The Case for a More Strategic Financial Management System

Modern research universities are among the most complex institutions in society. Most have multiple colleges, with arts and sciences at their core, and include numerous professional schools teaching undergraduates and professional graduate students, with large research enterprises led by faculty who are training doctoral students. All endeavor to attract the most talented staff and students. They strive for excellence in everything they do and, as Howard Bowen described in his 1980 book, they spend every penny they have to do so; this reality has become known as Bowen’s law.

Today, many research universities are under stress, as external research funding and state support for public institutions have not kept pace with either inflation or the aspirations of faculty within established research universities or aspiring new ones. Institutionally reported data collected by the National Science Foundation show that university support is the fastest-growing source for research: in 2021, 25 cents on every dollar spent on research came from the home university. Except for several elite institutions, endowment support does not cover these expenses, so they must be subsidized by student tuition as a cost of students having research-active faculty as their teachers and mentors.

Research universities therefore face difficult choices in balancing their emphasis on research excellence with providing outstanding educations and outcomes for their students, all without inordinately increasing tuition. Simultaneously, pundits and politicians are accusing universities of lax cost control at best and dysfunction at worst. Driven by concerns about access, public confidence in higher education is at a low ebb. Research universities need strategic, intentional leadership to navigate these challenges.

The role of university leadership is to identify, in collaboration with the academic leadership, faculty and the governing board, the center of the university—the elements that are core to its mission, what establishes the university’s distinctive academic brand. And from this vantage point the leadership directs the university to strengthen its identity while continually testing the strategy against the changing world. This combination of strategically reinforcing and evolving the center and testing for relevance leads to the growing and sustainable excellence and impact that are required for an enduring high-quality research university.

Today, it is more important than ever that senior leaders articulate the center of a university, create a universitywide strategic plan and align the plans of individual schools with it. The plans must answer the questions of what kind of university you wish it to be, what it will be great at and what you do not want it to do. The ability of leadership to perform these functions is inextricably linked to the financial management system of the university, which must facilitate the implementation of the strategy. I refer to such a system as strategy-centered management, or SCM. I believe that strong strategy-centered management is superior to decentralized financial management systems that have been deployed in research universities over the last half century. I will present my case in the remainder of this essay.

Decentralized financial management systems are most often associated with the concept of responsibility center management (RCM) first implemented in the 1970s at the University of Pennsylvania and the University of Southern California. The essential concept in RCM was to move management and budget decisions away from central authority—presidents and provosts—to deans of schools. Begun before the availability of vast amounts of operating data from modern enterprise systems, RCM pushed decisions down to the deans who have responsibility for both revenue generation from tuition and research and expense control. Controlling costs was a key motivation, understanding that Bowen’s law would be operating locally. In RCM, allocations to schools are based on formulas, and revenue generation and central functions, such as student services and university administration, are funded by taxes on the schools.

The need for decentralization also was driven by the changing funding models for medical schools, where the growth of research support from the National Institutes of Health and clinical revenue led to staffing models dominated by the “sod money” from these sources. RCM cut medical schools loose from central budgeting. Inside Higher Ed’s 2011 survey of chief business officers found that 48 percent of private doctoral universities and 21 percent of public ones used RCM. I suspect these proportions are higher today.

Before the 1970s, essentially all institutions were budgeted centrally, with presidents and provosts playing pivotal roles in revenue allocation. In a centralized system, schools and units prepare annual budgets, and provosts and presidents then make resource allocations based on availability of funding and priorities. The pressure for excellence invariably leads to more requests than available funding, so gracefully saying no is an art practiced by successful leaders. RCM was created partially to free leaders from this responsibility.

One of the other heralded virtues of RCM is catalyzing revenue generation by entrepreneurial schools, especially by enhancing tuition revenue. Systematic studies of whether this has actually occurred are scarce. Perhaps the most rigorous analysis is by Ozan Jaquette, Dennis A. Kramer II and Bradley R. Curs, who evaluated the impact of RCM on tuition revenue at four public institutions. They found moderate evidence at three institutions that growth in tuition revenue could be associated with RCM and no evidence at the fourth. The results are far from overwhelming.

There certainly are counterexamples; Boston University’s online M.B.A. program was created by our Questrom School of Business operating in the SCM system. It is entirely feasible to incentivize schools and colleges to develop new programs for tuition growth without instituting formulaic budgeting and decentralized management across the university.

Another, more subtle reason for the growing popularity of RCM may have to do with the ever-shortening tenure of university presidents, especially at state research universities, where the median time in office is now five years for doctoral institutions, according to the most recent American Council on Education presidential survey. Because the president is not central to the formulaic budget decisions in RCM, the frequent changes in leadership are more easily accommodated.

But there are negative consequences to RCM. A severe one is that, while pushing resource decisions to the schools may reinforce disciplinary excellence, it drives fragmentation of the university, making interconnections more difficult. The extreme result is to manage the university as a holding company.

James Duderstadt, the superb president emeritus leading a decentralized system at the University of Michigan, observed in Fixing the Fragmented University (Jossey-Bass, 2006) that “the comprehensive university is managed effectively as a federation. The university administration sets some general rules and regulations, acts as an arbiter, raises money for the enterprise, and tries—with limited success—to keep activities roughly coordinated. But rarely does the university find strong vision or leadership from the top.”

