NACUBO Warns – Enrollments May Be Declining with Tuition Discounts

NACUBO just published its survey of tuition discounting, and the results are disturbing.  For the first time, a number of private colleges reported that new student enrollment declined despite increases in a tuition-discounting program.  Over the past several decades, tuition discounting strategies have provided private colleges with a mechanism to increase tuition by 2% over inflation while deflating the increase for new students through higher tuition discounts.

When tuition discounting strategies stop working, new student revenue drops and net tuition revenues fall below expectations.  Failed discounting strategies will quickly undermine the budgetary and financial stability of many private colleges.

Two possible reasons may explain why tuition discounting strategies are losing their punch.  The first reason is based on the underlying economics of discounting strategy, and the second reason is due to diminishing returns with tuition discounts.  This blog will talk about why the economics may be changing and how the tuition discount algebraic expression could accelerate the problems with lost net tuition revenue.

Economic Premise Underlying Tuition Discounting – Price Inelasticity

The basic economic premise underpinning tuition discounting is that students are price inelastic.  That is, if discounts do not reduce tuition below the previous year’s tuition rate, an increase in tuition will not result in a loss of student revenue.  More than likely, if the new tuition level leads to a drop in new student enrollment, it will be small and the higher tuition rate will offset the loss.

Why are students price inelastic?  Students in the past have not been price shoppers.  They tended to pick a college based on reputation, hearsay, or recommendations from friends or family.  Also, students have not needed to shop because tuition could be paid from savings or discretionary income or if they borrowed money, they did not accumulate large amounts of debt.  Lastly, until recently, students were likely to finish their degree at the college where they first enrolled.  They did not transfer elsewhere because transferring credits was too difficult and their personal investment in their own academic credits and social network were too high to forego.

When tuition discounting strategies were well-behaved as in Chart I, enrollments grew and total tuition revenue increased.  Presidents and Chief Financial Officers counted on tuition strategies to produce well-behaved patterns of tuition income flow, which led to budgetary and financial stability.

Chart I

   Well-Behaved Discounting:  Tuition Net of Inflation (0%).  Annual     Increment (5%) and Discount (base year discount: 42% with annual tuition increment of 1%) Compared to the Net Tuition Rate

 Are Students Becoming More Price Elastic?

Recent evidence suggests that students and their parents have become aggressive shoppers looking for the best price.  As colleges ease their rules in accepting transfer credit, they are encouraging students to continue to shop for the best deal, be it price, academic programs, sports, or amenities, even when they have enrolled and earned credit.  The best deal may encompass more than price.  One of the unexpected outcomes, with the increasing probability of transfers, is that colleges are forced to with both new students and their currently enrolled students.  Shopping by new and enrolled students suggests that price inelasticity is waning as students become more price elasticity.  Greater price elasticity will distort the customary tuition discount strategy of jacking up tuition prices then discounting it to new students.  Price elasticity suggests that higher tuition levels will drive students to find cheaper alternatives and that they may prefer easily understood posted prices rather than complex financial aid packages.

The Tuition Discount Formula Contains a Kicker

The tuition discount strategy typically has two components, a rate of change for tuition and a rate of change for tuition discounts.  As price inelasticity wanes and is replaced by greater price elasticity, a quirky aspect of the tuition discount strategy rears its ugly head.

When price elastic conditions prevail, tuition discounting strategies incorporate a kicker.  The kicker becomes apparent because static enrollment no longer masks the tendency of the tuition discount to produce diminishing returns and negative dollar changes.  This perverse aspect of tuition discounting is readily evident in Chart II.

Chart II

Hidden Kicker:  Tuition Net of Inflation (3%).  Annual Increment (5%) and Discount (base year discount: 42% with annual tuition increment of 1%) Compared to the Net Tuition Rate

Under the inflationary, incremental tuition, tuition discount, and static enrollment conditions in Chart II, posted tuition has a nice positive slope.  However, net tuition rate exhibits an alarming negative slope.  As price elasticity takes hold more colleges will find that as the enrollment mask is stripped away, net tuition rate will generate diminishing returns.  By implication, diminishing returns for the net tuition rate will carry through to diminishing returns for net tuition revenue.  Chart III clearly illustrates how marginal changes (diminishing returns) have a very steep and negative slope.  Presidents and Chief Financial Officers need to be worried about diminishing returns when tuition discounting strategies stop working; that is, enrollment no longer increases as net tuition rates increase over time.

Chart III

Effect of the Hidden Kicker on Marginal Change in Net Tuition

Private Colleges Should Take Prudent Steps to Build New Financial Strategies

For years, private colleges have been able to have their cake and eat it too by raising tuition faster than inflation and then partially reducing the impact through tuition discounts.  If tuition discount strategies are losing their capacity to generate new net tuition revenue, then it is prudent that private colleges, especially financially weak institutions, consider alternatives to the classic tuition discount strategy.  Moreover, government and media criticism about rising posted tuition charges only adds pressure to colleges to find new ways to fund the delivery system for education without depending upon never ending increases in tuition rates.

What Should Colleges Do If the Tuition Discounting Strategy Is Becoming Obsolete?

Private colleges will need a different perspective if they intend to develop new funding strategies and to deal with governmental oversight on tuition prices.  Here are several strategies for managing tuition pricing that Stevens Strategy has implemented with our clients.

1. Responsibility Centered Management (RCM) Analysis identifies programs that generate sufficient net income to support the general operation of the institution.  This analysis can be the basis for developing expense allocation strategies, cost controls, and new income producing programs.
2. Programs and Resource Optimization (PRO) adds mission centeredness, quality and marketability reviews to the RCM analysis of academic and other revenue generating programs.
3. Operational Cost Analysis pinpoints cost efficiencies and inefficiencies.
4. Financial, Marketing, and Operational Reviews – Stevens Strategy works closely with the President and Chief Operations Officers to review current financial, marketing, and income production strategies, practices, policies, operational systems,  to determine if they support the mission of the institution, generate adequate income, and provide a smooth-running cost effective operation.
5. Financial Health Checkup involves a thorough evaluation of financial conditions both short- and long-term to determine if financial stability is improving or declining.
6. Equilibrium Analysis focuses on the strategies needed to achieve economic equilibrium given known economic, financial, regulatory, competitive, and operational conditions.

Stevens Strategy recommends that Presidents and Chief Operational Officers conduct a careful review of their institutional discounting strategies, plans, and performance data.  Our firm can assist you in conducting the review and provide recommendations on changes that may need to be made to manage and control tuition and discounting strategies.  Contact us at [email protected] for more information.

Michael Townsley, PhD

Senior Consultant, Stevens Strategy