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OK, so it’s one thing to know what forces are driving tuition increases.  It’s another thing to know where money is being spent.   That is a problem of different proportions because universities do not report their spending in neat categories like

  • cost of scaling beyond capacity
  • making up for lost subsidies
  • cross-subsidies with loss leaders

And, as The Delta Project’s Jane Wellman is  fond of pointing out,  there is no category representing value that ends up on a student’s diploma.

It’s not a completely satisfactory approach, but you can look that the “Where does the money go?” in question in two ways.

The Accounting View

As I pointed out in a previous post, overall spending has not substantially increased — even as tuition has risen.  What has increased is spending in the following categories:

  • institutional grant aid
  • public service and research
  • energy
  • facilities
  • contingent faculty
  • residence hall operations
  • groundskeeping
  • online
  • admin
  • bookstore
  • general staffing
  • financial services

These are interesting categories because increases in these areas generally compensates for decreased spending in others.  Take contingent faculty, for example. Increased spending for part-time or adjunct professors compensates for an overall reduction in tenure-track faculty. Contingent faculty carry  a completely different cost platform.  In many cases health care costs can be trimmed by reducing the number of full-time faculty. adjunct professors do not require expensive startup packages. Capital requirements also change, because office and lab demands are not the same.

This brings us to a second way of tracking dollars: what behaviors result in large shifts in spending priorities.

The Behavioral View

Behaviors are interesting because you can imagine controlling them.  Here are the behaviors that institutions report as affecting their current spending priorities.

  • Making up for lost revenue
  •  Lost productivity
  •  Capital expenditures
  •  Cost of non-core activities
  •  Administrative bloat
  •  Giving it away
  •  Compliance
  •  Health Care and other costs of an aging workforce
  •  Unquantified “quality”
  • Overshooting markets like internationalization
  • Stealing revenue  from academic programs
  • Operational inefficiency
  • High cost of materials
  • inappropriate skills utilization

There are others of course.  Stanford president John Hennessey has recently pointed to labor costs tied to the professorate drive cost increases, but I can’t find anyone who will show me a price increase that is due to increased faculty costs.

I can find examples of capital projects where initial funding plans have collapsed. Few of these projects are drop-dead institutional requirements.  There are a fair number of vanity projects and many examples of non-core activities like athletic practice facilities or mixed-use facilities that were once thought be revenue-producing opportunities but for which a real market never materialized.  When funding profiles change dramatically, one response might be to re-evaluate the need for a new building, but that rarely happens.

This is a true money pit.  There are really only three sources of discretionary revenue: tuition, government allocations, and private gifts. One way to make up for lost revenue is to increase income from other sources.  In most cases, this means tuition.

Critics seem hell-bent to fabricate exotic reasons that college tuition is rising. “It is a market response to free-flowing federal dollars”, say some.  “It is a conspiracy,” say others. “Declining productivity!” say those who are convinced that college professors are overpaid and underworked.

The 2011 annual spending report of the Delta Project on Postsecondary Education Costs, Productivity, and Accountability — the last annual report issued by Delta before it sadly closed its doors last spring — makes it clear that easy answers are likely to be wrong:

There is much public discussion and concern over rising tuition but much less attention to the intricate relationships among tuition and revenue sources–particularly state and local appropriations in the public sector — and spending.

Take the issue of lost appropriations, for example. It is true that from 1999 to 2009 tuition at public research universities rose at a much higher rate (56%) than the 32% increase at their private counterparts.  These increases are almost entirely explained by the loss of state appropriates, as opposed, say, to increased spending.

All other factors are incidental. Nor does the rate of increase tell the whole story, because private universities are starting from a much higher base for their sticker prices the average dollar increase at the private institutions was three times that of the private universities.  The situation is much worse at public community colleges which have seen the greatest increase in enrollment. This is because, when it comes to tuition, even small changes in enrollment headcount have a big effect on prices. And that is where capacity comes into play.

Private universities have been able to keep their increases in check because they do not accept as many students as they could otherwise afford.  The increasing enrollment pressures have been absorbed by community colleges, and public masters and research universities. Students, who cannot afford to attend private institutions flock to quality public universities.  These are the very institutions that have not added capacity over the last forty years.

It is seductive but entirely false to think of higher education as a single sided market — that is, a system in which there is a supplier of goods and services to a customer who is willing to pay a price determined by the marginal cost of production.  That is not higher education.  Higher education is a multi-sided market, a collection of stakeholders with often competing interests and cross subsidies that make it difficult to determine fair pricing schemes.

