Strategic management of college resources: a hypothetical walkthrough.
Harper, Vernon B., Jr.
"Straight answers to tough questions inside the black box of
academic finance [using] a hypothetical institution as way to show the
consequences of the tough answers to those questions."
One residual of the Great Recession is a combative fiscal,
monetary, and legislative environment that continues to reshape
postsecondary education. College leaders are being directed to improve
the academic performance of students and the financial performance of
the entire enterprise. It is a challenging climate in which the
traditional tactics of increasing both tuition and financial aid offer
diminishing returns. Those who choose to lead in this climate will
require more than courage to succeed; they will need reliable tools to
manage and optimize institutional resources. This type of resource
planning must be able to capture the complex financial relationships
between academic units while being easily comprehensible to campus
stakeholders. In the pages that follow, a model for optimizing resources
is presented as a "walkthrough." The walkthrough takes
advantage of fabricated data from a small independent college (SIC), and
the exercise is based on the assumption that external resources are not
forthcoming. The primary vehicle for understanding SIC's structural
problems and its attendant solutions is the contribution margin income
statement that is presented as an appendix to this article. Of the many
financial statements, the income statement "is relevant to decision
making because it specifies how alternative choices impact income"
(Horngren et al. 2011, p. 181). In addition, the contribution margin
income statement differs from year-end audited statements in that it
eschews the NACUBO (National Association of College and University
Business Officers) functional classifications that hide managerially
relevant information, such as the relationship between expenses and
revenues.
This hypothetical institution is conceptualized as an independent
urban institution with a small population of only undergraduate students
(2,741 FTE) who largely commute. The leadership's goal is to build
a pool of strategic resources, or operating reserves, from within the
financial boundaries of the institution. These strategic resources would
be reinvested into academic capital and programming; although building
reserves is a strategic objective, the preservation of academic programs
is the highest priority. Importantly, SIC's small endowment
($10,975,500) provides little to the unrestricted operating budget. This
institution is highly tuition dependent (94 percent), based on its
tuition dependence ratio (see income statement: D6 / E7 + E12 + C32).
Organizationally, the institution is comprised of three academic
divisions. The School of Art and Social Science is the exclusive steward
of the general education program. Over time, two professional schools
have been added to the academic portfolio: the School of Technology and
the School of Business. Importantly, the college has no graduate
programs or any appreciable overhead recovery from sponsored research.
FINANCIAL ASSESSMENT
For SIC, the -13 percent net income ratio (see the income
statement: C33 / C24) indicates that the institution is operating with a
deficit of $2,948,517 (C33). Due to soaring expenses, the institution
has consistently raised its nominal tuition, which is now $33,000 per
academic year for first-time full-time freshman ($1,100 per credit
hour), and fees. As shown on the income statement, the institution has a
total credit production of 82,233 (C5). As with many institutions,
intense competition has led to extensive tuition discounting. In figure
1, the relationship among enrollment, credit production, gross tuition
revenue, and discounting is depicted by school so as to determine the
percentage of student financial aid awarded by each school.
In order to determine the amount of financial aid a student
receives, institutions often build enrollment matrices based on the two
dimensions of financial need and academic merit, with the cells
suggesting an average aid amount for each respective student. In this
way, financial aid is leveraged to maximize net tuition revenue (NTR)
from an entering class. Useful as this approach may be, it fails to
describe the patterns or clusters of discounting by school. As can be
seen in figure 1, the overall discount rate of 53 percent hides the
underlying variance among academic divisions, where it is apparent that
the highest-discount students are pooling in the School of Technology
and the School of Business. Importantly, the pools of discounted student
revenue should be coupled with expense structures to offer a complete
picture of financial performance by school. Contribution margin is one
statistic to link NTR to instructional expense.
In the world of commerce, contribution margin is a common tool used
to estimate the performance of multiple products or services. In
postsecondary education, it is often overlooked managerially. In the
simplest terms, contribution margin for a nonprofit organization is the
amount that a given activity produces to cover overhead costs. For this
exercise, contribution margin is derived by subtracting direct expenses
(operating budgets, equipment, salaries, and benefits) and those
expenses allocated to each school by credit hour (library, media
services, and academic administration) from the NTR generated by
students within a school (see Whalen 1991 for revenue attribution and
cost allocation methods). (5) Townsley (1993) writes that small
independent colleges and universities are successful when their leaders
are "aware of the central role that contribution margins have upon
programs and upon the scale of the administration and student
services" (p. 61).
