Financial Management – A Call for Modernization

Too few universities have embraced modern systems of accountability and transparency. Long-employed accounting structures in commercial businesses such as centralization, standardization, automation and integration are often counter-cultural in universities – and the opportunity cost can be substantial. But more importantly the transparency, controls and timeliness achieved through modern financial management systems can significantly improve decision-making.

When CEOs and CFOs try to employ modern systems of accountability and efficiency, they often are met with strong cultural objection from the academic side – the University of Michigan, University of Texas and Howard University are three recent public examples. As a result, universities pour money into the status quo – supporting the unsustainable business model discussed in the previous blog post. A transition has to occur, and will ultimately occur. The question is whether it will be a managed transition while there are still financial reserves to cushion the change, or a forced transition as financial reserves are depleted.

There is a sad misimpression among some academics that “if only the endowment were higher,” financial problems would be solved. Sure, a larger endowment can throw off more cash for operating support. But, to a very high degree, the endowment is restricted as to use and cannot be deployed for general needs which change regularly. Moreover, the annual draw on the average endowment is relatively low (about 5%) and thus usually covers only a small percentage of annual operating costs. So – although no one wants to give up hope, the endowment is not a realistic source of growth capital or inflation offsets.

Complicating higher ed financial management is the convoluted way tuition and fees are paid. The system of government and private loans is complex and is causing students and families to assume substantial obligations – even before they know if the student will have a degree to exploit in the future. And nearly half of the future obligations are for money that never went to the university – it was used for other purposes determined by the student. So, when you hear that student debt is high, please note that a large percentage of the borrowing was NOT for university charges but rather normal living expenses.

Finally, let me address the culture of non-accountably.  Traditional higher ed is run like the federal government – employees spend the money and leaders must raise the money. Almost no university holds faculty accountable for revenue – or to manage a bottom line. Consequently, revenue stress is often seen as an administrative problem, and not shared by the academic community. So – the perceived issue is almost always not enough revenue. The problem is seldom seen as an unproductive and/or inefficient cost structure. Unfortunately, as mentioned in prior blog posts, the ability to raise prices indiscriminately is over. Sound financial management will require robust cost control and accountability. Managing to the bottom line must become a shared responsibility.

Our next blog topic will explore the issues of shared governance without shared responsibility.

Robert M. Tarola, CPA, CGMA
President
Right Advisory LLC
www.rightadvisory.com
Twitter: @rtarola

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The Traditional Higher-Ed Business Model – An Unsustainable Tradition

I have touched on some of the major challenges to traditional higher education in prior blog posts. Now lets look at the traditional business model. As a professional services business, the higher ed design is inverted compared with the commercial model. There are far too many owners (tenured faculty – the rainmakers) compared with workers (support faculty – the troops). It is an inherently “low leverage” model – about 2-3 support faculty for every tenured faculty member. A commercial professional services business would be closer to 10 troops for every rainmaker. Consequently, the model has little ability to achieve productivity gains causing inflation to be transferred to customers. Commercial businesses would adjust the number and experience level of support professionals to balance career aspirations with cost control. The inability to adjust employment mix, and related cost, is the main reason for stress in the model when pricing becomes inelastic – as it has been since at least 2008. 

There are two main levers of productivity in the traditional higher ed model – student/faculty ratio and the level of funded research. Being low on both measures is a recipe for distress. Being high on both measures creates financial flexibility and options for the institution. There is also the cost of administration, which must always be driven to a lower percentage of revenue.

Lets start with student/faculty ratio. For the most part, this metric defines an institution. Is it high-touch (single digits to 1) or high-volume (high teens/low twenties to 1)? At high-volume, the cost structure per student is generally low and the leverage factor is generally high – creating flexibility when needing to address financial challenges. It is just the opposite for high-touch institutions.  The lower the student/faculty ratio, the harder it is to cover cost inflation with productivity gains. Consequently, cost increases must be passed on to students – straining the value proposition. At some point – many would say it is now – higher prices for the same outcomes cannot be justified, causing lower demand. The lower demand starts a bottom line crisis that can only be addressed with cost cutting – an always-difficult situation for a traditional institution.

Is research the silver bullet? It could be! The profit from funded research activity can cover a lot of imbedded cost.  This is another form of leverage – where the fixed costs of buildings and faculty are used to produce more dollars. A high-touch institution with a high research mandate can, in many cases, blend the best of both to offset higher costs from inflation. This allows for increased competiveness on the value proposition.

Although administrative functions are not leverageable per se, the cost to deliver high quality services can be minimized by deploying techniques long-used by commercial businesses. Techniques such as standardization, automation, consolidation and integration (“shared services”) are ways to save money and improve effectiveness. No institution can justify high admin costs as part of the value proposition.

The market place will ultimately insist on a sensible balance of cost and value. It will take a partnership with faculty to push productivity toward research and/or larger classes, and accept a more efficient admin model. Those partnerships are often difficult to forge – but not doing so could mean unsatisfied careers and customers. The institutions that can offset inflation with productivity gains will be sustainable. The ones that cannot – will not.

Robert M. Tarola, CPA, CGMA
President
Right Advisory LLC
www.rightadvisory.com
Twitter: @rtarola