The Crisis in Higher Education: Harvard and Operational Analysis
We have a crisis on our hands. Over the past decade, over 100 colleges have ceased operations. According to consulting firm Bain, this trend will accelerate over the next decade. Dozens of colleges will cease operations, and financial pain will cause shrinking departments, dwindling services, and myriad other emergency efforts. While all colleges must adjust to shifting demographics, liberal arts colleges will tend to experience the greatest pain.
Recently, Bill Ackman published a business analysis of Harvard University in which he contrasted Harvard’s strong brand and cash position with the apparent declining value of the university’s services. He rated Harvard a ‘hold.’
As higher education faces increasing financial pressures, this ‘business analysis’ exercise is fundamental for every college. A strategy for efficient capital allocation that drives the college’s mission is key for higher education’s continued success. So, here are a few notes using Ackman’s analysis as a starting point.
What Kind of College Are You?
Ackman’s analysis suffers from a lack of situational awareness, which is to be expected since “higher ed” isn’t an industry that he usually analyzes. Higher education operates with two fundamentally different (and financially oppositional) missions: skills retailer and institution. Public universities generally (and most private universities) are skills retailers. Their mission is economic: at a particular cost (in USD and time), a customer acquires marketable skills that, over time, far exceed the cost in value. To survive and thrive, skills retailers need to be (1) highly market-responsive by keeping the shelves stocked with the skills customers want to buy, and (2) financially efficient, such that they cost neither the customer nor the taxpayer more than the direct, economic value they produce.
In contrast to the skills retailers, a few colleges operate as institutions. Their purpose is not to drive measurable economic value but rather immeasurable sustenance that great civilizations generally and democracies specifically require. (The measure of an institution’s import is usually more obvious in the collapse than in the rise. In fact, an institution’s value is often greatly obscured in the maintenance phase of a civilization, seemingly a valueless luxury for its lack of immediate measurable financial production.)
Ackman’s analysis reviews Harvard’s changing mission statement, which mutated from focusing on truth, wisdom, and knowledge to emphasizing “evolving identities” and “social transformation,” but these mission statements are fundamental in prioritizing resource allocation. Harvard is not trying to produce employable web designers; Harvard is trying to change the world. Empires of ideas — like empires of geography — are cash-intensive; we should remember that when reviewing Harvard’s financials.
Retailer vs. Institution
Ackman’s analysis observes that Harvard employs far more faculty in African-American studies than the number of annual graduates would warrant. In fact, most Ivy League and similar schools employ far more faculty than is warranted in these ‘studies’ areas; undergraduate students tend to major in the areas that they always did: economics, English, history, biology, etc. And yet, over-staffing these areas may be warranted if the college is acting as institution and not skills retailer; these departments exist to engage cognitive framing and cultural signaling, not to produce graduates. At institutions, questions about the validity of any academic department are addressed by mission, not money.
The key difference isn’t in the set of applicable financial metrics but rather in the benchmarks applied once the metrics are produced. Cost-per-student ratios are relevant to all organizations, though ‘cost-per-student’ in itself is mostly useless; it needs to be observed in its components: admissions-cost-per, housing-cost-per, etc., and there are employee corollaries. If this sounds laborious, consider that all colleges possess this data, they just don’t transform it into actionable insights. This data will reveal the positive and negative cash pools within the system, from which an organization may identify inefficiencies and opportunities.
A liberal arts college acting as an institution will have very negative cash-flow in its academic operations, and the entire rest of the college must be wholly focused on feeding cash to the academic machine. This should be recognized as a valuable mission to the nation. The liberal arts college is a civilization’s armory of wisdom, without which a culture is undefended.
A liberal arts college produces cash from tuition, donors, housing and public support. That cash must be sufficient to operate its cash-flow-negative academic departments (English, history, the arts, etc.) at a level commensurate with its mission. At such schools, downsizing the English department isn’t a financial decision; it’s mission suicide.
But a skills retailer is more balanced in its cash flow operations, and cash flow anomalies — even in academic departments — are more warning signs than possible indications of mission-aligned financial health. If the core output is employed graduates, then the core measure of an academic department is employable skills transfer. The market — not the mission — passes judgement on resource allocation for retailers.
For most colleges, understanding the cash-flow for not only departments but also majors is imperative; a dynamic cash model follows students from prospect to graduate, and includes measures of cost of prospect acquisition. We cannot assume all prospects are converted to matriculants at equal cost. A disparity in acquisition cost is often a sign of differences in brand and program perception; the perception of a weak program will cost more to attract students and often even more to keep them through to graduation. (A basic but often effective measure of brand strength is non-discounted, non-recruited yield by intended major over time. If you use a normalizing factor for discount rates, such yields are often ascertainable across peer groups. Another quick brand gauge is the delta between sticker and discount price over time. Depending on the results, you may need to inflation-adjust the prices.)
Measuring Success Generally
For a skills retailer, measuring success is easy: are graduates securing jobs? Which jobs? At what salaries? Organizational quality assessment starts at the outputs.
For an institution, measuring success is difficult and focuses on the inputs and process. Are we attracting the right students and faculty? Is the academic program fertile ground for cultivating that combustible alchemy of tradition and rebellion that sustains the American tradition? Whether or not graduates secure employment is antithetical to the purpose. In the dolce vita phase of a nation, the outputs may be unnoticeable or irrelevant, so assessments of institutions must resist the urge to measure outputs.