Importantly, Stuart, Erkel, and Shull (2010, p. 201) describe the
computational challenge of a contribution margin analysis when they
write that it is necessary to
compare costs and revenues across programs, and consider the
complexity and variability of faculty workloads and salaries, plans
of study and credits per course, numbers and proportions of
students enrolled full-time and part-time in different programs,
and percentages of tuition dollars returned to the college by type
of student.
Even with these challenges, an institution that is able to craft a
contribution margin framework will be rewarded with data indicating the
relative productivity of different academic activities.
OVERHEAD COVERAGE AND EFFICIENCY RATIOS
The underlying logic of the overhead coverage matrix (figure 2) is
that the delivery of each academic credit produces a linear amount of
institutional overhead. Admittedly, the relationship between academic
credits and overhead could in fact be stepwise or even curvilinear;
however, the overhead coverage matrix offers a solid starting point for
more detailed analysis. Moreover, the concept of overhead coverage is
strongly related to the notion of cost absorption, in which overhead
costs are apportioned and then absorbed by a revenue-generating unit
based on a particular variable, in this case, credit hours (see Rumble
1997).
As shown in figure 2, the first comparison is among credit hours,
credit hours percent-of-total, and contribution margin percent-of-total.
The assumption is that an academic division should produce a
contribution margin percent-of-total that is equal to or greater than
the credit hours percent-of-total. In the SIC example, the School of Art
and Social Science produces 40 percent of the credits (33,235) yet 52
percent of SIC's contribution margin ($11,848,278). By taking total
overhead ($26,265,445) into account from the income statement, it is
easy to determine that the School of Art and Social Science is actually
covering 45 percent of the college overhead. On the other hand, the
School of Technology accounts for 31 percent of the credit hours yet
only 20 percent of the contribution margin and covers only 17 percent of
the overhead. Lastly, the School of Business accounts for 28 percent of
credit hours and contribution margin with 25 percent overhead coverage.
In total, the academic divisions cover only 87 percent of the total
college overhead ($22,969,839 / $26,265,445), which means that 13
percent of the college overhead must be carried, or cut, for the
institution to achieve financial balance.
In truth, few institutions couple their revenue-generating
activities (academic divisions) and overhead in this way, for there are
sizable political and practical barriers to setting contribution margin
expectations. Yet, this approach reveals how the schools' financial
contribution relates to the performance of other revenue-generating
activities such as auxiliaries. For this exercise, the SIC leadership
has already traversed these barriers, meaning that the SIC academic
divisions are expected to carry 95 percent of the institutional overhead
largely due to a lack of auxiliary revenue. (6) The expected coverage
rate of 95 percent equates to a per credit hour rate of $303
([$26,265,445 / 82,233] x .95), so the School of Art and Social Science
is expected to cover $10,083,499 of the college overhead (33,235 x
$303). Similarly, the School of Technology is expected to cover
$7,789,795, while the School of Business should be covering $7,076,198.
A further inspection of figure 2 reveals the overhead coverage
variance, which is the difference between the expected overhead coverage
and the actual contribution margin. For example, the School of Art and
Social Science performs $1,764,779 above its 95 percent expected
coverage. On the other hand, the School of Technology and the School of
Business underperform by $3,245,320 and $499,112, respectively, for a
combined $3,744,432. The notion of subsidy is infrequently raised in
postsecondary education, yet its financial impact is felt across entire
institutions as resource scarcity. In the SIC example, the School of Art
and Social Science is essentially funding the overhead created by the
other schools with its $1,764,779 excess. Even with the School of Art
and Social Science surplus, the remaining uncovered overhead is
$1,992,947 ($3,744,432 - $1,751,485). Since auxiliary revenue falls
short of covering this $1,992,947, the ongoing structural problem is
quite clear.
SIC leadership also can take advantage of efficiency ratios (figure
3) to further diagnose the structural problems within each school. In
short, an efficiency ratio reveals the ability of an academic division
to convert revenue into contribution margin (direct expense / net
revenue). As with any ratios, efficiency ratios must be treated with
caution, for they aggregate underlying information, which could prove to
create a distortion.
