Business issues

Wanted: A Dependable Backer

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With states supporting a smaller share of public universities' budgets, should the federal government step in?

From Modernist to Modern

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At meeting of campus planners, 2 colleges describe cost-effective efforts to transform outmoded libraries into vibrant centers of campus activity.

About Face?

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Trustees at financially struggling Birmingham-Southern turn to retired general and banker to lead hoped-for recovery.

Community College Venture Sold

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Princeton Review unloads business line that delivers academic programs to two-year institutions seeking to build enrollments.

So You Say You're Broke?

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Hearing that the University of California system had $2.5 billion in “unrestricted net assets” on hand in 2010 could make anyone question the necessity of the 32 percent tuition hike that has been proposed, or the 11 to 26 furlough days that more than 100,000 employees were forced to take in 2009.

Entrepreneurship vs. Scholarship?

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Trying to wring revenues from research poses risks to academe, one scholar warns.

Slow Growing

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For third straight year, average tuition at private colleges and universities will increase less than pre-recession, but again outpaces inflation. Institutional financial aid continues to grow.

U. of San Francisco changes how it assesses academic programs

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New programs at University of San Francisco must fit "mission," but deans are using more sophisticated tools to show they can make money, too.

Finding One's Way By Losing It

As colleges across the country prepare to launch a new academic year, our normal anticipatory excitement is tempered by the cascading consequences of the prolonged recession. At the same time that mushrooming financial exigencies have forced colleges and universities to shrink budgets and temper their ambitions, at least temporarily, the economic turmoil has savaged our sense of order and predictability. “Uncertainty sometimes seems our only certainty,” President Drew Faust of Harvard told alumni in February. She added that “discipline and sacrifice” will be required to weather the financial crisis.

Indeed, for many of us, the exhilaration of certainty has given way to the weariness of worry; optimism has been overcome by doubt. It’s no wonder we feel bereft, even dazed and confused. Where are we headed? How can we regain our bearings?

Such questions recall the Buddhist story about a man on horseback galloping past a monk. “Where are you going?” yells the monk. The man replies, “I don’t know -- ask my horse.” In recent months we too have often felt that we’re riding on a runaway horse. We struggle to sort things out, to understand the complex causes of our sufferings. Yet uncertainty prevails -- even among the supposed financial experts. Who knows what the next six months or two years will bring?

It’s quite natural for people to feel perplexed -- and perhaps even paralyzed -- by the extraordinary circumstances that have converged to disorient and dishearten us. Despair is the absence of hope, and many people are despairing.

But despair will not get us very far -- just ask Chicago Cubs fans. Yes, lamentation has its place, but it’s not enough to bemoan our situation: we need to move forward. Trauma can be a great teacher. The economic crisis is beginning to reveal fresh opportunities to those bold and creative enough to seize them. For example, there is already considerable discussion taking place about compressing the typical undergraduate college experience into three years rather than four. The imperative need to reduce expenses, reassess priorities, and generate new sources of revenue will be healthy to the extent that our colleges emerge from this latest fiscal crisis leaner and more nimble.

Retrenchment, in other words, can lead to unexpected advances. Consider, for example, the panache displayed by the World War I French officer who reported to headquarters during the Battle of the Marne: “My center is giving way, my right is in retreat. Situation excellent, I am attacking.” Today, however, our enemy is more elusive. It’s not so much an advancing army as it is a stalemating fear. How do we deal with the unknown depth and duration of our economic malaise?

One option is to do nothing, to wait for clarity and direction. Another is to lash out against the people and forces that have caused the financial meltdown. A more constructive choice is to acknowledge that life sometimes poses mysteries to be embraced rather than problems to be solved. At times we attack uncertainty by leveraging the power of the unknown, as often occurs in the martial arts. On other occasions, we confront the unknown in an effort to absorb its energies. Out of the roiling darkness may come beneficial light. That is the theme of a provocative book with an intriguing title by the cultural essayist Rebecca Solnit. It's called “A Field Guide to Getting Lost.” The book’s lucid, lean narrative trumpets the counterintuitive notion that we occasionally benefit from being lost.

