Alerts
Alerts
April 25, 2014

The looming financial crisis for colleges and universities

Although the economic recovery is now five years old, the liquidity at many, if not most, colleges and universities has deteriorated and is now in the early stages of what could well become a crisis. The U.S. higher education system is the basis of our historical economic success and, while many of the challenges facing it are being discussed, change needs to be implemented sooner rather than later. Otherwise, colleges and universities risk facing the same fate as many failed businesses in other industries, such as automotive suppliers, who carried on with business as usual.

Potential warning signs to the presidents of educational institutions as well as the board members, many of whom have fiduciary responsibilities, need to be examined. This is especially true if unrestricted endowments are not significant. These include frequently raising tuition as much as possible, reductions in financial aid, lessening of admission standards, and increased costs to attract students. Additional indications that immediate action needs to be taken are declines in net tuition revenue, tuition revenue becoming a larger percentage of income, fixed assets increasing more rapidly than revenue, debt expenses rising faster than instruction expenses, and issues with access to government funding.

The historical reaction in higher education to financial issues has been to raise tuition, but this no longer works. Post-recession families have less savings and home equity to borrow for higher education. They are now more savvy customers and frequently base education choices upon objective factors, such as median graduate salaries, rather than emotional factors, such as how scenic the campus is or that family members are alumnus. The focus on return on investment, as well as other factors has helped drive online enrollment, which increased more than 15 percent per year from 2002 to 2010 to over 30 percent of enrollments.

The pitfalls, and possible solutions

As has been the case in other industries that experienced challenges, this imminent crisis did not occur overnight and is due in no small measure to institutional failure to recognize and react to change and adapt successfully. Part of higher education’s financial challenge is attributable to a desire for prestige and a belief that by offering more institutions would be more likely to succeed. However, this strategy of “if you build it, they will come” has failed. Revenue has not kept pace with the long-term debt, administrative costs, and student service costs of expanding into new areas. The result is that institutions now find themselves over-leveraged. Like all organizations, educational institutions must determine their core business, which is how they distinguish themselves in the market, and then focus on it.

Another cause for inertia in higher education is its fragmented, decentralized organizational structure. As opposed to the corporate structure where authority and power reside with the board and is delegated to the executive team, authority in higher education resides with the faculty. The faculty has tenure and academic autonomy, and change cannot be achieved without broad consensus. Because faculty typically view academic matters as their first priorities and have little experience in financial matters, they tend to perceive business matters as secondary and are resistant to change. Therefore, it is important to provide faculty with clear evidence that the issues will not pass simply because the economy will improve, and that institution-wide change is necessary to fulfill educational purpose.

Compounding these inefficiencies is how the college's departments, or even individual faculty, are operated as isolated silos, each with their own data management, procurement, scheduling, facilities, management, and budgeting, with no mechanism in place to align them. This obviously results in duplication, waste, and excessive employment costs. Less obvious, but of extreme concern, is the increased risk of data security breaches, which can result in significant legal exposure and adverse publicity, attributable to the decentralization of IT functions. Many of these non-core functions can be outsourced or centralized, reducing risk and cost.

Real estate and other physical assets also can be converted to cash via sale and leaseback transactions, with no impact on the use of the asset. Higher education institutions are not professional facilities managers, and can often realize cash and reduce ongoing expenses in this manner.

Colleges and universities have the opportunity to continue to be the wellspring of the U.S. economy, but they will not be able to do so by maintaining the status quo. They must each focus on their core mission: providing affordable quality education, typically in specific areas. While institutional change is difficult, it is often necessary. Unless institutions of higher education are efficient and operate on financially sound principles, they will fail.

For more information, please contact:

Stephen M. Gross
248.220.1337
sgross@mcdonaldhopkins.com

The twists and turns of business restructuring are complex and demanding. Our attorneys approach every case with creativity and insight to ensure the solutions are cost-effective and practical. At every turn, you can be confident that our attorneys will guide you through the process, always providing practical and informed advice. We are positioned to respond to the special demands of a variety of matters in a wide range of industries, including health care, automotive, retail/distribution, franchise distribution and technology, real estate/construction, telecommunications, and mining/exploration.

Carl J. Grassi, President
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