Academic medical centers should research and embrace new approaches to financing, operations, and governance to become more cost-efficient and profitable in an era of reform.

 At a Glance

Academic medical centers should consider five strategies for becoming more cost-efficient and profitable as reforms are implemented:

  • Make faculty responsible for cost and quality.
  • Explore opportunities to collaborate with community hospitals.
  • Extend care and education beyond the walls of the organization, employing technology and innovative teaching practices.
  • Maximize healthcare IT investment by sharing data-rich patient records with other medical centers and research institutes.
  • Align research with business strategy.

Academic medical centers (AMCs) traditionally have been the wellspring of a trained physician workforce and of cutting-edge medical, scientific, and technological advancements. They are recognized for the care they provide for the most complex medical conditions. Yet the distinct mission of AMCs may be in jeopardy because the sources of revenue they have relied on in the past are changing. Most are already dancing on razor-thin margins. AMC finance executives therefore know that new strategies are needed to optimize revenue and protect the organization’s mission. 

State budget cuts, decreased payments, increased patient demand, and higher consumer expectations have placed AMCs and their value proposition under a microscope. Historically, AMCs have attracted many of the nation’s leading physicians and researchers as well as medical students seeking prestigious residencies and internships. Leading pharmaceutical and medical device companies have sought to partner with AMC researchers. 

The teaching and research mission of AMCs, however, has generally caused their costs of doing business to be higher than those of community hospitals. Clinical care generates about 85 percent of an AMC’s revenue, which is used to partially subsidize the center’s research and academic mission. This economic model has worked for a long time and has enabled many AMCs to thrive financially.

 AMC operating margins have averaged approximately 5 percent over the past three years, barely above that of industries such as regional airlines, grocery stores, and specialty retailing (company-reported financial information, compiled from Yahoo! Finance, July 2012). Changing operating, financial, and regulatory forces in the healthcare industry also pose challenges for AMCs, putting up to 10 percent of their traditional revenue at risk.
Further, the Supreme Court’s affirmation of the Affordable Care Act (ACA) affects AMCs because states that choose not to expand their Medicaid programs will have more uninsured residents, thus likely increasing the number of uninsured patients that come to AMCs for treatment. Moreover, certain sources of funding, such as grants, are being cut from the federal budget, and commercial payers may shift toward narrower networks that exclude AMCs.

In a healthcare reform market focused on lowering costs and raising standards of care and accountability, AMCs’ economic, operating, and governance models are becoming an albatross, choking profitability and hampering their ability to react in an environment where new and existing market participants are adapting more quickly. Under these circumstances, AMCs have a pressing need to identify ways to protect and improve performance.

Setting the Stage for Change Under Reform

The balance of change facing AMCs in an era of reform is likely to result in relative reductions in revenue for many AMCs, depending on their sources of funding. 

AMC finance executives are well aware of the funding challenges ahead. Among 100 AMC leaders responding to a recent survey, 70 identified decreased indirect medical education (IME) funding as a significant threat to their institutions (The Future of the Academic Medical Center: Strategies to Avoid a Margin Meltdown, PwC Health Research Institute, February 2012). An analysis by the Medicare Payment Advisory Commission (MedPAC) found that only 40 to 45 percent of current IME payments are justified to cover the higher care costs of Medicare inpatients, suggesting a potential cut in IME payments of up to 60 percent (Report to the Congress: Aligning Incentives in Medicare, MedPAC, June 2010). In addition, President Obama’s budget proposal includes an $11 billion reduction in IME payments over 10 years (Budget of the United States Government, Fiscal Year 2014, U.S. Office of Management and Budget, April 2013). 

