The markets are buzzing with the latest Rock Health report on funding for digital health in the first half of 2021. At nearly $15 billion, the funding surpasses the amount for the full year 2020.

Everything is up: deal volumes, deal sizes, M&A activity, IPOs and SPACs. By all indications, the digital transformation of healthcare is fully underway, and it's time to party like it's 1999.

What the explosion in VC funding data doesn't tell us, however, is how all these heavily-funded startups are doing in the market.

Health systems are rapidly transforming their healthcare delivery models with online access and patient engagement tools, remote monitoring and other virtual care modalities. Digital transformation leaders are also grappling with fundamental questions: how much to invest in these efforts, who to partner with, and how to execute effectively on multiple fronts.

While COVID-19 has accelerated the shift towards digital health, it has also given rise to a surge in workloads for CIOs and chief digital officers.

In the words of Mike Restuccia, CIO of Penn Medicine in Philadelphia, the post-COVID-19 normal looks a lot like the pre COVID-19 normal – plus a plethora of other responsibilities and activities.

In addition to the traditional IT functions, such as infrastructure management and EHR optimization, the post-COVID-19 era has added to workloads in the form of more "tele," more digital patient engagement and more remote monitoring of patients – all big lifts from an IT perspective.

The 'problem of plenty' for healthcare organizations

There is unprecedented opportunity for digital health solution providers, arising from the digitalization of core care delivery services. The opportunity is big enough to justify the mushrooming of digital health startups (more than 5,000 deals funded since 2010, by one estimate).

Some of the startups are truly innovative category creators. Others are competing with other startups by offering similar services. Still others are focusing on ever-smaller niches to differentiate and create value. (Damo Consulting's digital health intelligence database identifies no less than 15 companies offering digital payment solutions.)

The startups are spending vast amounts of VC money on advertising, marketing, product development and client acquisition.

Health systems are reducing their technology footprint today and are aggressively consolidating their information systems for agility and cost-efficiency, tapping into a handful of enterprise technology vendors for the bulk of their needs.

They're reluctant to bring on new digital health startups, raising the entry thresholds for startups to mitigate risk, reduce vendor proliferation and reduce administrative overheads.

Many health systems are going a step further by taking equity stakes in promising startups, thus making a long-term commitment to a handful of innovative solution providers, potentially accompanied by the phasing out of other existing vendors with similar solutions.

Digital health startups, for their part, are fighting to stay relevant. A rapid consolidation among digital health startups pursuing scale economies and enhanced relevance with clients is driving a spurt in M&A. The consolidation is the result of the threat of marginalization as much as it is due to demands from enterprise clients.

From mega-deals such as Livongo-Teladoc to smaller ones such as Grand Rounds-Doctor On Demand, the pursuit of scale and continued relevance has been a driving factor driving digital health companies.

The challenge for health system digital transformation leaders now is to choose among many potential solution providers for long-term relationships, especially among relatively young companies with small founder-led teams and dependent on VC money to keep the lights on.

The trifecta for digital health solution providers

For digital health companies to succeed, they must get three factors right: low cost, operational scale and service quality.

After announcing the launch of its Amazon Care service for virtual primary care and home care for all 50 states in May, Amazon revealed that it would need to hire "thousands of employees" to scale the service.

This was a challenge that Amazon either did not anticipate or underestimated. Coming on the back of a promise to provide access to a clinician in 60 seconds or less, the scaling problem becomes a critical bottleneck in delivering the promised service levels.

Apple, another big tech firm that has made a deep commitment to the healthcare sector, is also reported to be struggling, though for different reasons.

Apple's consumer-focused healthcare applications such as sleep monitoring, heart rate indicator and the more recently launched hand-washing app (my favourite) are high-quality services that nevertheless lack the seamlessness of a holistic healthcare experience.

Despite the integration with patient data in EHR systems, the apps operate as stand-alone solutions. Most importantly, physicians don't necessarily refer to Apple's Health app data in their patient care, an added factor that can slow down the growth of the services.

Where does that leave digital health startups? Despite the absence of scale and a product offering that is largely unproven, giants like Amazon can offer the services at low cost indefinitely till they get the trifecta right.

For many digital health startups, both time and money are in short supply, notwithstanding the latest VC funding data that favors more mature startups and later rounds of funding. These firms are left with limited choices, offering low-priced services to win market share and outrun the clock.

The largest of the digital health companies are locked in this grim battle today, continuing to post losses to pursue market share and growth. When the giants of technology cannot demonstrate a pathway to sustainably profitable growth, startups must adopt different tactics for survival.

They rely on nimbleness and consolidation to keep existing clients while using VC money to subsidize new clients, hoping they will turn a profit or more likely find an exit for investors through a liquidity event.

The digital health solution markets are in an exciting state of hyper-growth – at least as measured by the amounts of VC money pouring into the sector. For many startup founders, the flow of funds and the astronomical valuations may be just what the doctor ordered, providing them with the runway to refine their product offerings and build lasting relationships.

For others, it may just be a delaying of the inevitable. It's hard to tell today which is which. The challenge for their health system clients just got more complicated. 

Paddy Padmanabhan is the author of Healthcare Digital Transformation – How Consumerism, Technology and Pandemic Are Accelerating the Future. He is the founder and CEO of Damo Consulting.