Focus on Net Revenue, Not Discount Rate

Contrary to common perceptions, the tuition discount rate isn’t a measure of institutional financial health on its own, Gregory Matthews writes.

May 20, 2022
 
 
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I can’t think of a metric that is more misunderstood and misused among college presidents, trustees, faculty and staff than the tuition discount rate. When a metric is commonly misunderstood in its purpose, it becomes almost useless.

Dispelling the Myths

What is the tuition discount metric? Why is it important and what does it really mean? Tuition discounting typically refers to the National Association of College and University Business Officers discount rate, which the organization defines as “the total institutional grant aid awarded to undergraduates,” captured as “a percentage of the gross tuition and fee revenue the institution would collect if all students paid the full tuition and fee sticker price.”

Each year, NACUBO reports results from its annual discount study. The latest report, just released this week, considers 359 four-year private colleges and universities out of approximately 1,660 private colleges in the United States. From 2012–13 to 2021–22, the national discount rate reported by NACUBO for first-year undergraduate students grew from 44.8 percent to 54.5 percent. That ratio is a good representation of the general population becoming less willing—and less able—to pay for growing college costs over time, but it doesn’t mean much more.

Universities often misunderstand and misuse the tuition discount metric by considering it to be an indicator of institutional financial health. But the tuition discount rate is not an indicator of financial health on its own, nor can it be used as a ratio to accurately compare colleges to each other.

Trustees, presidents, chief financial officers and others often think that rising discounts are bad and lower discounts are good, but this might not be true at your college, because a tuition discount rate is not the full picture of your finances. If we really think about it, on average, rising discounts are normal given the slow growth of family incomes and the comparatively fast rate of price increases at colleges and universities.

Discount Rates Aren’t Comparable Across Institutions

A few short examples can illustrate why we cannot rely on the discount rate as a way of comparing financial health and revenue. If two colleges have tuition discount rates of 50 percent and College A has tuition of $50,000 per year, and College B has tuition of $35,000 per year, we can easily see that College A has greater net tuition revenue per student, because 50 percent of $50,000 is $25,000 and 50 percent of $35,000 is $17,500. The 50 percent discount rate can’t be used to compare the schools, because the net revenue is not the same. If College A had a discount rate of 60 percent, its net revenue per student would be $20,000, which is still greater than College B at a 50 percent discount. The net revenue associated with a discount rate is dependent on the amount of tuition charged, meaning the discount itself is not a relevant indicator of financial strength on its own.

One of the most significant reasons that the tuition discount rate is the wrong metric for a college to use to determine financial health is that the NACUBO calculation does not differentiate between scholarships that are funded from a college endowment and those that are unfunded. The NACUBO definition treats them the same way for its discounting ratio. This is problematic because unfunded institutional grants and scholarships act more like a price reduction, while scholarships and grants funded by endowment income are real money directed to student accounts and act as revenue to the operating budget. For those colleges that can fully fund all institutional financial aid through their endowments, discounting means that low-income students (indirectly) pay into the operating budget in ways that are like full-pay students.

The following table illustrates how two colleges can have the same price, the same discount rate and very different net revenues if any portion of a discount is funded by endowment income.

 

College A

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College B

Tuition and fees

$50,000

$50,000

Room and board

$10,000

$10,000

Comprehensive cost

$60,000

$60,000

Total Institutional Grants and Scholarships

$30,000

$30,000

—Funded portion of scholarships and grants

$0

$12,000

—Unfunded portion of scholarships and grants

$30,000

$18,000

Discount rate

60%

60%

Net revenue from student

$30,000

$42,000

When college officials talk about reducing discount rates, they are saying they want to reduce financial aid provided by the college to students in order to increase net revenue. Because discounting represents institutional financial aid, fewer students would be able to afford going to a college that reduces discounting by too much. According to U.S. Census data, in households where people are 35 to 44 years old, roughly 19 percent have incomes of $180,000 or more. A family often needs to earn $180,000 or more to be in the full-pay-capable category at an expensive residential private college. That means that in any pool of students, there are approximately 81 percent who are less capable of paying. Access to education is important, and not just for the wealthy.

Net Revenue Is a Better Metric

When people talk about reducing discounts, what they are trying to say is that they want to increase net revenue. What can be done to increase net revenue at your school?

The following are solutions to consider for slowing discount rate growth and improving net revenue:

  • Engage with a company that does econometric modeling if you don’t already. There are several reputable organizations that do this work. Econometric modeling optimizes the financial aid needed to recruit a desired number of students from an admit pool. For example, if you typically have 3,000 admitted students and you want to have 700 net deposits in a first-year class, the model will tell you how to optimize your awarding to do that. If you want 750 students, the model will have to change, and you will likely decrease your average net revenue per student to get that increased number. If you already engage with a company that does econometric modeling for financial aid, don’t fight the system. Your market dictates what students will pay for what they think you are worth. If the econometric model gives you a net revenue per student of $28,000 per year to get 700 students, don’t expect to get 700 students for a $30,000 net revenue per student out of that same pool of 3,000 admitted students. It is often the case that having a slightly lower net revenue per student can bring in more total net revenue, and the econometric model can tell you that.
  • Focus on increasing graduation rates. The average graduation rate for private nonprofit colleges is 68 percent, according to federal data. Increasing graduation rates is one of the best ways to increase net revenue per student, because students who stay longer are subject to price increases and pay more over time. Also, when a college increases its graduation rate, that college does not need to have as many first-year students, and those students who require more financial aid can be accepted in smaller numbers. Furthermore, rankings are heavily influenced by graduation rates. If a college wants more affluent families and more academically talented students, it needs to show that it is worth the investment, and strong graduation rates demonstrate that.
  • Make endowment building for scholarships a top priority. This takes a while but is among the best financial solutions. If financial aid is a funded discount rather than an unfunded discount, it enhances cash flow no matter what your total discount rate is.
  • Invest in growing admission applications to enable the college to grow more selective in order to increase financial strength as graduation rates increase.
  • Reduce other expenses. In my experience, colleges rarely evaluate and reduce expenses, but they frequently add expenses without verifying if those expenses lead to students graduating with a degree or if those expenses support revenue generation. For example, if you have invested money in efforts to increase retention, and over time the retention rates are not increasing, you may have invested in the wrong activities and can either repurpose or remove that expense without much risk.

You may have noticed that I did not list finding more affluent people to recruit as a solution. Admissions offices are already recruiting affluent families. If you don’t now have a significant number of affluent people committing to your school, it is likely because your institution is not yet attractive enough for them when compared to other colleges. Affluent people can afford to be selective, and they are. For example, if your college has graduation rates that are significantly lower than those of your competitors, you won’t be as attractive to affluent families because your statistics are not good enough for them when compared to your competition. It is not about finding affluent families; it is about showing that you are a better option for them.

It is reasonable for colleges and universities to find ways to reduce costs and to increase available revenue. It is not reasonable for them to do that at the expense of their customers—the students. Rather than make the mistake of believing that your college gives away too much financial aid by discounting too much, look at the systemic issues that prevent you from having a better reputation and a stronger financial position by raising more funds for scholarships, increasing retention and graduation rates, and focusing on student success. Your value to students will then improve and so will your net revenue.

Bio

Gregory Matthews is vice president for enrollment management at Norwich University, in Vermont.

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