AMC leaders recognized several other significant threats in the same survey. Among respondents to the aforementioned survey, 61 percent said the reduction in disproportionate share hospital (DSH) payment for Medicare and Medicaid was the next biggest threat. In 2014, under the ACA, each hospital will continue to receive 25 percent of its Medicare DSH payments, and the remaining 75 percent will be subject to a new formula based on the reduction in DSH payments, the percentage decrease in the number of uninsured nationally, and each hospital’s ratio of uncompensated care as compared with all DSH hospitals. Because DSH payments will decrease, AMCs will need to attract newly insured patients to make up for declining subsidies.

More than half of surveyed AMC leaders cited Medicare market basket updates as another significant threat to revenue. This threat includes reductions in the Medicare annual update factor of 1.1 percent in 2012, increasing to an expected 1.75 percent in 2019, with productivity adjustments. As the aging baby boomer population transitions to Medicare, Medicare’s share will increase. Teaching hospitals should plan to address their cost structure to maintain margins on Medicare payment rates.

Another major threat to revenue, cited as a concern by 53 percent of AMC survey participants, was the potential for state budget cuts. These cuts would affect not only patient care payment, but also operating budgets for public institutions such as AMCs. 

Forty-nine percent of respondents raised concerns about new funding models. For example, in trying to minimize costs, competitive accountable care organizations (ACOs) may be tempted to reduce hospital use and high-cost services. Bundling of services also could result in decreased use of inpatient hospital services. AMCs would need to demonstrate superior outcomes on cost and quality to have ACOs consider outsourcing patient care to them. 

The Way Forward 

Five strategies can help AMCs overcome the financial and operational challenges they face and put them on the path to becoming more cost-efficient and profitable.

 Make faculty responsible for cost and quality. The size and complexity of AMCs makes them unwieldy. Structural issues—multiple layers of oversight, siloed organizations, and varied, yet interdependent, missions—compound this challenge. Eighty-five percent of the AMC leaders surveyed indicated that governance issues already make it difficult to carry out their mission. 

Some AMCs have weak cost controls, especially in research and education, leaving them poorly positioned for a shift to new, quality-based payment models. Three out of four AMC leaders said they planned to address funding and revenue challenges by improving quality and focusing on outcomes (see the exhibit below). 



Quality and price-of-care variability are another issue. ACOs and other entities that share in cost savings achieved generally require price standardization, yet treatment prices can vary by as much as 200 percent among hospitals affiliated with the same AMC. 

 End the culture of isolation. Medicine seemingly has bifurcated between community hospitals that offer primary and secondary care and AMCs that provide tertiary and quaternary care. However inexact this distinction is, it can foster an isolationist culture that closes AMCs off from a large number of potential patients. 

Such a culture can be deadly in an environment that, through the ACO model, seeks to promote greater collaboration between high-quality, low-cost providers such as community hospitals and high-quality, high-cost providers such as AMCs. Achieving greater collaboration will require AMCs to consider affiliations with healthcare organizations that provide appropriate levels of care and broader patient populations for research. The opportunities are significant: The aforementioned PwC study also surveyed 1,000 consumers and found that three in five consumers (59 percent) said they are likely to seek treatment from a community hospital if it is associated with an AMC.

AMCs also face efforts by health plan sponsors to limit participants’ use of higher-cost providers through higher copayments for out-of-network services. Developing referral networks through acquisitions or partnerships with community hospitals can help to maintain market share and optimize revenue.

Strengthening access within a regional market is one approach; leveraging the brand to move outside that market is another. Mergers, acquisitions, and partnerships can help achieve the goal of broadening an AMC’s service reach, thereby increasing the pool of patients for research and treatment—especially if the AMC merges with a high-performing healthcare system that lacks select core competencies that only an AMC can provide. 

 Employ new kinds of extenders to increase effectiveness. Healthcare systems increasingly seek to extend care and education beyond their organizational walls, leveraging technology and innovative practices to alter teaching, accelerate research, and reduce the costs of care. 

With changing consumer expectations, providers now should come to the patient rather than vice versa, deploying healthcare extenders such as telemedicine, simulation technology, and shared services to change how they provide care. Sixty-nine of the AMC leaders surveyed said they are inclined to use these strategies as a way to expand their reach and generate cost savings.