Institutional success requires strong leadership and a coherent plan. Ackman quantifies what may be assessed as results contrary to the appropriate actions of an institution (uniformity in faculty ideology, for example) and concludes that an increasing “price” in the context of decreasing quality may be a recipe for failure. This analysis conflates the imperatives of retailer and institution; price (and its discount) may signal brand strength and market position, but faculty uniformity is a matter of mission.
Measuring Success Operationally
The critical supply of free cash required to stabilize a college and pursue its mission first depends on whether it’s an education retailer or an institution. But the metrics are the same: in every regard, resource efficiency is the critical metric: what is the resource allocation required to achieve a particular objective? The “correct” answer depends on the benchmarks, but the questions are the same. What is the cost to matriculate a particular student (“customer acquisition cost”)? What is the cost to onboard a new employee? What are the administrative and faculty costs to operate various programs? All of these should be assessed as rates, not nominal figures. Every college starts in the red on day-one of a student matriculation. Is the college $500 or $5000 in the red? And how does that correlate to program/major? Does it cost the college $100 to on-board a new administrator or $1000? And what does it cost their peers? Etc. etc. Every high-functioning business performs such calculations. I know of no college that does.
The absence of pure market forces in higher education over the last fifty years has caused substantial operational anomalies and compounded inefficiencies; the purpose of a ‘business analysis’ exercise is to unlock (often vast) stores of underutilized resources so that those resources may be redeployed. (A business analysis starting point: those reports you file with the trustees or the state? Those are not budgets. Those are financial reports. No company attempts to operate itself from its 10Q. The number of colleges that have no effective operating budget would dumbfound corporate CEOs.)
Here’s one example of a glaring critical error that likely is costing many colleges millions per year. Treating technology as a cost center and not a value creator is a mistake that has destroyed many private sector companies over the past few decades. The clearest sign of technology-as-cost-center is that the CIO isn’t in the president’s cabinet and doesn’t have absolute authority over all technology decisions. Review pitches from twenty years ago about efficiency gains from technology spending; more technology was promised to deliver greater efficiencies. Now, review a college’s administrative and technology spend per revenue dollar over time; why didn’t those efficiencies materialize? There’s a lot of inefficiency in relegating a CIO to being a procurement, maintenance and training bureaucrat.
Harvard College’s Enrollment Has Been Flat
Ackman’s report demonstrates that the College’s enrollment has been flat but the university’s CAGR is about 5%. That CAGR is being entirely supported by its Continuing Education program. Harvard College’s 15-year CAGR is 3.9%, while Continuing Education’s CAGR over the same period is 6.4%.
There are two significant problems here. First, I’d need more information about the reported revenue numbers to believe them. Student counts or the derived (students)(tuition) revenue numbers are entirely useless when examining operational costs and efficiency. All colleges discount, and many colleges discount significantly. Ackman includes a ‘scholarship’ number that implies a university-wide discount rate of 13.6%. Harvard discounts its undergraduate price far more than that; if the number applies wholly to undergraduates, then the discount rate is about 56%. Harvard has significantly changed its undergraduate financial aid over the past twenty years, so it’s possible that the undergraduate revenue CAGR of 3.9% — the lowest among Harvard’s tuition revenue sources — is actually much lower. It’s possible that Continuing Education is producing more of the revenue growth than it even seems.
Perhaps more disconcerting is the trend to lean on Continuing Education for revenue growth while, according to Ackman, decreasing quality. This brand leveraging has been a key component of private equity for decades (buy a strong brand, cut R&D and related, and squeeze cash from the brand). Harvard seems to be following that strategy; the key issue with that strategy, aside from general brand dilution, is that luxury brands that start distributing in Walmart usually cannot regain their luxury position. Dilution is often a one-way street. Harvard is selling more down-brand (probably non-discounted) units and supporting operations from brand fumes. (One challenge with education revenue is its lack of repeat customers, but alumni giving is essentially repeat-buying; in Harvard’s case, these alumni are giving based on a long-gone brand experience that will eventually exhaust its potential; it seems quite possible that giving to Harvard will likely begin a long-term downward trend.) Aside, keeping an eye on unit #s/discount is important; a harbinger of a dying organization is one that can only increase unit sales through discounting.
Quantitative to Qualitative
Harvard, though, is a strange case; its endowment has insulated itself from the market more than most universities. To further understand whether Harvard is a buy, sell, or hold, we’d need to characterize the comprehensive set of metrics by comparing them to a peer group. The first caution about peer group construction is not to assume the peer group must be composed of similar organizations of the same category (e.g. all public universities). The second caution is not to define your peer group by the endpoint of your dataset but rather by the beginning point. Ackman’s sub-categorized financial data covers fifteen years, so define the peer group by your peers fifteen years ago and see where each is today. This can be quite instructive for qualifying endowment performance. The final caution is that peer group qualification is relative; it’s possible all group members underperformed. But peer analysis across pricing, all-source revenue, and other operational metrics can often reveal substantial disparities that can guide improvement efforts.
Operational Overview
The result of such comprehensive analysis should be to discover inefficiencies that can be reallocated to other opportunities. But it should also provide substantial insight into overall operational optimization: what is the optimal number of students? The optimal price points? The optimal costs? Such an overview should guide hiring, expanding or contracting programs, and launching new programs. And finally, such an operational overview should be a contributing starting point for a master plan.
Education is generally terrible at capacity utilization (K12) and resource allocation, so the good news is that most colleges actually have adequate cash flow to be successful; they just need to apply private sector solutions to education.
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On the demographic crisis: https://medium.com/@nathan-a-allen/strategy-notes-the-demographic-crisis-011467709b64