As seen in figure 3, the School of Art and Social Science requires
30 cents of expense (30 percent) to generate one dollar of revenue,
while the School of Technology and the School of Business possess 60
percent and 40 percent ratios respectively. Importantly, the 30 percent
spread is a useful derivative statistic that indicates the variance in
efficiency between the schools, and it can be used by administrators to
track the efficacy of cost management initiatives. In the end, the
efficiency ratios simply confirm what has been observed in the
contribution margin data, which is the fact that the School of Art and
Social Science is a more financially efficient entity.
RESOURCE MANAGEMENT
Planning and managing the financial resources of a college requires
a sustained commitment from its institutional leadership. This small
independent college exercise captures many of the difficult challenges
currently facing actual institutions, and it naturally leads to
potential remedies and solutions. Moreover, the solutions described
herein are intended to be structural, taking advantage of SIC's
current financial resources rather than anticipating new revenue. In
reality, any efforts to restructure academic and administrative
activities like those described in figure 4 would require multiple years
and intensive consensus building among campus coalitions in order to be
successful. In addition, figure 4 also conveys that the pursuit of each
tactic carries significant risks to be managed by the college
leadership.
The first tactic is to differentiate tuition by capping discount
rates by school. In this way, the cost of comparatively expensive
academic programs is borne by those who are the direct beneficiaries.
For example, the 171 entering students in the School of Technology
represent $5,643,000 of gross tuition revenue (171 x $33,000), and a 9
percent drop in the discount rate (45 percent versus 54 percent) for
those students would increase the NTR in the School of Technology by
$530,442. A similar calculation for the 155 entering students in the
School of Business would yield $460,350. All other things being equal,
the positive revenue impact of $990,792 from the School of Technology
and the School of Business should cut the SIC deficit by a third.
However, the higher cost of attendance due to capping the discount rate
poses a real financial risk to the college because the lack of aid may
affect students' propensity to enroll. Of equal importance, the
54.4 percent and 54 percent discount rates suggest that these students
are highly desirable, likely because of their high quality (SAT score
and GPA). If these students fail to enroll, then there may be a steep
decline in institutional prestige. To diminish this risk, the college
could reallocate projected reserves to enhanced marketing of its
programs in order to broaden the pool of prospective enrollees. A full
discussion of the management of these types of risks is beyond the scope
of this article; however, authors write that higher education
institutions should "manage their strategic risks within the
context of implementing strategic initiatives" (Tahey et al. 2010,
p. 10).
While most of SIC's deficit is addressed through revenue
increases, the college's expense drivers must be addressed in order
to fill the remaining portion of the gap. For many institutions,
across-the-board reductions are the favored approach; however, this
approach merely rescales the problem. Dickeson (2010) describes how
colleges and universities tend to "make necessary budget cuts
across the board so that all programs suffer equally ..., which is
politically expedient" (p. 23). Dickeson goes further to state that
reductions need to be targeted in order to ultimately alter the balance
of institutional subsidies. At the same time, it is important to
acknowledge that academic programs possess inherently different expense
structures due to varying types of pedagogy. An attempt to forcibly
equalize instructional costs would impair and eventually terminate
higher-expense programs. The reduction plan described below is intended
to address the underlying institutional subsidies but would not
eradicate this type of cross-divisional support.
By providing empirical support, efficiency ratios can point toward
both the location and magnitude of reductions. For example, the 60
percent efficiency ratio for the School of Technology shown in figure 3
must be improved in order to address the underlying subsidy. A $540,253
(7 percent) expense budget cut to the School of Technology (as described
in figure 4) would improve its ratio by 5 percent to 55 percent
efficiency, as shown in the updated efficiency ratios presented in
figure 5. Since the School of Business is more efficient (40 percent
ratio), its lesser 4 percent expense reduction equals $186,584, which
drops its efficiency ratio to 38 percent. Lastly, the School of Art and
Social Science would see a reduction of $108,279 to its total budget (2
percent), dropping the school's ratio from 30 percent to 29
percent. In sum, the reductions to the academic enterprise amount to
$835,116 and potentially include a reduction in force. When combined
with revenue enhancements ($990,792), the total increase in resources
from the academic divisions is $1,825,908. The impact of the revenue and
expense tactics can be seen in figure 5, which shows that the overall
institutional efficiency ratio improved from 42 percent to 39 percent
and the efficiency spread ratio also improved from 30 percent to 26
percent.
It is of major importance to note that the ability of academic
leaders to continue to deliver high-quality programming is questionable
with reductions of this magnitude. If the institution's prestige is
ultimately harmed by reductions, then the long-term impact on enrollment
would destroy any gains achieved on the expense side. The college could
mitigate this risk by ensuring that a robust student learning outcomes
assessment system is in place so that any drop in academic quality could
quickly be addressed by the academic leadership.
