Ernst & Young LLP; Chicago
Ernst & Young LLP; Detroit
The U.S. higher education sector had been fueled by three decades of sustained enrollment growth that extended through 2010. Both public and private investment flowed to the sector, and credit remained readily accessible to roughly 4,000 U.S. institutions. This access to capital enabled investment in programs, buildings and infrastructure to accommodate rising enrollments, enhance access to students and create a differentiated educational experience.
Since 2010, the sector has entered a much different era. Enrollments are flat, creating more competition for students and the revenue dollars that follow them. State and federal funding for public institutions was cut during the recession and has since been slow to recover to its historic levels. At the same time, institutions are grappling with rising expenses due to higher fixed-cost structures from the schools’ years of investment and growth. Moreover, many states are moving to performance-based funding mechanisms while expecting publicly funded institutions to look internally to right-size operations and focus on improving student outcomes. This is also true for private institutions and, in particular, smaller institutions, which are often more tuition-dependent.
Challenges and the Need for Financial Transformation
The current landscape has created a need for financial transformation at many institutions. Despite the general nondiscrimination provision in the Bankruptcy Code, a traditional bankruptcy process is not a practical option for turning around a university. The Higher Education Act Amendments of 1992 make universities that file for bankruptcy ineligible to participate in the Title IV program, leading to loss of access to federal loans and grants that are used by many students to pay for tuition. Beyond that, the reputational damage to a university during bankruptcy could further drive enrollment losses.
Instead, institutions typically respond to financial challenges with one-time measures such as accessing debt markets, deferring maintenance and capital investments, and implementing staff reductions or wage freezes. These reactionary measures often fall short of the more holistic transformation needed to address any structural challenges and right-size institutions in today’s competitive conditions. Furthermore, these measures ignore the need for aligning deeper business-operating model changes to an intentional, longer-term strategy that can deliver a sustainable value to students.
Change of this magnitude can be extremely challenging amid the distractions of financial distress and simultaneous cuts. Many of the traditional financial approaches, such as cash management, financial forecasting, contract renegotiation and performance analytics, are essential. Additionally, institutions need to re-evaluate their academic practices while taking a hard look at their enrollment strategies, program portfolio, teaching models and retention efforts. This will be crucial to ensure that institutions are attracting the right students to the right places, retaining them until graduation, and providing them with valuable outcomes post-graduation. Too many institutions have gotten overzealous in the veritable arms race for students, as evidenced by sprawling campuses, investments in research, pursuit of rankings, and rising tuition and discount rates.
Carrying out this level of change successfully, in a shared governance context with diverse stakeholders, requires rigorous analysis and deep engagement with the institution. Many institutions lack the visibility and tools at their disposal to easily assess financial health and to make financial decisions that are consistent with their strategic needs. Furthermore, recent cuts have left many institutions so lean at their central offices and administrative functions that limited capacity exists to perform critical analyses and implement change.
Improve Cost Structure and Offerings Through Collaboration
One might argue that the fundamental problem today is that there are too many institutions chasing too few students. As a result, net tuition revenue growth is lagging the inflation rate at most universities. In an effort to curtail enrollment losses, universities are essentially “buying” students with discounts and scholarships. In the 2014-15 academic year, the average freshman discount rate was close to 50 percent among the colleges and universities surveyed by the National Association of College and University Business Officers.
The cost structure of many universities cannot be supported by flat or declining enrollment. But although institutions find themselves in a wide range of financial conditions today, in some cases there are tremendous opportunities for universities to partner or even merge with institutions that would be a strategic fit for the future. Educational leaders will need to consider alternatives to going it alone and investigate opportunities to cooperate and partner more deeply with other universities.
This could go well beyond simple agreements between colleges or universities to share back-office operations or to cross-list academic courses, which often result in good publicity, but not much else. Collaboration in this new era involves colleges and universities coming together as seemingly one institution to change their future directions. The benefits of partnerships and collaboration go beyond cost-reductions and enrollment gains; they can also enhance the academic experience and access by helping to avoid cuts in certain programs and maintain diversity in programs. For example, a science department shared among a few state colleges allows for a wide array of majors with top-notch faculty that could not be maintained by any of those colleges individually.
Some early partnerships among universities relied on them being located a short distance from each other to collaborate. But with technological advances, institutions need not rely on proximity to create efficiencies through collaboration. For example, across Pennsylvania, 10 liberal arts colleges are partnering on faculty development, studies abroad, and compliance- and risk-management.
The institutions at the most risk of failure must collaborate out of necessity, so those in a position of strength should work with other colleges and universities for the opportunities they present. The time has come for at least some institutions to join together in order to deal with the strong headwinds of weakened enrollment, tight funding and growing competition.
Education Sector Strategies and Next Steps
College and university mergers or closures certainly have some precedent in the higher-education sector, though nothing close as of yet to what is happening in multiple other sectors. The sustained period of growth in recent times has left the higher-education sector at a tipping point. Many universities will need to accept that their current structures are not sustainable and that some form of transformation will be necessary.
While a traditional in-court restructuring is not a practical option for universities, a successful transformation will require a strong financial approach and understanding. In addition, universities will require some combination of cost-reduction efforts (on both the administrative and academic sides) and revenue-generating strategies (student-retention strategies, enrollment and student-mix strategies, and pricing strategies), and an openness to move toward stronger outside collaboration.
Partnerships between institutions can be a winning approach for many colleges, even those currently operating from a position of strength. Collaboration can provide a much-needed boost — and quickly — in academic and co-curricular offerings for institutions lacking strengths in certain areas.
This article was originally published in the May 2017 edition of the Financial Advisors & Investment Banking Committee Newsletter. Participation in ABI's committees is one of the many benefits of becoming a member. Committees provide networking and leadership opportunities. For additional information on how you could become involved in ABI and our Committees please visit membership.abi.org