Perilous Times

Clayton M. Christensen and Michael B. Horn write about why they stand behind their analysis that many private colleges are in trouble.

April 1, 2019
 
Green Mountain College, which is closing
 

In New England, where we live, small private colleges have felt the chill of winter. Nearly every week brings the news of another college closing or looking to merge.

That’s brought renewed attention to the predictions we’ve made that a spate of colleges are likely to fail -- meaning close, merge or be acquired, or declare bankruptcy -- in the years ahead.

We’ve admittedly played with those predictions over time -- from suggesting that 25 percent of colleges would fail in The New York Times in 2013 to one of us, Clay Christensen, making more casual predictions in front of audiences where he has said that 50 percent of colleges would fail. The predictions have predictably generated some animosity and rolling of eyes. But it’s also prompted some college and university presidents to tell us in public and private settings that they think the 50 percent failure prediction is conservative -- that is, the number of failures will be far higher.

Either way, the varied responses bring to mind something Clay Christensen often tells his students: you might not like gravity, but gravity doesn’t care. Many colleges are in trouble. And they are not in trouble because we are saying so.

Nor are they in trouble primarily because of disruptive innovation. Many have mistaken our predictions for claims that online learning will be the most significant factor in sending colleges and universities to their ruin.

That’s understandable. We’ve made careers out of explaining the power of disruptive innovation -- a type of innovation that improves over time as it enables a whole new group of people to consume a service that, thanks to technology and an innovative business model, is now more affordable, convenient and accessible than existing offerings.

But the real challenge facing many colleges and universities at the moment is that their business model is fundamentally broken. “Business model” isn’t a popular phrase in higher education, either, but all colleges have one. When we use the term, we are referring to the revenue that an institution must take in to support the resources and processes it uses to deliver on its value proposition.

Many colleges and universities are increasingly unable to bring in enough revenue to cover their costs.

The average tuition discount rate at private colleges was a whopping 49.9 percent for first-time, full-time freshmen in 2017-18, according to the National Association of College and University Business Officers. That means that students are paying roughly half of what colleges and universities say they charge. A tuition discount rate above 35 percent puts a college in a danger zone, particularly when it is heavily dependent on tuition. Many institutions have discount rates far above that now.

Fund-raising and endowments don’t offer much hope to bring in the necessary amount of revenue for most schools, either.

Although the total amount of alumni giving to universities is up -- it ticked in at $11.37 billion in 2017, which was up 14.5 percent from the year prior -- the number of alumni who give has actually fallen. Fewer younger donors give. Only 5 percent of alumni from public universities donate, and just 18 percent of private university alumni give.

What that means is fewer people are giving bigger gifts. And, with certain exceptions from which it’s dangerous to extrapolate, most of those gifts are going to the well-off elite institutions that are not at risk.

On top of that, just 11 percent of colleges and universities hold roughly 75 percent of the $500 billion in endowment wealth in the United States. That means most institutions don’t have substantial endowments that can support their costs over time -- and many endowments have significant donor restrictions on how they can be used. In other words, the limited dollars in many endowments may not be able to support a college’s most urgent needs.

What makes this even worse is that the natural pressure in higher education is for costs to increase -- thanks to the lack of economies of scale and the complexity of higher education operations. A major reason for the complexity of those operations is that many colleges and universities have multiple value propositions with multiple business models for multiple stakeholders. Managing that complexity has driven up the cost of administrative overhead over time.

The net impact is that today, according to Moody’s, at least 25 percent of private colleges are running deficits. At public colleges, even in a good economy, expenses have outpaced revenue the past three years. And Moody’s examines only the stronger players in higher education -- the 500 or so that issue debt through the public markets.

In addition to grappling with crumbling business models, demographics are beginning to hurt traditional colleges and universities as the pool of 18-year-olds is starting to decline. Carleton professor Nathan D. Grawe forecasts that there will be precipitous declines in certain regions beginning in 2026.

This will only make things harder on colleges.

First, in the competition to attract students, colleges and universities will continue their arms race. For many, that will mean adopting copycat sustaining innovations -- more faculty, more extravagant facilities, more administrative positions -- that add cost. But this will further strain their business model, because they are already struggling to bring in enough revenue from a mixture of tuition, government funding, endowment returns and donations. For those institutions that are largely dependent on tuition for revenue and have small endowments, they will be in big trouble.

Second, for those that can’t keep up and those that experience enrollment declines, their large fixed costs -- thanks to tenured faculty, debt payments associated with financing their many buildings, and associated building-maintenance costs -- place them in peril without an easy ability to adjust.

Against this backdrop, it is true that the emergence of the first disruptive innovation in education since the printing press -- online learning -- will also play a role as more students enroll in online learning experiences. The full impact of disruption in higher education will take at least a generation to be felt, however, not overnight.

Still, there is evidence that the disruption is taking hold. Even as enrollments in accredited colleges and universities have shrunk consistently since 2010, enrollment in online learning continues to rise. Nearly 20 percent of students are now enrolled in a mostly online program. And many students enroll in unaccredited online programs, as well as last-mile blended-learning boot camp programs, which are not counted in these statistics.

As New Englanders can attest, colleges are visibly feeling these forces. According to Moody’s, private college closures have doubled from their historical rate and are on track to keep rising. Mergers have more than doubled this decade from the one prior.

But the predicted failures are not a fait accompli. Our careers haven’t just been focused on explaining the power of disruptive innovation, but in helping established players solve the innovator’s dilemma and innovate successfully. Colleges and universities can innovate to not just survive but thrive.

Several have done just that.

Led by President Paul LeBlanc, Southern New Hampshire University, once a small, troubled private college where Clay Christensen served on the board, established a new business model powered by online learning and unencumbered from the traditional campus-based model to grow the university into one of the largest in the country.

Simmons University, also in New England and also once on the brink of failure, has established thriving online programs in social work and nursing.

Other traditional brick-and-mortar colleges have the opportunity to carve out a specific focus around a meaningful “job to be done” -- the progress that an individual is trying to make in a particular circumstance -- in the lives of its students.

One of us, Michael Horn, is currently writing a book titled Choosing College on this topic. The essence is that if a college focuses on delivering on one job to be done, it can become more efficient. If a college tries to do lots of “jobs” for lots of people, then an organization’s processes become complicated and overhead costs soar.

Delivering on an in-demand job to be done also allows organizations to charge premium prices that people are delighted to pay -- which has the potential to solve the business model challenges facing colleges and universities.

By way of example, places like Olin College and Babson College in New England each seem to be delivering on a meaningful job that critical numbers of students are prioritizing. Students have specific project-based experiences and therefore have confidence that they will leave as an accomplished engineer or entrepreneur.

Innovation, of course, isn’t a guarantee. Many small colleges are in dire straits.

But standing still, avoiding innovation and trying to be many things to many people is a nonstarter. We look forward to many individual colleges innovating, defying the odds and proving our predictions wrong.

Bio

Clayton M. Christensen is the Kim B. Clark Professor of Administration at the Harvard Business School. He co-founded the Clayton Christensen Institute with Michael B. Horn, who is a distinguished fellow at the institute and a senior partner at Entangled Solutions.

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