To create operating reserves for SIC, the administrative enterprise
(allocated expense and overhead) also must endure a disruptive level of
reduction. Accordingly, figure 4 shows both 5 percent and 7 percent
reductions in allocated expense and overhead respectively, which would
yield a combined $1,936,581. Regarding allocated expense, a 5 percent
cut in library, media services, and academic administration may be very
visible to current students, and thus it poses a serious risk to
retention. A 7 percent reduction in overhead would yield the largest
dollar value of savings, yet deep cuts in overhead may reduce the
service quality of many functional units. The risks related to
reductions in allocated expense and overhead could be mitigated through
quality control monitoring of service levels in the areas subject to
reductions. Again, reductions on this scale are likely to induce
retrenchment, which would be painful. A robust communication plan is
also recommended to make the objectives of the reductions clear to
constituents. The total actions taken to address SIC's structural
deficit of $2,948,517 would include a combination of increases to
revenue and reductions in overall expense and generate operating
reserves of $813,972 ($3,762,489 - $2,948,517). SIC administration can
use this pool of operating reserves to support the achievement of
strategic initiatives, as well as new programming.
In the end, this exercise is an over-simplification of the complex
and challenging process of resource management. Yet, the exercise shows
that strategic resource management is exceedingly difficult and
politically perilous, for no institution would welcome dramatic
increases in student tuition or reductions in expenses. However, most
postsecondary institutions now exist in an environment where external
funding sources are increasingly competitive and scarce. And,
ultimately, it is this environment that will push colleges and
universities to consider the dramatic restructuring of existing
resources. Thus, success will in part be based on possessing reliable
and valid tools such as the overhead cover matrix, as well as courage.
APPENDIX: SMALL INDEPENDENT COLLEGE (SIC) CONTRIBUTION MARGIN INCOME
STATEMENT
Credit Hours Net Tuition Direct
Revenue Expense
(NTR) and
Fees
School of Art and 33,235 $18,059,899 $5,413,981
Social Science
School of Technology 25,675 $12,878,580 $7,717,905
School of Business 23,323 $11,801,438 $4,664,600
Total 82,233 $42,739,917 $17,796,486
Academic Library and Total
Affairs Media
Allocated Allocated
Expense Expense
School of Art and $365,585 $432,055 $797,460
Social Science
School of Technology $282,425 $333,775 $616,200
School of Business $256,553 $303,199 $559,752
Total $904,563 $1,069,029 $1,973,592
Contribution Contribution Contribution
Margin Margin % Margin %
of NTR of Total
School of Art and $11,848,278 66% 52%
Social Science
School of Technology $4,544,475 35% 20%
School of Business $6,577,086 55% 28%
Total $22,969,839 54%
Other Revenue Other
Revenue %
of Total
Net Auxiliary Income $121,445 35%
Net Endowment Income $109,755 32%
Net Grant Income $67,090 19%
Net Misc. Revenue $48,799 14%
Subtotal Other Revenue $347,089 100%
Total Net Revenue $23,316,928
Overhead Overhead
% of Total
Administration $12,045,435 46%
Student Services $3,469,969 13%
Facilities/Space $3,769,514 14%
Athletics $2,257,864 9%
Information Technology $2,289,320 9%
Debt Service $2,433,343 9%
Total Overhead $26,265,445 100%
Change in Net Assets ($2,948,517)
REFERENCES
Dickeson, R. C. 2010. Prioritizing Academic Programs and Services:
Reallocating Resources to Achieve Strategic Balance. San Francisco:
Jossey-Bass.
Horngren, C. T, G. L. Sundem, W. O. Stratton, D. Burgstahler, and
J. Schatzberg. 2011. Introduction to Management Accounting. 15th ed.
Boston: Prentice Hall.
Rumble, G. 1997. The Costs and Economics of Open and Distance
Learning. New York: Routledge Falmer.
Stuart, G. W., E. A. Erkel, and L. H. Shull. 2010. Allocating
Resources in a Data-Driven College of Nursing. Nursing Outlook 58 (4):
200-206.
Tahey, P., R. Salluzzo, F. Prager, L. Mezzina, and C. Cowen. 2010.
Strategic Financial Analysis for Higher Education: Identifying,
Measuring & Reporting Risks. 7th ed. New York: Prager, Sealy &
Co LLC; KPMG LLP; and Attain LLC.