To never to have been lost, Solnit says, is never to have lived. Echoing the Jewish tradition at Passover of leaving a door open overnight for the prophet Elijah to visit, Solnit urges us to “Leave the door open for the unknown, the door into the dark. That’s where the most important things come from, where you yourself came from, and where you will go [in the end].” Solnit reminds us that it is important to remain open to chance and the unknown, for it is only by relinquishing certainty that we approach the divine.

There is, in other words, great value in exploring the unforeseen -- and in remaking ourselves in the process. The financial crisis has led all colleges to initiate or renew focused reassessments of their mission, their structure, their vision, and their constraints. Such exercises on many campuses have become more participatory because of the seriousness of the situation. That is a good thing. All campus constituents have both a direct stake in the dialogue and vital contributions to make to it; only a shared sense of responsibility -- and an unconventional willingness to reassess priorities and examine all options -- will enable many colleges to weather the storm and emerge even stronger by sharpening their focus. At Cornell University, for examples, 20 task forces have been created to “reimagine Cornell.” As Provost Kent Fuchs recently acknowledged, the streamlining process may have been prompted by budget cutbacks, but it has become an opportunity for institutional improvement: “It’s very scary, but there is a lot of freedom to think creatively.”

At Cornell as well as many other campuses, people are asking truly strategic questions: Can unnecessary or mediocre programs and activities be cut back or cut out? What innovations might be spurred by the crisis? In other words, frugality and caution are not enough. The disorienting exigencies of the recession will be truly beneficial to the extent that they embolden campus communities to make hard decisions and consider fresh ideas and approaches that have been postponed too long.

While economic chaos and confusion beckons, clarity awaits those colleges and universities that transform the financial crisis into a catalyst for creativity -- and courage. By tapping the energies of shared sacrifice and the opportunities for revitalized innovation, campus communities can harness uncertainty and redirect its inertia. Somewhere amid the murkiness of our economic dilemma lies the opportunity for new discoveries, clarifying insights, and the impetus for streamlined performance. As Winston Churchill observed, “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”

So let us resolve to traverse the unmapped territory of our future not with gloomy foreboding or unspoken terror or vengeful rage but with eager anticipation for what good and unexpected things might emerge from the unknown and unfamiliar. By embracing the mystery of uncertainty, we will find its own forms of beauty and energy and coherence -- and we will discover in ourselves the ironic capacity to be renewed and even transformed by the shock of insecurity.

David E. Shi
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David E. Shi is president of Furman University, in South Carolina.

Breaking the Cost Spiral

In 1980, Howard R. Bowen’s revenue theory of cost was put forth to explain the financial trends of higher education. The basic idea was that colleges and universities will spend everything they have, so if you increase their revenue, you should expect their costs to go up too, creating a spiral.

In the decades since, we have witnessed the implications of this theory. It has now become apparent that American higher education has an insatiable appetite for more money; it is a black hole that cannot be filled.

Colleges are referred to as “cookie monsters” who “seek out all the resources that they can get their hands on and then devour them” (the higher education scholar Ronald G. Ehrenberg) and to “compulsive gamblers” for which “there is never enough money to satisfy their desires” (the former Harvard University president Derek Bok).

The main reason for this is that competition in higher education is based on reputation. The nonprofit status of most institutions of higher education and the principal agent problem (the fact that you typically don’t know that those you’ve hired aren’t acting in their own interests instead of yours) also contribute to the problem.

Spending and Reputation, a Costly Competition

The academic literature shows that when people don’t know the true quality of something, they tend to rely on the reputation of the supplier. For prospective students, it is virtually impossible to know the true quality of an undergraduate degree: the student purchases the service only once, participates in the provision of the service, the service provided is a capital asset, there is no secondary market for degrees, and the value of the degree may not be known for years after it is purchased.

If students and the public were certain about academic quality before they attended or donated to an institution, they would have no need for reputations. But because they are uncertain about quality, they rely on reputation. Knowing this, colleges compete based on reputation.

