Cost and price in higher education, again

These administrators are like cookie monsters… They seek out all the resources that they can get their hands on and then devour them

Ronald Ehrenberg in Tuition Rising

As economic conditions around the country (and world) impose increasing limitations on funding for higher education, it is worthwhile to review some of the major reasons that higher education costs are so high and rise so rapidly. An understanding of these reasons is critical to making rational responses that preserve (and perhaps even strengthen) important components of institutional mission. This is, of course, a subject that has been extensively written about over the past several decades by many authors, but since responses to the current economic situation seem to generally ignore what is known about the problem, perhaps another brief review is justified. Interested readers will find my many earlier takes on this issue collected here. 

The quote above is basically a brief restatement of what is known as Bowen's Rule, which appeared in one of the earlier (1980) extended studies of cost in higher education. Bowen pointed out that budgeting in higher education is basically the inverse of that which occurs in most industries: first you see how much income you can raise, then you spend it all in pursuit of an elusive goal of "excellence" and brand. I put excellence in quotes because it is a concept that primarily is internally defined by academe itself rather than by its customers.

Interestingly, however, a recent work by Christensen, Horn, Caldera and Soares (CHCS) called Disrupting College showed that many of the cost issues in higher education actually correspond extremely closely to well - studied cost issues in other industries. Turns out there are cookie monsters everywhere!

I will lean heavily on their analysis, because it gives a somewhat different perspective and brings in data from other industries that demonstrate the difficulties of finding simple, minimalist solutions to cost problems.While the terminology used may be offensive to some in higher education, the insights to be gained are, I think, worth the discomfort that may result. 

I want to focus on research universities, because that is where much of the public debate is focusing. Both cost and price are of importance, of course. I will not differentiate between public and private research universities, because in reality, most of the difference between the two sectors comes in how the price is allocated to different types of customers. To a high degree, the costs are the same in both sectors, and by Bowen's Rule, the prices are therefore the same (or vice-versa).  As I mentioned in the first paragraph, it is important to consider both why the cost is so high, and why the cost has risen for three decades at an annual rate well beyond that of inflation.  

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First, why does higher education cost so much? CHCS lay the problem squarely at the feet of our intertwining multiple missions of teaching, research, and social growth of students:

There are three generic types of business models: solution shops, value-adding process businesses, and facilitated user networks. Each of these is comprised of its own value proposition, resources, processes, and profit formula.Universities have become conflations of all three types of business models. This has resulted in extraordinarily complex—some might say confused—institutions where much of the cost is tied up in coordinative overhead rather than in research and teaching. 

CHCS identify research with the solution shop model, which focus on diagnosing and solving unstructured problems; teaching with the value-adding process model, which uses resources and processes to turn incomplete inputs into more complete outputs of higher value; and social growth with facilitated user networks in which participants exchange things with each other. 

This conflation of different models in the university causes a big problem, since research in corporations show that mixing different types of business models in one organization is extremely expensive - it demands a mix of resources (including personnel) and processes that is very inefficient and expensive when looked at from the perspective of any of its component models. In fact, the overhead costs in such mixed-model organizations can dwarf the actual production costs. And, according to CHCS, this is just the real cost problem in a research university: 

Our best guess is that the overhead burden rate in conventional universities is between 4.0 and 5.0. In other words, universities spend four to five dollars on overhead for every dollar spent in teaching, assessment, and research....

Traditional universities trying to emulate the prestige of Harvard are structured ....in order to optimize the “solution shop” activities of their faculty. The value-added process activities of teaching students are sub-optimally force-fit into this structure.

And, one must add, the social growth- facilitated user networks are similarly sub-optimally fit into the structure. One must also emphasize that the solution- shop research activities of the faculty are simply optimized within the constraints of the existing multi-model organization, rather than in an absolute way. Most faculty will tell you that all that teaching and service seriously interferes with their research! 

Most of what has been written previously about the cost of higher education can be fit into this framework. What seems to be important to me about this perspective is that it tells us that corporations known for efficiency (relative to universities, at least) have the same cost issues when running a "conglomerate" organization. Thus, the problem is not that universities are inefficiently run, it is that they are built on a model that intrinsically carries a huge overhead.  The model itself will have to be changed in major ways in order to reduce costs appreciably.

Let me turn briefly to price and how it relates to this picture. The price that captures everyone's attention is that which is attributed to the educational component - tuition and fees, plus State support for educational activities in the public sector.  The other prices of major importance for the university are the prices charged to funders of research (primarily government and corporations), and room and board, which covers a component of the socialization activities. Given market forces that limit the prices that can be charged in each of these areas, the sum of all of these prices is not sufficient to cover all of the costs of all of the activities in these areas that the university wants to have. As a consequence, additional resources must be found e.g.philanthropy, patents, to balance the books.

Universities don't keep their books in a way that makes it easy to calculate how costs are allocated to the various functions, but it is clear that cross subsidization of activities is at the core of budgetary operations. Thus, the "educational function" actually carries many of the costs of social growth, e.g. recreation centers, student affairs, as well as of faculty research. The most obvious example of the latter is the very significant increase in cost and loss in productivity that comes when teaching faculty who teach four or more courses per semester are replaced with much more expensive research intensive faculty who teach two or fewer courses per semester. And, it must be noted, there are no data that suggest that student learning at the undergraduate level is better when such a replacement is made - this is simply part of the optimization of the "solution shop" activities mentioned by CHCS, and an example of the excess overhead that appears in this mixed model. In the end, however, what purports to be the price of the educational function is, in reality providing significant price subsidization for other activities of the university.