Local newspapers were a multi- sided market,  in which extremely profitable classified advertising subsidized news, subscriber fees, and print advertising.  It was a system that worked well until Craig’s List came along an undermined the whole value proposition that supported local news.  The result was rapidly dropping classified ad revenue, rapidly increasing print ad rates followed by a corresponding drop in demand for print ad, and ultimately a cash crisis in which subscribers fled to other media for their local news.  Newspapers were slow to recognize that they were a three-sided market. 

Higher education is taking the same path, and that is significant because it helps explain why the lack of capacity in American universities lies at the root of cost increases.

Success in a multi-sided market is determined by platform success in which a single horizontal layer allows many stakeholders to share common services at a total cost that is less than the cost of offering those same services in a vertically integrated business.

A multi-sided business without a scalable platform eventually succumbs to the nonlinear costs of growth.  Not only do the various services have to work out pairwise agreements with the other services, but individual stakeholders must also do the same.  As the number of stakeholders grow the overall cost of providing services grows in proportion to the ad hoc arrangements needed to keep everyone happy.

Universities have not invested in platform scalability for at least the last fifty years. Their processes and structures are locked into a set of capacity assumptions that are falling by the wayside. And they are rewarded for growing in a market where students seeking value are fleeing lesser institutions for those that are already overcrowded.

The obvious losers are the second and third tier institutions who desperately need students.  These are the schools that offer the steepest discounts. So steep that they cannot sustain them without falling into the financial danger zone I have talked about before.

The other losers are the students who are driven to higher quality by increasing prices.  Which institutions are they?  They are the very universities which have not added capacity but which have incentives to continue growing.

It is growth that comes at nonlinear costs.  There are no easy ways for most institutions to subsidize or cross-subsidize those costs, so they are passed on to students.

Next:  Where does the money go?

What is Driving Up the Cost of College?“, asked the question that many outside and inside academia want to know the answer to — especially this time of year as families contemplate writing college tuition checks that over four years will top $200,000   According to a recent Pew poll, the majority of Americans believe that a college education is becoming unaffordable and want to know why. Facile explanations are easy to come by, but there are few that match the facts.

So what’s going on?  Much of the popular discussion of tuition increases is based on three  “facts” that  are not true.  They may be easy to toss off on editorial pages or cable talk shows, but they are myths.

Myth 1: The rate of college tuition increases is abnormally high.

If you listen to many commentators, college tuition is hyper-inflationary.  In fact, students at many public campuses have seen tuition and fees double over the last decade, and–as the stubbornly persistent effects of the recession strain family budgets–become increasingly unaffordable.

Affordability is a real problem and prices are on an unsustainable path, but it is not the case that we are in the middle of some hyper-inflationary bubble.

In normal times, tuition rises at roughly twice the rate of inflation.  From 1958-1996 that averaged somewhere near 8%.  For most of those years, the increases were offset by increased spending for financial aid and by general growth in personal income, which hid many of the most serious consequences of this rise in prices.

Recent years are different, some argue. Let’s take a look at that claim. Annual inflation for 2011 was 3.16%, but that actually understates inflation for the months in which trustees and legislative committees approve tuition increases. The  annual rate of inflation for the last three quarters of 2011 was just under 3.5%.

Private institutions  raised their prices last year, but the rate of increase was actually in line with inflation.   2011-2012 tuition increases at nonprofit private institutions averaged around 4%.  For-profits increased their prices  3.6%. When it comes to holding the line on prices, these institutions actually performed much better than historical trends.

Public universities raised their prices at the much more dramatic rate of 8.6%, 20% above historical highs of the decade 1992-2001.

In short, the only increases that are above historical highs are at public universities, but only by a relatively modest amount.

Myth 2:  Easy availability of Federally-backed student loans is driving tuition increases.

This is a myth with many political consequences, but there is very little evidence that it is true.

The theory behind this myth is that a free market will cause prices to rise in proportion to a market’s ability to pay those prices, and the widespread availability of federal loans affects a student’s ability to pay.  The often unstated political corollary to this theory is that the students who are least able to pay are also the ones who are least likely to complete their degrees and pay back the loans.

In reality, the part of the higher education market that has control over its prices has been demonstrably immune from any such affect.

Less than 40% of all Federal aid is in the form of student loans (the rest is used for Pell grants and merit-based support).  These loans are distributed to public, non-profit and for-profit institutions, but for-profits tend to get a disproportionately large percentage of these loans.   These are the institutions that have raised their fees the least.

The remaining loans are distributed to nonprofit and public institutions, but since non-profits have also had historically low tuition increases, all of the factors affecting tuition would have to be concentrated in the sector that has the least flexibility in setting its own prices — the public colleges and universities. And as we have seen prices when viewed as a multiple of consumer price increases have risen only 20% faster than historical averages at these institutions.

Public institutions cannot retain earnings, so costs would have to have risen in proportion to loan availability, but that has not been the case.  Costs at public universities have been constant for several years.

