Double, Double Toil and Trouble
As someone who has worked in senior financial management positions for over 30 years in higher education, I can confidently state that in 2024, there will never be a more challenging time for colleges and universities, particularly those that are highly tuition-dependent for most of their revenue.
Now that I am continuing my career as an independent consultant who takes on interim CFO positions at colleges and universities, I am challenged every day to help those institutions find a way to increase their net tuition revenue and draw from a pool of potential students that is about to shrink very rapidly due to the phenomenon known as the “demographic cliff.” And when you add in the fact that students, families, and society at large are questioning the value of college education, our higher education institutions are really facing an existential threat if they are unable to find a value proposition to attract potential students from a shrinking pool.
The ultimate question has become, “How does an institution put together a portfolio of programs that will attract students who are willing and able to pay for an education that will provide the knowledge and skills needed to demonstrate their value in the labor force and become well-educated and productive citizens?”
Markets and Margins
Fortunately, we now live in an era where not only is there an abundance of internal and external data to help us consider a broad range of potential program opportunities but also sophisticated mathematical tools to perform the analysis and assist with making data-informed decisions.
Colleges and universities must fully understand the markets they compete in, student demand for programs, and labor market demand for graduates of those programs. Ultimately, it is necessary to understand the financial contribution (margin) of new and existing programs to the bottom line of a college or university to sustain the institution’s financial health. For this last item, Gray Decision Intelligence has developed an approach called “program economics” that provides an effective method for analyzing, calculating, and comparing program revenue, program costs, and, thus, program margin.
The idea of using program economics rather than traditional budgeting by department is one that can take many college and university faculty and administrators some time to get used to. Traditionally, most colleges and universities are organized around academic departments and schools. Therefore, the idea of making financial decisions based on programs (which are based on student majors) can at first be difficult to understand and appreciate. However, once the community understands the concepts of program economics and how the calculations are performed, it becomes easy to see how the resulting data can be used to make much more effective decisions about the overall program portfolio of the institution.
Demystifying Program Economics
The fundamental principle of program economics is that revenue follows the student (major), and costs follow the instructor, not the department. Although this can make the calculations a bit more complicated and the data required more comprehensive, it does result in a very clear understanding of the contribution from any given program.
The methodology for calculating program economics is first to identify each student and their major and assign the tuition revenue (less any institutional scholarship or discount) for the student to each course she/he takes to arrive at a prorated revenue per credit hour for each course.
The second step is to calculate direct instructional cost by identifying the faculty, the courses they teach, the salaries and benefits for each, and the percentage of time they are teaching and not doing research or service work. This enables us to calculate the cost for each course that they teach.
The final step is calculating the direct instructional margin, which is simply instructional revenue minus instructional cost. This measures the amount of funds a program contributes to (or takes from) institutional funds.
It is important to note that, under program economics, indirect costs of the institution (e.g., administration, library, public safety, alumni affairs, etc.) are not assigned to individual programs but rather are treated as overhead of the institution. Even programs with a low margin are expected to help pay for the institution’s overhead. However, under a system like program economics, it is possible and even desirable to identify some high-margin programs to offset the cost of low-margin programs, particularly if those low-margin programs are important to the overall mission of the institution.
The Student-Centric Approach
In summary, the most important point to emphasize is the student-centric approach to program economics. Because the ultimate goal of the institution is to devise a portfolio of programs that will attract students, understanding the cost and revenue of programs on a per-student basis will enable the data-informed analysis to guide institutions in their portfolio development.
Powering Strategic Decisions with Program Economics Data
By performing a program economic analysis, an institution can derive invaluable insights and learn important lessons about putting together a total program portfolio that will enable it to draw more students, even in the face of fierce competition and a dwindling number of potential students. For example, it can help to identify opportunities to provide targeted scholarships for students that would entice them to enroll in courses with excess capacity. It can also help to identify programs that might be making money, but only at the expense of other programs. It will help to identify how faculty salary and benefits costs drive the cost of programs, particularly if faculty are doing a low percentage of teaching versus research and service activity. Courses that habitually have too few students or that duplicate course content in another department will be highlighted. Finally, combined with data on student demand and labor market demand for graduates in local and regional markets, it can help the institution identify large programs with high margins in growing markets and small programs that may have low margins but are in growing markets.
The Power of Program Economics
The most important point from this post is the power of program economics to provide financial sustainability to colleges and universities during this time of enormous financial, social, and political challenges to higher education. Utilizing program economics to make data-informed decisions about program portfolios can provide a demonstrated competitive advantage for colleges and universities.
