When Higher Education and Economics Collide

In the movie, Armageddon, there’s some over-the-top dialogue between an unlikely but
entertaining duo, Billy Bob Thornton and Bruce Willis, who team up to save the planet from an
asteroid named Dottie:

“Well, it’s coming, right now, right for us, at 22 thousand miles an hour. Not a soul on Earth can
hide from it.”

As fiction morphs into reality 10 years later, Dottie has swung around and taken dead aim at
higher education. It’s too late to pull down the shades and hide. The carnage is everywhere and
state-funded universities have taken the brunt of it.

For example, in Louisiana, LSU is facing a 20.6% budget cut in FY10 on top of a $10 mil cut
from FY09. Even venerable Harvard University feels the pain. It offered buyouts to 1,600
employees and suffered an $11 billion loss in its $36 billion endowment.1-2 Arizona State
University’s budget was cut $22 million in FY09 on top of $6 million in FY08. ASU is now
planning for a 40% reduction in state funding in FY10 over FY08. For California’s vaunted
higher education system – ground zero for Dottie – the financial situation had been characterized
by Cal State University’s Chancellor, Charles B. Reed, as a “mega meltdown.” In fact, on top of
a $97 million cut for FY09, the Cal State system is now staring at a massive $584 million crater
for FY10. The Cal State Northridge campus, devastated by a 6.7 magnitude earthquake in 1994,
is facing mandatory budget cuts of $41 million. With 85% of costs tied to salaries and benefits,
the pain is personal.

Professors are upset, naturally, and some have responded to prospective cutbacks with
philosophical despair. At University of Western Ontario, Nathan Sussman quit as Chair of the
Economics Department rather than downsize staff, calling his orders a “moral dilemma.” At
LSU, where Regents recently axed graduate linguistics programs, faculty cited “reputational
implications” of their actions: “For LSU to terminate the linguistics graduate programs… would
be, in this respect, for LSU to embrace the University of Arkansas as its peer, rather than the
University of Florida, the University of Georgia, or UT-Austin,” faculty wrote.3

Private universities haven’t escaped Dottie’s wrath, either, and according to a December 2008
survey,4 private college presidents plan to:

1. freeze new hiring, give smaller increases in salaries and impose unpaid furloughs
2. charge higher tuition prices
3. ask for more state and federal funding
4. delay renovations, maintenance; reduce discretionary spending, like travel
5. reduce wage increases, freeze salaries

But budgetary nibbles and price increases don’t add up to a strategy and for good reason. Most
academic leaders never built a company or made payroll with their own money. They never
pruned a product line, restructured a factory or built a marketing campaign. To the contrary, they
have grown fat on a steady diet of tuition increases and unbridled growth in administrative
overhead. In fact, from 2002 and 2006, the average tuition at the typical public university rose
over $1,400, or 27 percent, while spending on each student only went up by 1 percent, or $149.
This begs a bailout-esque question, “Where did all that money go?” A retrospective analysis by
the Delta Project on Postsecondary Education Costs, Productivity, and Accountability5 shows a
whopping 44% of all academic spending goes to administrative support (i.e., the bureaucrats) and
a falling share to faculty salaries and student instruction. Imagine stockholder’s reaction to a
CEO who let his company’s overhead rise 27% on zero sales growth.

While most universities pulled down the shades hoping Dottie would pass by, a few academic
leaders took bold action and challenged convention. Wisconsin Chancellor Carolyn Martin held
four forums on campus with students, faculty and staff6 to gather ideas for innovation and
efficiency given impending budget cuts. She says, “The boldest ideas came from students.” Ohio
State President Gordon Gee gave a speech on February 9 challenging faculty and staff to
“reconfigure ourselves” and reorganize traditional academic into “interdisciplinary clusters.” He
also kept tuition levels constant the past two years7 and hired a businesswoman with 30 years
experience in health care (no Ph.D. degree - gasp!) to run the University’s business school. At
Cal State Northrdige, President Jolene Koester held weekly video broadcasts and town halls with
the campus community with a level of honesty and transparency that corporate CEOs rarely
match.

These are good initial steps and it’s gratifying to see leaders of our best universities make change
happen rather than just talk a good game. But the fact remains these steps represent tweaks to a
sputtering business model.

