners instead of doctors. This would be a more optimal use of resources from not just cost perspective, but also from coverage perspecdtive (more supply available to cover patients 24-7). It would also let Teladoc cleanly differentiate itself against your typical “health plan with video option”– important if TDOC wants to go direct-to-consumer and build that brand.