So why have prices increased? In fact, total state support for public institutions dropped 7.5% in 2011-12. The total increase in tuition can be attributed to making up for lost income. Federal loan availability may be correlated with tuition increases but there is no reason for believing it is a cause.

Myth 3: Tuition rises because of declining productivity.  Professors are earning more and teaching less.

Productivity is not easy to measure in academia, but one thing is certain: unproductive professors are not a contributing factor to rising tuition.

One popular measure is the average ratio of students to faculty in general education courses.  This number has risen significantly at public universities whose state budgets have been squeezed.  In many industries this would be the very definition of increased productivity, which would mean that rich professors are skimming the cream off the top of rising revenues.

That is not true.  Faculty salaries have been stagnant at public colleges for almost a decade.  Many large state institutions have resorted to hiring part-time or “contingent” faculty to satisfy increased demand, which further depresses average annual compensation.

Another  measure of productivity is the number of courses taught per semester.  This number has been on a slight decline for over a decade, which might indicate that prices are going up even as productivity is decreasing.

However, the decline in average teaching load has been most noticeable at schools that are building sponsored research programs.  As I have pointed out in prior posts, sponsored research seldom pays for itself, so a decline in teaching loads represents, not  a productivity decrease, but rather a shifting of costs from academic programs to another income producing activity but one which often fails to cover even its own costs.

Next:  Three Reasons that Tuition is Rising: Capacity, Capacity Capacity

Sometime last year — exactly when depends on whose data you rely upon — the debt total of American college students topped a trillion dollars, surpassing credit cards, second only to home mortgages as the major source of indebtedness for students and families.

The principle reason that students are taking on debt is a dramatic rise in the cost of attending college. I have used this chart on other occasions,  but it is still the most dramatic illustration of what has  happened to  college tuition over the last twenty years.

This chart stops at 2005.  From 2005 to 2012, tuition has risen at an annualized rate of 8%. It is a breathtaking climb, and it means that students (and their families) are turning to student loans in unsustainable numbers.

None of this is news.  It is fodder for cable TV talk shows, Presidential campaign speeches, and a considerable number of faux populist attacks on the very idea of a college degree. The Obama administration has even weighed in with a Race to the Top for Colleges initiative that focuses to a large measure on affordability.

Conservatives say that it is the ready availability Federally backed loans that a driving cost increases.  Progressives –including many who support the Occupy Wall Street movement — say that that a the same cultural factors that drove banking abuses are also driving the disparity between who can afford a college education and who can not.

There is little evidence that either statement is true and considerable evidence that neither are. I will return to this subject in a later post.

The first thing to understand about the rise in college costs is the difference between the cost of running a university — the spending side of the equation —  and the price paid by students. In higher education there are all kinds of prices.  There is the advertised or sticker price, which is what it sounds like. But sticker prices can be discounted, and there are also wholesale and retail prices.

For-profits aside, you would think that there would be a straightforward relationship between costs and prices since, after all, the name of the budget game in a university is to take in just enough revenue to offset the costs of operating programs and facilities.You would think, for example, that costs were simply passed along to students in the form of tuition and fees, which are components of the revenue side.

If that were true then rising tuition would be a result of rising costs.  Some costs, like healthcare, have risen dramatically, but the rise in tuition is for the most part unrelated to increased operational costs.

College costs are high and have been high for at least a hundred years. When Harvard President Charles Elliot began  to dismantle the university’s rigid core curriculum — replacing it with an elective system — in the late 19th century, he grew the size of Harvard’s faculty tenfold. It was a shock to Harvard’s carefully tuned financial model, but it led to even more dramatic growth in private giving, creating a sustainable system in which endowed funds are used to offset variable costs of operation.

Labor alone accounts for much of the variable cost of running a university.  That means, as James Surowiecki, pointed out in his recent New Yorker article:

In other words, teachers today aren’t any more productive than they were in 1980. The problem is that colleges can’t pay 1980 salaries, and the only way they can pay 2011 salaries is by raising prices

That, however, does not really explain why tuition has risen so dramatically. Faculty salaries have been stagnant for almost a decade. Furthermore, when measured as cost per degree awarded, universities are actually just as productive today as they were in 2005.

As Surowieki points out the “arms race” that causes universities to invest in bling could explain some of the increase, except that the rate of increase in those expenditures have been flat,  too. In fact spending in general has been flat.

So what’s going on?  Have universities been pocketing the difference between what it takes to run an academic program and what students are willing to pay? The only players in the higher ed game that have the ability to do that are the For-Profits and their 3.2%  tuition increases have been the lowest among all types of institutions.

This post begins a series that over the next couple of weeks tries to answer the “What’s going on?” question.  Part primer and part road map, the series continues next week with some of the facts you think you know about college tuition that are in reality not true.