On one hand, I’m sympathetic to higher education’s plight and, frankly, ticked off about it. The
American system of higher education is a national competitive advantage we should not fritter
away because of an economic downturn or public mismanagement. If I had my way, I’d redirect
funds that Congress budgeted for Harry Reid’s $8 billion Maglev train and Nancy Pelosi’s $30
million mouse protection program to research labs Caltech, MIT and Johns Hopkins where new
technologies are invented that benefit generations of Americans at all levels of society.

But on the other hand, there’s no free lunch in a recession and everyone should get a haircut. I
happen to live in Illinois where fiscal responsibility has been valued like a red-headed stepchild.
Given the State of Illinois’ $11.6 billion deficit and a $53 billion FY2010 budget (give or take a
$billion here or there), should Illinois higher education get a pass? Unlike California, spending in
Illinois for higher education is up slightly in the FY2010 budget and up 10% since FY2008
(excluding contributions to retirement). That’s $3 billion in taxpayer subsidy for starters, not
including tuition payments from mom and dad or contributions from non-parental donors. Based
on data from Governor Quinn’s FY2010 Budget8 and enrollments numbers from the Illinois
Board of Higher Education,9 here’s what our public universities get from Illinois taxpayers:10

University Students State State Funding

(#) Funding Per Student
($) ($)

1. University of Illinois 72,928 755,815,000 10,364

2. Southern Illinois University 34,381 238,138,000 6,926
3. Chicago State University 6,810 43,146,000 6,336
4. Western Illinois University 13,331 60,903,000 4,569
5. Northern Illinois University 25,254 109,225,000 4,325
6. Illinois State University 20,274 86,258,000 4,255
7. Eastern Illinois University 12,179 51,407,000 4,221
8. Northeastern Illinois 11,644 43,837,000 3,765
University

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So, as a bailout-fatigued parent of 2 college students who still believes “billion” is a large
number, I’m going to ask the hard question: Could Illinois taxpayers and parents get better
results on the state’s nearly $3 billion higher education investment if a tough-as-nails product
manager ran our state’s portfolio of universities and community colleges?

There are two iron-clad laws of product management I’ve experienced first hand. One law,
which econmists call the “experience curve,” goes like this:

Unit production costs decrease for each doubling of volume, assuming design and complexity are
constant

The second law links complexity to business performance:

Complexity and scale are inversely related with cost and quality

Simply stated, 1) “the more you produce, the less it costs” and 2) performance deteriorates as
variety goes up. If you think terms like “experience curve” and “complexity” are ivory tower
nonsense, read the book, “The Machine That Changed the World,11” or visit a Pontiac dealership.

Arizona State University is one education factory that makes my point.

Since 2002, ASU increased the number of academic programs from 273 to 331, established 16
new schools and launched 44 new academic centers and institutes. Growth is exciting when cash
is flowing, but given the vice grip of our current economic downtourn, unwinding that growth
into real cost reductions requires tough choices. Like General Motors, ASU must decide which
programs to keep and which programs to drop.

Beyond budgetary tweaking, what can a university do to get its costs in line with shrinking
revenues when “costs walk?” At University of Illinois’ Champaign campus, Chancellor Richard
Herman recently told a gathering of students and staff, “(T)he reality is that our assets are people
and 80 percent of our expenditures go to salaries.” At Cal State University, Chancellor Charles
B. Reed recently said that 85% of CSU’s costs are salaries and benefits.

So, what is a Chancellor to do? At ASU, the Chancellor implemented a furlough program
mandating 10-15 days off without pay for faculty, staff and administrators, basically equal to a 5-
7% haircut. Stanford, Syracuse and Indiana froze salaries. In California, the Board of Regents
proposed 11-26 furlough days for faculty and staff on top of a 2-Fridays-a-month shut down for
entire campuses. But is spreading the pain evenly through budgetary tweaking like furloughs and
pay freezes across everyone’s paycheck a smart haircut?

Ultimately, leadership is about strategy, resource allocation and results. Even though their
organizations and products are different, higher education could take a lesson from business
before politicians step in and do it for them. How? Two simple performance metrics from
product management -- product profitability and yield -- can help higher education manage
smarter through these difficult times.

1. Product Profitability. Imagine for a moment that all the colleges at University of Illinois
were brands, its programs were products and courses were components. Some colleges have
strong brands and a loyal following, like the College of Engineering and its 7,600 students.
Its Department of Computer Science provides tremendous value through tuition, federal
research grants and alumni donations. In contrast, the College of Liberal Arts and Sciences

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(LAS) provides comparatively less brand value but educates more than 15,000 students.
LAS’ Department of Slavic and Baltic Languages and Literatures, while well-respected,
provides considerably less value to the University than Computer Science. I’m not picking
on Slavic Languages at all; rather, it is representative of several boutique departments that
make up the complex fabric of this university.