The last sentence is the most prophetic. University planning—both centrally and within each school—is an essential element in today’s world. Importantly, the plan should be implemented with dogged focus on annual operations and with progress measured against agreed-upon metrics. This requires leadership and centralized decision-making. Aligning resources with strategic objectives requires control of expenses across the institution and the allocation of reserves generated from operations for strategic objectives. This process is best achieved by a hybrid financial management system that blends 1) centralized budgeting of revenues and expenses for core activities 2) with revenue-sharing with schools on noncore activities, but still with strong expense control and 3) a focus on funding priorities that cross school boundaries and that interconnect the university.

The last feature involves a recognition that many of the important challenges and opportunities facing research universities (and universities in general) cannot be addressed or solved by a single school or discipline, operating in an organizationally fragmented institution. This point is clear if a university leader asks themselves the following five questions.

1. Undergraduate education today is more interconnected than ever, with new interdisciplinary degrees, joint degrees and minors increasing in importance and spanning across the professional schools. How do we make it seamless for students to design educational experiences across our entire university?
2. The same is true for many of our faculty members, who increasingly do not fit well in the traditional disciplinary units. How are research universities best organized, managed and budgeted to attract and retain such talent?
3. Most of the grand challenges facing society don’t align with single disciplines. How are decisions made on which initiatives to support, how are these initiatives organized for maximum impact and how are resources allocated to execute these decisions?
4. Universities are facing the reality that they cannot afford to compete effectively in research in every discipline. How and by whom are choices made? How do these choices affect resource allocation?
5. How does a university develop a strategy for online education and avoid the inefficiencies of having multiple units that produce and service these programs? Will an effective universitywide organization work? Can the university avoid creating special academic units staffed by adjunct faculty?

The development of RCM in the 1970s did not anticipate these questions. It imagined schools as separate academic entities within the university. In addition, research on interdisciplinarity that began in the ’70s, along with RCM, never considered the impact of the financial management system on the success of universitywide initiatives, taking for granted that disciplinary guilds held primacy over any attempt at interconnections. An SCM system supports a more tightly integrated, less fragmented research university, with much more porous academic boundaries.

The choices for leadership organization and financial management system are more important for an institution that is purposefully working to change its profile, growing in stature and influence. Boston University, where I served as president for most of the past two decades, has purposely worked to enhance its position as a leading research university, and our implementation of SCM has been at least partially responsible for our success.

Here are some examples. Using the resources generated by SCM, we greatly expanded need-based financial aid for undergraduates by increasing aid at an annual rate double our increase in tuition. Twenty percent of our first-year students are now Pell Grant recipients. We created a modern general education program across all 10 schools involved in our undergraduate program and expanded student services to enhance student success. New universitywide research thrusts have been developed involving faculty from across the university. At the same time, we have addressed deferred maintenance and the demand for new facilities and built the university’s balance sheet (our Moody’s credit rating improved from A3, upper medium grade, in 2004, to Aa3, high grade, in 2023).

Necessarily, financial performance has driven our progress. Our budget discipline has led to best-in-class free cash flow margin, averaging 8.4 percent over the last five years, compared to a median of 1.8 percent for a peer group of private research universities. The reserves generated as free cash are reinvested strategically or set aside as financial ballast.

A final example that demonstrates the power of SCM has been the creation of the universitywide Faculty of Computing and Data Sciences, a faculty unit reporting to an associate provost and composed of faculty with full-time appointments in FCDS, as well as faculty from across the university with split appointments. This novel organization recognizes that machine learning, artificial intelligence and other data sciences are having a pronounced impact on our society and must be integrated into essentially all disciplines, so that a universitywide strategy is required. FCDS already has more than 40 faculty members. Its creation and other initiatives for interconnecting academic disciplines would have been extremely difficult or impossible without the SCM system supporting academic leadership and resource allocation.

The result for Boston University has been a decreased applicant acceptance rate (11 percent for fall 2023) and increased applicant yield. External research revenue topped $650 million last fiscal year, more than a twofold increase since 2005, when I assumed the presidency. And with the external recognition of our progress has come increased philanthropic support; cash giving topped $270 million last fiscal year, 3.5 times what it was in 2005.

I have no illusion that this short essay will motivate anyone to change their financial management system. Doing so is an enormous shift in process and culture. Several authors have quoted Machiavelli when considering such an undertaking: “It must be considered that there is nothing more difficult to carry out, nor more doubtful of success, nor more dangerous to handle, than to initiate a new order of things. For the reformer has enemies in all those who profit by the old order and only lukewarm defenders in all those who would profit by the new order.”

I do hope that this essay will have you question whether your financial management system is reinforcing your strategic intent. Or perhaps it will motivate you to think about leadership during a time of extraordinary transition for higher education. Besides the organizational changes inferred, SCM implies a particular type of university leadership—one that interacts with all the stakeholders but that does not shy away from making difficult decisions.

When writing about strengths and weaknesses of centralized and decentralized financial management systems, John Curry, one of the founders of RCM, and his co-authors Andrew L. Laws and Jon C. Strauss said this about centralized systems: “When base allocations are appropriately managed, the model putatively puts a very large steering wheel in the hands of senior leadership: the sum of all unrestricted revenues. The ability to steer the university toward central priorities is apparently maximized and funding of multidisciplinary activities is relatively simple.” Isn’t this exactly the approach needed to create a cohesive, strategically directed research university that is going to thrive in the decades ahead?