Theme Park U: The problem with American universities

Theme Park U: The problem with American universities

Everyone knows that US college tuitions have soared. Less publicized yet even more troubling is the underlying cause: Universities themselves have major financial problems.

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Theme Park U: The problem with American universities

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Everyone knows that US college tuitions have soared. Less publicized yet even more troubling is the underlying cause: Universities themselves have major financial problems.

You can see some of the reasons why on the typical campus tour now underway for high school students and their parents. As these families stand on the precipice of a massive investment, they likely are hearing about cool new dormitory amenities (water park!) or specialty dining halls (vegan everything!). But they’ll probably learn very little about what would make the next four years at that school distinctive academically. Even as schools have tightly managed teaching budgets, spending in other areas such as facilities, administration and “student services” continues to grow.

These amenities are now priced around $41,000 per year, on average, at a private college. That price tag has risen more than four times the rate of the consumer price index over the past three decades. Public universities may cost less, but they, too, have been rapidly closing the gap. Students and their parents could be forgiven for asking: Will a degree from this college provide four times the advantage in life that it would have 30 years ago? What are we getting for all this added cost?

Two years ago, education entrepreneur Tom Dretler and I documented how one-third of higher education institutions were on an unsustainable financial path, with significant declines in both equity ratios (equity as a percentage of assets) and expense ratios (expenses as a percentage of revenue) between 2006 and 2010. Most institutions seemed to be slavishly following what we called the “Law of More”: They believed that the more amenities they built, the more they would prosper.

Since we published our report, public debate and media attention have focused on the high and rising cost of college, which helped to slow tuition growth. Yet the underlying financial problems persist. The National Center for Education Statistics has just released the latest financial data, for 2012, and what’s happened since 2010 is alarming.

Most universities’ balance sheets have held steady or improved since 2010, largely because endowments were bolstered by the stock market’s recovery. But the expense ratio is a different story. More than half of the schools have seen their expense ratios worsen by 5 percentage points or more. While many schools managed to slow their cost growth, costs still rose overall. The average public institution saw costs grow 1.9% per year from 2010 to 2012 and the average private institution, 5.3%. This is better than the 7% annual growth of the past, but it’s not enough.

The problem is exacerbated by declines in revenue at most institutions: -0.2% for the publics, -3.2% for the privates. Too many schools have too many empty seats, leading to rising tuition discounts and declining yields—a particular challenge outside the elite 100 universities. Sponsored research is also declining, and it’s concentrating in fewer institutions.

In response, many schools have launched new programs such as cash-cow master’s degrees and undifferentiated online courses. Yet it’s more urgent to address the fundamental cost issues. What can this vital sector do to overturn the Law of More?

First, each institution needs to develop a real strategy—meaning to define what makes its education program distinctive, then direct resources to that mission. Equally important, each school must define what it will not do. Princeton, for example, has always resisted the temptation to launch a business school. If campus leaders don’t make these strategic decisions, much of our higher ed system will slide into mediocrity.

Universities also need to raise the productivity of their academic and administrative operations. The ongoing shift from tenure-track faculty to part-time instructors does not count, because teaching and research quality often suffers as a result. That’s wage arbitrage, not productivity improvement.

Going for greater efficiency does not mean that effectiveness will decline. In fact, redundant or fragmented operations tend to take longer and have quality problems. Stronger management can fix that. Vanderbilt last year hired a veteran of IBM as its vice chancellor for information technology. He has helped Vanderbilt build a much stronger IT capability and cut redundancy—all at lower cost.

Finally, schools must fix their internal economics. Universities tend to operate as a federation of colleges or departments. Budget models are complex, and the flow of funds is convoluted. People who manage budgets often have limited options to influence individual academic departments. For example, many campuses don’t charge departments for electricity based on how much power each department consumes.

Schools that streamline will have more resources to divert to those things, such as teaching, that actually matter most to their customers. In a recent Bain & Company survey of current and prospective students for one large university, “amenities” and “athletics” ranked 10th and 11th in importance. The top two? “Strength in field of study” and “post-graduation employment.” So as high-schoolers and parents visit a school, they can ask what makes it unique. If the campus tour guide has no better description of the school’s core identity than its dining hall choices, then the best choice for those families may be to spend their $41,000 per year elsewhere.

Written by Jeff Denneen, who leads the Americas Higher Education practice for Bain & Company and is a partner in the Atlanta office.