Higher Education Policy and Practice

Economic Equilibrium in Higher Education

Economic equilibrium is a state of long-term financial sustainability for an institution of higher education. Richard Cyert, who developed the concept, set these conditions for a state of economic equilibrium:

  1. There is sufficient quality and quantity of resources to fulfill the mission of an institution.
  2. The organization maintains:
    1. The purchasing power of its financial assets
    2. Its facilities in satisfactory condition.(1)

Cyert’s equilibrium is mission-driven and is a fragile state that depends on income flows from operations and capital gifts to maintain the purchasing power of its financial assets and its facilities in satisfactory condition.  Disequilibrium occurs during periods when -deficits absorb assets, endowments decline in value, net tuition is uncompetitive, costs are too high, gifts are inadequate, government initiatives increase costs or decrease revenue flows, and/or the demographics of student markets change in unexpected ways.  What colleges need is a dynamic state of economic equilibrium in which financial resources grow so as to avoid a state of disequilibrium.  An institution cannot assume that positive but small changes in net income and financial assets are sufficient to either stave off disequilibrium or to sustain a state of economic equilibrium.

When an institution’s financial condition has eroded to the point where it has cash and financial reserves have been seriously depleted, developing a strategic plan to achieve a dynamic state of equilibrium is difficult.  Easy decisions, such as raising tuition or simply cutting expenses across the board, can be counterproductive if it pushes the college outside its competitive boundaries (2).  As Richard Cyert noted, “[T]he trick of managing the contracting organization is to break the vicious circle which tends to lead to disintegration of the organization.  Management must develop counter forces which will allow the organization to maintain viability.”(3)

In sum, boards of trustees must expect more from presidents and chief financial officers than a simple budget that only responds to current financial and economic conditions.

Equilibrium Principles
Cyert’s equilibrium can be restated as a set of principles:

  • Financial Equilibrium is a financial state where a college has the financial resources (net assets) to sustain its mission and to provide for future generation of students.
  • Disequilibrium is evident when a college has a history of: deficits, low or non-existent cash reserves, excess endowment draws, loans from the endowment, short-term cash loans, large deferred maintenance claims, and net assets are shrinking or growing at a rate less than the rate of inflation.
  • Reaching a state of financial equilibrium requires the elimination of the causes of disequilibrium.
  • Difference between equilibrium and disequilibrium is the equilibrium gap.

Identifying the Equilibrium Gap
The followings steps are used to estimate the Equilibrium Gap that will have to be closed to reach equilibrium.

  1. Close the Purchasing Power Gap for Financial Assets.
    1. If there was deficit reported in the prior year audit, enter the amount of the audited deficit.
    2. If the cash balance in the last audit was negative, enter the amount of the cash balance.
    3. If there was a line-of-credit balance in the last audit, enter the balance of the line-of-credit or any other short-term cash loans.
    4. Sum these four figures and it will be the amount needed to close the purchasing power gap.
  2. Close the Endowment Gap
    1. Amount of endowment draw in the last audit in excess of a 4.5% prudent draw.
    2. Loan balance in the endowment fund from the prior audit.
  3. Close the Fixed Asset Gap (two alternative methods of computing the gap are available)
    1. Measure One:  If the college has a maintenance schedule that is not being funded, add the accumulated unfunded. Expenditures.
    2. Measure Two:  This measure provides a method for estimating the value of unfunded maintenance for non-financial assets, if the institution does not have a maintenance schedule:
      1. Take 3.3% of the total undepreciated value of the buildings on campus times the number of years that the college has not expended funds on the maintenance of its buildings.  (3.3% is used because of technology changes and the potential for significant changes in the cost of energy; a thirty year span rather than a forty or fifty year span is used.)
      2. Use 6.7% of equipment value excluding technology times the number of years that the college has not expended funds on the maintenance of its equipment or fixtures.  (This factor uses fifteen years rather than a longer period owing to the accelerated rate which equipment and fixtures become obsolete.)
      3. Use 20% of the value of technology times the number of years that the college has not expended funds on the maintenance of its technology not to exceed total cost.  (This assumes that hardware and software for instructional, administrative, or other uses has a life span of five years.)
      4. Total the maintenance costs for rebuilding the infrastructure of the campus.
  4. Adjust the total for cash, endowment, and non-financial assets by the rate-of-inflation for the number of years that the college will need used to close the Equilibrium Gap.