Next: Three Myths about Rising College Costs

This has been a bad year for intercollegiate athletics what with the Penn State scandal and the unpleasant glare of publicity that has reflected onto big-time, big money sports.  In today’s commentary section of The John William Pope Center for Higher Education, I write about the ringers and rogues who help maintain the Knute Rockne All American fiction of college sports.

The interests of the academic and athletic programs in most Division I and many Division II schools are not aligned.  I propose a legislative solution: a “firewall” that separates the two:

What is needed to save intercollegiate athletics is a Glass-Steagall Act for universities… It gets universities out of the sports entertainment business—a very good idea.

The last time I checked on the financial health of colleges and universities the news was not good: in 2010 the finances at 150 private nonprofits were so fragile that they failed the Education Department’s test of financial responsibility.  The Feds provide financial aid to students who attend responsibly managed educational  institutions, so it’s not unreasonable for them to ask whether audited financial returns reflect sound management. The 2011 test results were released in late October.

What does it take to pass the test? The ability to meet current and projected debt obligations is a factor, but the heart of the test is a numerical score: DOE looks at a weighted composite of  three ratios:

  1. Primary reserves: Ratio of adjusted equity to total expenses, a basic measure of liquidity
  2. Equity: Ratio of modified equity to modified expenses, an indication of an institution’s ability to borrow (modifications include things like one-time charges, allowances and extraordinary events)
  3. Net Income: Ratio of  before-tax income to total revenues, a  basic measure of profitabilty (incongruous for a non-profit but even the purest non-profit institutions do not like to deplete their cash positions)

A composite score of 1.5-3.0 indicates healthy finances. 1.5 is a passing grade.  Anything  less than 1.5 is not a passing grade.

A  score in the range of 1.0 to 1.4 — which DOE calls the zone — indicates a need for additional oversight.  This is a sore point with colleges– many of which would howl to high heaven if a Wall Street bank raised the same objection — who decry the bureaucratic heavy-handedness of a federal agency that would want to impose a modicum of accountability.

Anything below 0.9 is a failing score, and to continue receiving Federal Student Aid, a failing institution must supply additional letters of credit.

More than 180 private non-profits scored below 1.5 and 56% of those scored below 1.0.  A complete spreadsheet can be found here. Mind you, this is not the ragtag collection of colleges of cosmetology that populate the for-profit component of the DOE report. I’ve stripped those out of the spreadsheet. They are in awful shape too, but federal student aid to a future hair stylist never made much sense to begin with.  More on this in a later post.

No, the non-profits tested by the Department of Education are mainly liberal arts colleges, schools of design, independent schools of medicine and law, and denominational institutions (many with important historical roots).  They are in many ways the same schools whose free-wheeling approach to financial management gave John D. Rockefeller and Andrew Carnegie fits when they established the first philanthropic foundations to support higher education in the early 1900s.

By FY 2010 the stock market had begun to recover and endowments had started  to regain some of their lost value. The expectation was that the DOE scores would reflect an improving fiscal outlook for the nation’s private institutions. That obviously did not occur.

In most circumstances, these numbers would need no further elaboration.  In fact, news of the dismal  2011 report appeared  in Inside Higher Education and The Chronicle of Higher Education back in October. It was a press release issued by the National Association of Independent Colleges and Universities (NAICU) that caught my eye and raised my blood pressure. It said in part:

It must be noted that the list is under increased scrutiny by accounting experts who believe [federal] financial analysts are not always using the right accounting definitions.

and

The overwhelming majority of institutions that have appeared on the list in previous years continue to provide a quality education to their students.

I other words, despite the continued price inflation needed to prop up badly managed institutional priorities — and despite the mounting evidence that a many of these institutions are simply not delivering value to their students at the inflated prices —  the NAICU position seems to be that it’s the definitions that should be blamed.  If you’ve read this blog before or if you’ve scanned my book, you know that I can’t let this pass without comment.

There is a lot of complaining in the ranks of private non-profits about the accuracy of the test, but it is hardly a secret that there is something wrong with your business model  if the only way you can continue to operate is to continually and without warning raise prices to locked-in customers who are  (1) resigned to take on crushing debt or (2) eligible for unbounded federal, state and local subsidies to offset price increases.

How different would the picture have looked if construction of a few of those new dorms or fancy student centers had been delayed or an invitation to a money-losing post-season tournament had been declined? Would fiscal health have improved if administrative offices had shed some of their bloated staff? Might instructional costs have been held in check if clusters of small institutions had merged some of their general education requirements and created cost-efficient teaching pools for introductory English, history, and math courses?

Yes, the majority of the failing institutions probably do continue to provide a quality education to their students. But at what cost?