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Let me turn now to the reasons behind the rapidly increasing cost of higher education - 3%/year above the CPI for the past three decades. One traditional explanation also looks at the corporate side, and points out that enterprises whose major costs are for highly skilled workers who move in a broad market tend to see costs rising faster than the CPI.  Simply a question of paying competitive salaries for desirable workers. Some have argued that although this cost increase is real, it has been mitigated by turning to low cost graduate students and part time adjuncts for more teaching.  This is certainly true for some institutions, but universities have not uniformly turned to this solution. Thus some portion of the average increase probably still is due to this effect.

CHCS provide us with an alternative/additional explanation of the rapid cost rise based on corporate data: 

Our observation has been that as a general rule, head-on, sustaining competition among competitors with comparable business models, which lack economies of scale, drives prices up 6 percent to 10 percent per year in nominal terms.

Universities certainly all have comparable business models, and we lack economies of scale, so this shoe seems to fit. In our case, our sustaining competition has been called an arms race of ever upscaling athletic facilities, student services, lecture halls, big-name professors, etc. And, in addition some part of sustaining competition for higher education generally is mission creep - adding a master's degree to an undergraduate institution, etc. So the good news here is that higher education has actually kept price growth in better control than the corporate sector since we only grow at a nominal CPI plus 3% rather than the 6-10% found by CHCS! The bad news is it seems to be a universal effect seen across very different industries with very different drivers, so getting rid of the effect is probably not a reasonable goal.

If one sees price containment as absolutely necessary in the current reality (as I do), then one must look at the obvious caveats contained in the quote above: all competitors have the same business model, and there are no economies of scale. Thus an organization that hopes to contain real increases in price (as opposed to cost) either will have to try a very different business model, or find economies of scale, or both.

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The discussion above certainly does not suggest that universities should not try to improve efficiency and productivity by e.g. adopting approaches such as have been described by the National Center for Academic Transformation that demonstrate increased learning outcomes while decreasing costs by the order of 40%. Such innovations should be part of any program to control costs.  However, because overhead costs dominate the actual cost of teaching, such improvements will lead to only marginal decreases in total costs. Larger decreases will depend on more aggresive changes to the basic business model.

The CHCS analyses strongly suggest that in organizations having a conflation of business models similar to ours, no individual business model is optimized. This opens the possibility that through rational but creative reorganization and adoption of new procedures, we could create a model in which the efficiency and effectiveness of each and every one of our missions was increased - at a lower total cost.

In this day when we hear constant warnings of approaching doom from our academic leaders as they look at ever more constrained resources, this analysis suggests that doom is only inevitable if the leaders lack the vision and resolve to look beyond the current model.  Studies in other domains strongly suggest that we can achieve better outcomes with less - with leadership.   

Comments

[melodions]

he flip side is the tenured professors that do bring in millions in grants and have the authority to keep every penny that they hold onto for dear life.

[Education and Career Forum]

The cost of higher education also depends on the universities and courses. You have very properly elaborated higher education issues in this post.

[Kim N.]

Quite an interesting piece. It is disturbing to see that higher education continues to be on an incline as America's economy continues to plummet. It is sad to see that higher education is just another business that seeks to make money not future leaders.

[Gina W]

I agree with Lloyd. I am a non-tenured professor at a large inner city research institution. The tenured professors that bring in grant money are lured with higher salaries and lower teaching loads. The dollars certainly do not filter down to my salary. It is a wonder the nursing colleges are turning away students due to insufficient faculty.

[Jezreel Ricafort]

It is directly proportional, if you want high education, then the price of schooling should be higher to, let say for example if the professor is very experience and intelligent, if you hire them, then you need to pay them high.

[Grant Hughes]

Lloyd, what you say is dead on. The flip side is the tenured professors that do bring in millions in grants and have the authority to keep every penny that they hold onto for dear life. They then make the school pay for new labs out of general expenses and new labs are seriously expensive.

The problem then becomes the school using the much needed state monies granted to them for the benefit of the tenured professor and his hand picked small group of students because the school is afraid to lose the professor to another institution.

And then there are the athletic departments that squeeze university funds even though they bring in millions from alumni.

Education is getting harder to come by in state universities when the sole goal anymore is making money and it's usually the students who pay, and unfortunately part of that payment is lesser education

[Grant Hughes]

A major problem that I have seen first hand at the University of Maryland is the expense of keeping tenured professors.

Not all professors mind you but the professors that bring in substantial grant monies. The colleges do whatever it takes to make these professors happy including building new labs, offices and in some cases buildings.

In most cases the grant money coming in is in the millions but it stays with that particular professor and doesn't filter out of the dept. For the schools this is prestige and they hope that this prestige brings in more students but the outlay they make is generally much higher than the return.

Lloyd comments: and, in addition, the professor's research funding essentially never is sufficient to cover the real cost of the research - which then must come out of some other cash flow in direct competition with other activities of the university. And with addition research, they get higher salaries and often lower teaching loads, which drives down productivity, drives up costs in what one might imagine should be the major product of a university or college - education.

[JonathanN]

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[Krista R]

The increasing costs of higher education is a growing concern for quite a few people. The solution shop model of higher education has become such a part of daily functioning in a university, that I often don't think of it as part of a larger issue. I was somewhat alarmed when you stated that "The model itself will have to be changed in major ways in order to reduce costs appreciably." That seems to be a quite a large task!

In your final paragraph, you noted that "Studies in other domains strongly suggest that we can achieve better outcomes with less - with leadership." I would love to hear more about this in a future post.

[Online ged programs]

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