Table I
Matrix for Estimating Dollars Needed to
Close the Cyert Equilibrium Gap

Strategies for Eliminating the Equilibrium Gap
Here are several strategies that are common place in higher education for eliminating the Equilibrium Gap. The particular strategies selected will depend upon opportunities, both internally and externally, resources that it can use, and constraints on a particular strategic option.

  1. Enrollment, Recruitment, and Retention
    1. Enrollment, recruitment, and retention strategies are attractive to most private colleges (3) because enrollment generates more than 60% of their revenue.(4,5)  For most public institutions, enrollment is the single factor that determines their financial condition.
    2. The structure of the plan will depend upon the college’s student market, competition, financial aid resources, academic offerings, and willingness of the board, faculty, state and accrediting authorities to permit the institution to redesign, delete, or add new programs to the curriculum.
    3. Admission strategies are complicated by the net cost to students, the student’s long-term debt, the right mix of programs, and the pay-off when the student graduates and looks for employment.  (Graduate and professional schools add another level of complexity for student choice of a college and will not be considered here.)  Admission campaigns today have to be aggressive with continuous follow-up until the prospective student is sitting in the classroom.
    4. Retaining students once they are in college is an imperative given the cost of finding and admitting new students.  Every student lost before finishing a full course of study forces the college to find a replacement.  The result is that new student campaigns have to be devised to produce excess enrollment to offset attrition during the period that the cohort is enrolled. Most students, who do leave, will leave by the end of the first year.  The evidence suggests that retention depends on how well the student did in high school.  If new student leaves high school in the upper two-thirds of her/his class, and her/his parents believe that a degree is essential for success in life, then the probability of graduating within six years is high.(7)  If a student did not do well in high school and is the lower third of their high school graduating class, and college is merely a place to avoid earning a living, then persistence is low.(8)
  2. Gifts and Grants
    1. Gifts and grants play a critical role in most institutions even tuition-dependent colleges because these resources provide income to reach budgetary breakeven.  Plans to solicit gifts and grants have to consider the cost inherent in seeking money from alumni, friends of the college, corporate grants, foundation grants, and government grants.  A college at disequilibrium must allocate its resources (people, time, and money) only to efforts that have a high probability for a payoff in the short and medium term.  Writing documents for foundation and government grants can quickly absorb the meager resources of a struggling college and often there is little chance for a payoff.  Moreover, long term gift or grant projects should be postponed until the college nears its point of equilibrium.  For example, asking for major gifts requires a long-term campaign where the president or a senior staff member dedicates a large portion of her/his time to the care and feeding of wealthy donors or foundations.  Fly-in and fly-out visits will not work; the president must care about the person and understand their needs, hopes, and intentions.
  3. Endowments
    1. Endowments, which are treated by many as the panacea for all financial problems, do not simply grow incrementally every year.  Endowments are also another source of exasperation when endowments decline in value during major financial market crashes as happened from 2001 to 2002 and 2008 to 2009.  When a struggling college invests a good portion of its time adding funds to the endowment, they must also recognize that falling financial markets have large and unanticipated effects on net income (statement of activities) and the balance sheet (statement of financial positions).  When endowments lose market value, the loss could drive net income into sizeable deficits.  Deficits and reduction in the value of net assets may violate debt covenants and lower the score on the DOE test of financial responsibility, which could lead to government penalties.
    2. Investment committees have conflicting preferences.  They would probably prefer that the college maximize its returns to build investment value over the long term.  Savvy investment committees see the problem of losses in financial markets as a short-term problem for the CFO, but they believe that their charge is to build the wealth of the college over the long term. However, the CFO must explain to the board and the investment committee the fiscal and financial implications from selecting high-risk/high-return investment strategies.
  4. Auxiliaries
    1. Too many colleges and universities overlook net revenues from auxiliary operations. It is dismaying to find colleges where residence halls, food services, or bookstores regularly yield deficits.  At a minimum, auxiliaries should cover their direct expenses plus related interest expenses and principal payments for their debt.  If the auxiliary cannot achieve this elementary financial goal, the CFO should devise a plan to align operational performance with this goal.  Institutions at disequilibrium should outsource auxiliary operations that cannot support their own costs.
  5. Cost Controls
    1. Controlling costs is essential for institutions at disequilibrium they may discover that generating revenue to close a growing equilibrium gap is neigh impossible.  Several cost control solutions that have are effective include: consortia, outsourcing services, cutting back on middle-level management, and rigorously cutting unjustified costs.
  6. New Initiatives
    1. Most equilibrium strategies include new initiatives, especially if they promise sufficient scale to speed up the closing of the equilibrium gap.  Too often, presidents and chief administrative officers waste their scarce time tinkering around the edges on projects with either a small probability of success or a small chance of generating significant results.  Before a new strategic initiative is selected, it should be tested against the institution’s financial or budget planning model, and if it involves a new academic program, its success in the market should be tested.  Here is a simple list of potential new initiatives:
      1. Joint ventures, between community colleges and four-year institutions
      2. Synergistic initiatives:
        1. Between colleges to provide courses and degrees that one or the other or both cannot do on their own
        2. With corporations to provide specific skill or management training that leads to a degree
        3. Form partnerships with professional organizations, colleges, or other entities so that students can earn professional certification that fits into a building block degree
        4. Establish a consortium with other colleges to offer on-line programs that reduce their costs of delivery and expand their markets.
      3. Set-up building block degree programs in which students can earn certificates, course credit, and bring in credit from other agencies and colleges (example, MOOC courses) that can be put together into degree credits
      4. Re-engineering administrative processes by replacing offices with administrative networks
      5. Refinancing debt to reduce interest expenses
      6. Monitor changes in the labor market with human resource managers to devising new academic programs for new skills required by the labor market.

