The reality is that Universities and Colleges don’t cost enough!

The reality is that Universities and Colleges don’t cost enough!

There are a lot of articles, analysis and even a high profile documentary discussing the current problems with higher education, in particular the rapidly rising tuition, reduction in Government funding, increase in student debt, reduction in enrollments etc.  A lot of the discussion seems to revolve around factors that are external to the university or college, but there are a number of things that can be done internally to help alleviate the current pain but also empower the institution to not only survive but thrive during these turbulent times. My biggest concern at the moment is that universities and colleges don’t cost enough, that is:

Universities and colleges don’t cost enough of their organization!  Most universities and colleges don’t properly determine the full cost of delivering courses or more importantly what the margins are on individual courses.  The main costing undertaken in universities is either based on direct costs or worse the budget.  Direct costs are fine for some purposes if properly calculated, but they can be misleading if used uncritically.  The budget simply states how much is planned to be spent, not how much things cost.  Knowing which courses make money and which lose money requires the calculation of full costs.

Universities and colleges don’t cost enough of the time! Most universities and colleges perform ad-hoc, project based or crisis-based costing, rather than having an enduring costing solution. Why is that? Because it’s hard, especially if it’s being done in the standard tool of choice, the spread sheet. It’s very hard to build up a full representation of the university every time you want to do some type of analysis. These types of builds are usually BUILD ONCE, USE ONCE. Each time another project is raised or another crisis faced, the analyst will start with a fresh spread sheet, which is a very inefficient process. You want to have a solution that is BUILD ONCE, USE MANY.

Although cost is very important, to properly manage universities and colleges, management need to consider a wide range of issues, not just cost.


MISSION – Why does your university or college exist? I absolutely believe in the “greater good” argument for universities and colleges, however I’m also a pragmatist and I don’t care how noble your cause is, if you run out of cash you can’t do anything.  Cash for your institute is like oxygen for us humans, we need it for survival but it’s not what we are on the planet for. Take away our oxygen supply and we become somewhat less productive. William Massy, Professor Emeritus and Former Vice President for Business and Finance at Stanford University has written a great paper on this topic. I’ll summarize some of the key points below.

Not-for-profit Universities don’t exist to maximize profits, they exist to maximize mission. They want to produce as much high quality education, research and public service as possible given their current circumstances. But like for-profit enterprises, universities are limited by the marketplace and internal productivity. We could say then that the not-for-profit model looks like the for-profit model with mission attainment substituted for profit.

But what about the relationship between revenue and cost? While universities are not in the business to make money, neither can they operate without it. Any model seeking to describe university behavior must take money into account by adding a financial constraint to the maximization of mission attainment. The for-profit model doesn’t require this side condition because the difference between revenue and cost is the very quality they want to maximize.

So how do universities strike a balance between maximizing mission attainment while taking into consideration market constraints? We can start to represent this in a series of formulas, we can start with the rule that “Contribution to Mission Attainment” of each activity (x) that is accepted for funding should exceed the activity’s “Revenue minus Cost”. That is:

Contribution to Mission (x) > Net Cost (x)

The first term can be called “Love” or “Pain” depending on whether the activity contributes positively to mission attainment or detracts from it.

The second term called “Net Revenue” or “Net Cost” depending on whether the activity makes or loses money.

It’s obvious that any moneymaking activity with positive mission contribution should be funded, and conversely. What’s not to like about something that contributes both Love and Money, and what’s to like about one that contributes neither? The other possibilities are more interesting. One should fund a money-losing activity if and only if its mission contribution exceeds its net cost. Conversely, proposals that make money should be approved unless they too strongly detract from the mission.

The decision rule has an interesting and perhaps surprising interpretation. It says that some activities may be approved on the basis of “love” alone, others may be approved for strictly pecuniary reasons, and still others may be approved for a combination of the two. What is surprising about not-for-profit theory is its message that all three of these possibilities are equally virtuous.

When Universities Struggle. Having non-profit status and a strong sense of mission are necessary conditions for bucking the market, but they are not sufficient. To see why, consider what happens when a non-profit enterprise struggles financially. It turns out that the model’s mathematics divides each activity’s intrinsic priority by the so-called “marginal value of money” – a quantity that becomes infinite as the entity approaches bankruptcy.

Dividing anything by infinity yields zero, which means that the non-profit decision rule reduces to:

Contribution to Mission Attainment (x)/∞ > Net Cost (x)

-> Net Revenue (x) > 0

But this is exactly what for-profit entities do! This extremely important result says that if a university struggles sufficiently it will behave just like a business firm.

Behaving like a business firm means that, if sufficiently strapped financially, universities will respond to the market and only to the market. Mission attainment doesn’t matter, and the only proposals to be funded will be those that promise to make money.

MARGINS – Which courses make money and which ones lose money?  When we discuss Cost above we are talking about FULL Cost, not just direct cost. This means that it includes all the support and overhead costs of the school, faculty and university – it includes all IT support, HR, Financial, Facilities etc. This is very important because the margins you want to use for management are the margins calculated based on the FULL cost not just direct cost.  Knowing your margins is essential for setting appropriate tuition and seeing which areas are subsidizing other areas. There will be areas of the university that have low or negative margins, as explained above that’s not a problem as long as it is aligned with the mission.

MODELS – Models are developed to represent the way something works and allow people to play with them and test various things without impacting the real thing that is being modeled. For a university or college we are talking about two distinct types of models:

Historical – The historical model represents how the university operated in the past and operates in the present.

Predictive – The predictive model represents how the university might operate in the future.

The margins discussed above are calculated from the historical model. As mentioned earlier, this is a difficult task to undertake in a spreadsheet because of the sheer amount of data and the vast number of relationships that need to be captured when it comes to distributing all of the support and overhead costs throughout the organization. Therefore it’s recommended that the model is built using dedicated modelling software, specifically designed to support the rapid building and maintenance of models for complex organizations.  The objective of the model is that it is ENDURING, it’s a “Build Once-Use Many” model, not the spread sheet “Build Once – Use Once” approach. It also contains the entire organization, so it captures all of the support and overhead costs from schools, faculties and corporate.


Mission, Margins and Models should be considered in combination to support executive decision making. Another important factor is collaboration between academics and administrators who are responsible for different aspects of this combined analysis which needs to be carefully considered and balanced.

From an academic perspective, it’s no good being purely focused on mission and not the underlying financials in the margins and models, because as stated previously if the university or college gets into a financial crisis, the mission, which is vitally important to the academic, suddenly becomes irrelevant. So the objective is to avoid crisis management.

From an administrators perspective, it’s no good being focused on the financials, if the university or college is not providing the quality teaching or research required for the greater good of the country or indeed human kind or the planet. Finding a cure for cancer might cost a lot but think of the benefits.