Unfortunately, this reputation-based competition contributes to the revenue-to-cost spiral because more spending is helpful in improving a reputation. The direct relationship between expenditures per student and reputation is demonstrated in Figure 1, where spending per student is on the vertical axis and the U.S. News & World Report “reputation” score is on the horizontal axis.

The figure clearly reflects the public’s perception that “price is a prior indicator of quality.” In effect, reputation competition becomes a race to spend as much as possible per student, since expenditure is a proxy for quality.

As reputation increases, the institution receives more funding from donors, grants and research contracts. The institution is less dependent on tuition, it has more diverse revenue sources, and it is wealthier.

Source: IPEDS, U.S. News & World Report

Thus we observe an untargeted “pursuit of excellence” as colleges strive to be the “very best that they can be in almost every area of their activities.” Over all, the colleges’ behavior is best understood as “prestige maximization.

Nonprofit Status

Costs at nonprofit institutions are capped by revenue. While they cannot run chronic deficits, nonprofits exist to provide as much service as possible, and internal constituents can always find ways to use financial resources. Therefore, nonprofit institutions spend all the revenue they have, implying that when revenues rise, costs rise. Among colleges and universities, any increase in student ability to pay lifts the lid on revenues and costs follow.

The Principal/Agent Problem

The principal/agent problem is capitalism's Achilles heel; it exists whenever one group makes decisions supposedly in the interest of another group. As an example of the problem, suppose your car is broken. When you (the principal) take your car to a mechanic (the agent), you would like to get it fixed at the lowest cost possible. But the mechanic is better off if you spend more money, giving him an incentive to recommend unnecessary repairs. In this and many other instances, there is a difference between the actions the principal would like to see occur and the incentives of the agent to actually take those actions.

The problem in higher education arises because the interests of faculty members, administrators, and trustees (the agents) are not the same as the interests of students, parents, alumni, donors, and taxpayers (the principals). Since the agents make the decisions, they can pursue their own self-interest rather than the principal’s interest. The problem is well-known among professionally managed for-profit firms, despite the many constraints on agency abuse in the capital markets. Comparatively, there are few constraints on agency abuse in higher education. P/A problems always result in costs that are higher than necessary, contributing to higher education’s dismal cost control record.

How to Break the Spiral

The combination of quality uncertainty (and therefore competition based on reputation), nonprofit status, and the P/A problem leads to a persistent revenue-to-cost spiral. Because the spiral consumes any new funding, it undermines attempts to improve college access. Therefore, establishing effective cost control ought to be a prerequisite for any increase in higher education funding designed to improve access.

Fundamentally, the revenue-to-cost spiral will not be broken until uncertainty about college quality is reduced. This uncertainty leads to competition based on reputations, so larger expenditures are always in the institutions' interest under quality uncertainty. However, if output measures (by which we mean the value they add through teaching and research) were designed, the focus of competition would shift from its current reliance on reputation and prestige (who can spend the most) toward the more beneficial type of competition based on who provides the greatest value (who can produce the most value added education per dollar).

While reducing uncertainty about quality is essential, there are a number of complementary reforms that could also help break the revenue-to-cost spiral. Accreditation currently suppresses innovation and restricts competition, largely because the accreditors have been “captured” and now promote the interests of the institutions they are supposed to be regulating. Reform could correct these undesirable tendencies.

Moreover, the principal/agent problem can be addressed by improved transparency regarding the source and use of funds and operating policies such as teaching loads and staffing ratios. Before institutions can align teaching incentives, they must undertake serious studies to measure teaching productivity; once this is accomplished, professors can be rewarded for the quality of their teaching instead of just the quality of their research.

Lastly, institutional constraints could be strengthened by reforming governance arrangements and providing financial and other disclosures so that the media and other watchdogs could provide more oversight.

Robert Martin and Andrew Gillen
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Robert Martin is an emeritus professor at Centre College and author of numerous works on the economics of higher education. Andrew Gillen is the research director of the Center for College Affordability and Productivity.


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