Townsley, M. K. 1993. A Strategic Model for Enrollment-Driven
Private Colleges. Journal of Higher Education 8 (2): 57-66.
Whalen, E. L. 1991. Responsibility Center Budgeting: An Approach to
Decentralized Management for Institutions of Higher Education.
Bloomington, IN: Indiana University Press.
(5) Importantly, long-term liabilities (leases, bond debt, etc.)
are not included in the contribution margin calculation.
(6) It is unlikely that an institution would expect 100 percent
coverage of overhead by the academic divisions. In using this method, an
institution must consider carefully the expected percentage of overhead
to be carried by the various revenue-generating units.
AUTHOR BIOGRAPHY
Vernon B. Harper, Jr., PhD, is the Associate Vice President for
Planning and Academic Administration at West Chester University. Prior
to joining West Chester, Harper was the Associate Provost at Wilkes
University and the Associate for Academic Affairs at the State Council
of Higher Education for Virginia (SCHEV). Prior to those administrative
positions, Harper was on the faculty at Christopher Newport University
and California State University, San Bernardino.
Figure 1 Financial Aid by School
Division Incoming Current Credits Gross Tuition
Student Student Revenue
FTE FTE
School of Art and 222 1,108 33,235 $36,558,500
Social Science
School of Technology 171 856 25,675 $28,242,500
School of Business 155 777 23,323 $25,655,300
Total 548 2,741 82,233 $90,456,300
Division % of Student Net Tuition NTR Per
Financial Aid Revenue (NTR) Credit Hour
School of Art and 50.6% $18,059,899 $543
Social Science
School of Technology 54.4% $12,878,580 $501
School of Business 54% $11,801,438 $506
Total 53% * $42,739,917 $516 *
* These values represent the column averages, not the column totals.
Figure 2 Overhead Coverage Matrix
Division Credit Credit Contrib. Contrib.
Hours Hours % Margin $ Margin %
of Total of Total
School of Art and 33,235 40% $11,848,278 52%
Social Science
School of Technology 25,675 31% $4,544,475 20%
School of Business 23,323 28% $6,577,086 28%
Total 82,233 100% $22,969,839 100%
Division Overhead 95% Expected Overhead
Coverage % Overhead Coverage
Coverage Variance
School of Art and 45% $10,083,499 $1,764,779
Social Science
School of Technology 17% $7,789,795 -$3,245,320
School of Business 25% $7,076,198 -$499,112
Total 87% $24,949,492 -$1,979,653
Note: Total overhead = $26,265,445; per credit overhead rate at
95% = $303.40.
Figure 3 Efficiency Ratios
Division Direct Expense Net Tuition Efficiency
Revenue (NTR) Ratio
School of Art and $5,413,981 $18,059,899 30%
Social Science
School of Technology $7,717,905 $12,878,580 60%
School of Business $4,664,600 $11,801,438 40%
Total $17,796,486 $42,739,917 42% *
Spread 30%
(High/Low)
* This value represents the column average, not the column total.
Figure 4 SIC Tactical Planning Matrix
Tactic Revenue Impact Expense Impact
1 Cap discount rate for School of None
new enrollees in the Technology
School of Technology + $530,442
and School of Business
at 45%
School of
Business
+ $460,350
2 Use efficiency ratios None School of
to determine school-level Technology
reductions in direct expense -$540,253
School of
Business
-$186,584
School of Art
and Social
Science
-$108,279
3 Reduce allocated expenses None -$98,000
by 5%
4 Reduce overhead expenses -$1,838,581
by 7%
Sub-total Impact + $990,792 -$2,771,697
Grand Total Impact $3,762,489 in new resources
Risks(s)
1 High net cost to students may
reduce enrollment
2 Reductions may negatively impact
the ability of academic divisions to
deliver high-quality programs
3 Reductions could decrease
effectiveness of operations
4 and support programs
Figure 5 Efficiency Ratios after Revenue Increases and Expense
Reductions
Division Direct Expense Net Tuition Efficiency
Revenue (NTR) Ratio
School of Art and $5,305,702 $18,059,899 29%
Social Science
School of Technology $7,177,652 $13,409,022 55%
School of Business $4,478,016 $12,261,788 38%
Total $16,961,370 $43,730,709 39% *
Spread 26%
(High/Low)
* This value represents the column average, not the column total.