A product manager would calculate the profitability of each course taught in each department
within each college of the university, allocate revenues from outside sources (i.e., donations,
gifts, research grants), and subtract costs directly caused by that department’s faculty, staff
and operations. Once this database is organized, results can be viewed at a course,
department, program, or college level. Since the majority of costs walk, analysis of
contribution margin is quick and straightforward.

However, a product portfolio manager would take a broader perspective and look at all
courses taught in all departments across all universities in the State of Illinois. Why? To
align resources in a way that 1) satisfies student demand, 2) educates students profitably and
3) provides a stimulating and sustainable environment for scholars to flourish in their chosen
fields. (Quick note to my academic friends: this is a mixed-integer mathematical
optimization problem that models virtually an unlimited number of alternatives, including
constraints for academic excellence. And it’s not a hard problem)

How, specifically? Let’s start with Slavic and Baltic Language departments as an example.

If there are 8 Slavic and Baltic Language departments across Illinois’ public universities but
demand for only 25% of capacity, is it prudent for Illinois taxpayers to foot the bill for 75%
excess capacity? Probably not. Is it wise to get rid of all 8 departments due to low demand?
Of course not.

So, what steps could any single department undertake to improve its profitability or minimize
its loss? With only a local perspective, each department would insist on keeping enough
faculty and staff to sustain academic excellence and enough courses to be attractive to
students. With a wider lens, however, one might argue that merging 8 departments into 3
bigger departments and allocating them strategically based on demand and geography would
make more sense. Students interested in Slavic languages could still choose 1 of 3 schools to
attend, academic excellence would likely improve as more scholars collaborate together, and
selective reductions that balance capacity with demand would yield the cost reductions which
Dottie and state budgets demand. Moreover, the University with the best Slavic and Baltic
Language department could expand its product footprint by franchising instruction to other
Illinois universities that can’t afford the fixed costs of a boutique department through in-
residence, electronic or blended delivery models.

On the other hand, product managers don’t just downsize. They also expand capacity to steal
share from competitors with killer products. Let’s use the Department of Computer Science
at University of Illinois’ College of Engineering (ranked 4th nationally) as an example.

At a micro level, the capacity of the Department of Computer Science is constrained by

classroom space, faculty and its budget. Despite its strong ranking, enrollments held steady
between 590-625 students for the past 3 years. As a consequence, hundreds of highly
qualified Illinois students were forced to attend out of state schools like Michigan, Purdue
and Georgia Tech where they pay two or three times more for tuition than at University of
Illinois. And hundreds of out-of-state students who were willing to pay tuition premiums at

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 Illinois could not attend. These “leakage” and “stock-out” problems represents more than
lost revenue for the College of Engineering and University of Illinois. When markets don’t
clear, inefficiency imposes a cost. In this case, the State of Illinois is deprived of scarce
human capital that creates new technologies and builds new businesses, and Illinois taxpayers
subsidize higher education more than they should. The College of Engineering is deprived of
the revenue, research and scale it should naturally have. And the University of Illinois is
deprived the brand benefits, academic excellence and future donations that a right-sized
College of Engineering would yield.

To be clear, I am not advocating elimination or expansion of any particular department or

college. The point is to find a sustainable operating structure across the state’s publicly
funded higher education system where budget reality, scholarship and student need coexist at
the appropriate scale based on market demand and financial constraints.

If an institutional haircut is inevitable, data from product profitability analysis can be the
difference between a smart trim and a buzz cut.

2. Yield. At an automotive assembly plant, the concept of yield is a well-known metric. In

oversimplified form, yield is:

The percentage of total cars manufactured that passed final inspection able to be sold

In higher education, yield means “graduation rate:” the percentage of students who enroll and
graduate on time. What most people don’t know, and higher education doesn’t openly
discuss, is that graduation rates are remarkably low.

If yield in an automotive assembly plant is low, there are two possible explanations. One, the
raw materials are defective. Two, the manufacturing process is flawed. If graduation rates
are low in a university, there are three possible explanations. One, students are not capable of
graduating. Two, students choose not to graduate. Three, the educational process is flawed.