Strategic-equilibrium plans require constant and regular monitoring of key activities by the board of trustees and president.(9)  Monitoring should include monthly reports and benchmarks for admissions, retention, endowment performance, gifts, and new initiatives. Whether plans are working well and especially when they are not working well, key leaders must be ready to explain how a plan can be revised to reach a dynamic state of equilibrium.  In some instances, a “Plan B” must be kept on the back burner, just in case the original plan fails to produce results to eliminate the equilibrium gap.(10)  A “Plan B” is particularly important at colleges struggling to survive.  Their “Plan B” may require soul searching to determine if they can best serve their mission and, in particular, their students through a merger.(11)

Equilibrium is the boundary level for colleges and universities seeking to prosper.  By reaching and maintaining equilibrium, the institution should be producing excess revenues that will permit the college to survive unexpected and financially-costly events and to grow to better serve its mission and its students.

End Notes

  1. Ruger, A., J. Canary, and S. Land.; (2006); “The President’s Role in Financial Management” in A Handbook for Seminary Presidents; edited by G. Lewis and L.; William B. Erdman Publishing Company; Grand Rapids, Michigan.
  2. Competitive bounds refer to a matrix with price and quality as axes of the matrix. A specific market is depicted as a smaller square within the matrix which includes potential students who prefer to enroll at a specific college with a particular level of price and quality.
  3. Cyert, R. (July, August 1978); The Management of Universities of Constant or Decreasing Size; Public Administration Review; p. 345.
  4. Seventy-five percent of private colleges fall into the tuition-dependent category.
  5. JMA Higher Ed Stats (2003); Management ratios 2002 private colleges, universities, catalog #3690103. Boulder, CO: John Minter and Associates.
  6. JMA Higher Ed Stats (2008) Strategic higher education trends at a glance: F2 2002.csv and F2 2007.csv financial data. Boulder, CO: John Minter and Associates.
  7. Zemsky, Robert and Penney Oedel (1983) The Structure of College Choice. College Entrance Examination Board: New York.
  8. Adelman, C. (2006) The toolbox revisited: Paths to degree completion from high school to college. Washington, DC: U.S. Department of Education.
  9. Ruger, A. (February 12, 2010); Institutional Viability and Financially-Stressed Schools (unpublished); presented at a conference conducted by the Association of Theological Schools
  10. Ruger, A. (February 12, 2010); Institutional Viability and Financially-Stressed Schools (unpublished); presented at a conference conducted by the Association of Theological Schools.
  11. Townsley, M. (2002); The Small College Guide to Financial Health. Washington, DC: NACUBO; p. 180.
About the Author: Mike Townsley, Ph.D.

Michael Townsley has more than 20 years of experience in academic services, financial systems, budgets, marketing strategy, payment plans, IT administration, ancillary operations, and site management. Mike is Senior Consultant with Stevens Strategy and former President of Pennsylvania Institute of Technology. During his 20 years … (Read More)

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