Education also can be made more effective through the use of technology. For instance, some AMCs are using technology to bring students from different disciplines into the same classroom to extend team-based education, training them to work together at an earlier stage in their careers.

Telemedicine can both increase clinical effectiveness and help control costs. In Massachusetts, a telemedicine partnership permits an AMC’s physicians to remotely monitor and care for patients situated at partnering community hospitals. The specialists can care for nearly 50 percent more patients, decreasing mortality rates while also reducing costs. In one example of an AMC in Kansas, expanded telecommunications capabilities allow physicians and nurses to conduct virtual house visits. These visits enable physicians and nurses to coach patients through select tests and procedures and expand access to care in rural areas in cost-effective ways. 

 Maximize healthcare IT investments. AMCs have data-rich patient records. However, decentralized databases, multitiered silos, and lack of data interoperability make it difficult or impossible to share this valuable information, hindering operations, research, and collaboration and requiring significant time and resources to harmonize data. 

AMC leaders recognize the need to overcome these barriers. Sixty-five percent of the surveyed AMC leaders said they intend to collaborate with other medical centers or research institutes to share electronic health records (EHRs) over the next five years.

As AMCs deploy information and communications technologies, they should focus on using these technologies for analytics that support research and clinical care, which can generate significant returns. Data sharing is important not only within AMCs, but also across organizations. Currently, many EHR databases are available only to internal users. By enabling broader sharing of patient population clinical data, AMCs could foster greater collaboration around research and development. Further, data sharing could open up opportunities for partnership among AMCs for research grants and funding awards that provide incentives for this type of collaboration.

 Align research with business strategy. Pharmaceutical and life sciences companies are reassessing their business strategies and product pipelines in response to regulatory and market forces shifting the focus of payments from volume to demonstration of value. In addition, the 2012 Food and Drug Administration Safety and Innovation Act introduces greater incentives for antibiotics and rare-disease drug development through 2017. Not coincidentally, many companies and investors are taking a greater interest in translational research—finding practical applications from basic scientific findings. Sixty-two percent of AMC leaders surveyed say that coordinating translational research will be a high priority for their organizations over the next five years. As they follow this path, these organizations can capitalize on their existing strengths and develop transformational treatments. However, redirecting funding is only part of the solution. AMCs must start by improving communication between basic and clinical scientists, ensuring that the right people are speaking to one another. 

AMC leaders also should ensure that technology transfer offices, which typically take the lead in translating scientific research into marketable products, are led by those with corporate or venture capital experience. The business skills such executives bring can be important in helping to commercialize discoveries. They also can help these centers direct research funding to centers of excellence while avoiding potential conflicts of interest. 

That same experience can be especially helpful in developing collaborations with companies and industry groups. Such partnerships increasingly can provide needed research funding, especially in the so-called “valley of death” between the expiration of federal grants and commercialization. These partnerships also can provide viable channels for commercialization of intellectual property. The benefits for industry also can be substantial, with AMCs providing the patient data needed to advance new products through clinical trials.

Continuing to Fulfill Their Mission

The missions of education, research, and clinical care that AMCs fulfill in the United States are crucial to national health. Faced with continued financial, operating, and regulatory changes, AMCs that do not adapt their business model to emerging realities will find themselves with deteriorating finances, weakening capabilities, and growing institutional irrelevance. 

Strategies such as these can help AMCs as they seek to build a sustainable business model to replace outdated approaches, adapt to current and emerging conditions, and ensure their continued success. 

 Robert M. Valletta, FHFMA, CPA, is partner and U.S. healthcare provider practice leader, PwC, Boston, and a member of HFMA’s Massachusetts-Rhode Island Chapter. 

 Alicia Harkness is principal and leader, PwC’s education and academic medical center advisory practice, McLean, Va.

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