Several years ago, I had the pleasure of serving on a board of trustees for a small university. The school had a very modest endowment and predominantly served first generation students. My four years on the board was a crash course in the peculiarities of educational economics. The overall business model of higher education is one of the oddest things that I have ever seen. So, when Harvard professor Clayton Christensen, who is best known for his work in disruptive innovation, predicted that as many as half of American universities would close or go bankrupt within 10 to 15 years, I wasn’t at all surprised.
Higher education has been facing financial struggles for some time now, but unlike many other industries has managed to slow roll disruption and the decline in the price charged to consumers. In fact, only healthcare services have outpaced the expenses related to college in the United States.
The problem with higher education is its business model. I can hear the hissing now. Another business person trying to say that schools should run like a business. Your business model essentially describes the elements that drive your revenue in order to cover the resources and processes that enable an institution to deliver upon its value proposition.
If someone came to you with the following business idea would you invest? “We are a non-profit institution that produces a product that costs $100,000 to deliver. However, we discount that product by 35% to 40%, sometimes more. We make up the remainder by covering some of our expenses from the investments we have and the rest we try to make up by hiring a platoon of professional beggars who shake down previous customers for money on an annual basis. Sometimes we even convince some to pay for buildings and personnel.” Well, this is higher education in a nutshell.
The problem with this business model is that there in no incentive to reduce costs, therefore, the cost to deliver the product has continued to increase. Schools bear little if any of the risk should the value proposition not pay off. Students and their families are being asked to pay prices that they can no longer justify, because the salaries that they can garner after graduation no longer cover the cost of college in a meaningful period of time. They are burdened by student debt levels never before seen in the United States.
As for colleges, for the 2017-18 school year, the discount rate for private colleges hovered around 50%! At the same time the number of alumni giving is declining. Many people who are unfamiliar with the business model of higher education might say, “why don’t you use your endowment?” Well, most schools don’t have much of an endowment to speak of. Only 11% of colleges make up 75% of the estimated $500 billion held in endowment assets. On top of this, money in these endowments is often restricted with regard to how it can be put to use. Besides, while you may have to tap your endowment in an emergency, it is bad practice to remove more than just a few percentage points of gain each year from this pool of funds, thus allowing it to continue to grow and compound.
So, expenses are outpacing revenue and the traditional means to cover those costs are in decline and that is how you end up with 25% of colleges in the red today. Throw into the mix changing demographics and you have a perfect storm. The population of 18 years olds in the U.S. reached a peak a few years ago and more college age kids are reconsidering the value of a college education. To fill the gap, some schools have turned to foreign students. However, an overreliance on foreign students puts schools at the risk of economic shock should that populations interest in coming to the U.S. wane and there are plenty of reasons to believe this can happen.
The declining number of students further drives competition amongst schools which forces them to build gold plated dormitories, athletic facilities, and campus centers to name a few. This further raises the fixed costs that are part of the business model which makes it difficult quickly make adjustments without impacting student services, like uhhhh teaching.
Will Christensen’s prediction play out? I think it already is, but the question remains how many schools will have to go out of business before the powers who steer higher education are willing to make necessary adjustments to the model?
Higher education is a little like currency. We accept currencies that are backed by the full faith and trust of governments. I can purchase goods and services with a U.S. $50-dollar bill. People choose to go to college because they believe that it is the necessary path to a good job that will allow them to pay back their college loans and make a good living. The more damage that is done to the faith and trust that people have in these institutions the less willing they will be to attend them, especially if companies are willing to accept people without a college degree, or an alternative to the four-year degree becomes common. The answer, I believe, is in technology. It is right in front of their noses, but will colleges, or alternative institutions be the first to offer high quality education at a fraction of the current cost?
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