In the California State University system, graduation rates run about 16% after 4 years 48%
after six years. In Illinois, graduation rates vary widely across public and private
institutions.12 In fact, out of 240,000 students who begin college this year in Illinois, only
56% of them will graduate in 6 years and many schools are shockingly bad:

Graduation Rate
Institution 4 Years 6 Years
Northwestern University* 86% 92%
University Of Chicago* 82% 84%
Wheaton College* 78% 87%
University Of Illinois (Champaign) 61% 78%
Western Illinois University 32% 49%
Northern Illinois University 23% 49%
University Of Illinois - Chicago (UIC) 21% 42%
Southern Illinois University 21% 42%
Columbia College Chicago 26% 27%
Roosevelt University 20% 24%
Northeastern Illinois University 3% 19%
Chicago State University 3% 18%
* private school

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 Welcome to the soft underbelly of public higher education. If universities were
manufacturing plants, warning lights would flash, the line would STOP and problem-solving
teams would swing into action. But in higher education, lights don’t flash and heads don’t
roll when 50% of students fail to graduate in 6 years because universities get paid no matter
what.

What other industry could survive with a 50% failure rate?

As disturbing as these four- and six-year graduation rates are to most people, such lagging
indicators don’t explain “why” or “how” to fix the problem. Moreover, they don’t explain
students who intentionally transfer or, due to economic constraints, drop out to get a job.
Nevertheless, a product manager would look for underlying cause-and-effect relationships or
unusual patterns in the data that signal opportunities for improvement. For example, while
Chicago State University only graduates 3% of its students after 4 years, its problems begin
early: over 40% of Chicago State freshman students don’t survive freshman year.13 Is this
troubling statistic indicative of a flawed recruiting process, ill-prepared students or faulty
instruction and student support systems? Or, could this statistic reflect Chicago State’s
mission as a bridge to another school for financially-challenged students? At University of
Wisconsin, progressive Chancellor Carolyn Martin identified specific faculty shortages that
prevented scores of students from enrolling in an introductory organic chemistry class. Given
the sequencing of prerequisites for certain majors at Wisconsin, students were forced to elect
another course or spend $20,000 for another year in Madison.

While such numbers are disturbing, the situation is even worse for one segment of students –
military veterans. Data from DoD and the US Department of Education14 reveal that veterans
are “6 times” less likely to graduate at all post-secondary schools than non-veterans and “3 ½
times” less likely to graduate than non-veterans. Ironically, according to the US Department
of Veteran Affairs, veterans’ expectations for earning a degree are higher than traditional
students’ expectations upon matriculation.

Dottie is on a collision course with higher education and it’s too late to pull down the shades.
There is still time for policy makers and higher education to collaborate on a smarter haircut,
but budgetary tweaking isn’t enough. It’s time for Springfield to demand a clear strategy that
produces better results – education outcomes and efficiency – from higher education in
exchange for billions of taxpayer dollars every year. The alternative is Bailout 3.0.

1
http://chronicle.com/news/index.php?id=5967&utm_source=pm&utm_medium=en
2
http://www.boston.com/news/local/massachusetts/articles/2009/06/17/harvard_classrooms_labs_feel_pinch_of_budget_cuts/
3
http://m.insidehighered.com/news/2009/04/30/programs
4
http://www.naicu.edu/news_room/naicu-survey-examines-the-economic-concerns-of-private-college-and-university-leaders
5
http://www.insidehighered.com/news/2009/01/15/delta
6
http://chronicle.com/media/audio/v55/i24/martin/?utm_source=at&utm_medium=en
7
http://president.osu.edu/speeches/ace_02082009.php
8
http://budget.illinois.gov/documents/FY2010OperatingBudget.pdf
9
http://www.ibhe.state.il.us/Data Bank/DataBook/2008/Table I-2.pdf
10
$1.6 billion more is spent on community colleges, loan programs, retirement systems and administration. Figure does not include
federal and corporate research grants or alumni donations
11
http://www.amazon.com/Machine-That-Changed-World-Production/dp/0060974176
12
http://www.collegeresults.org/default.htm
13
http://www.blackcollegesearch.com/illinois-colleges/chicago-state-university.htm
14
Source: Aurora D'Amico, U.S. Department of Education Institute of Education Sciences, “Beginning Postsecondary Students
Longitudinal Study” (http://nces.ed.gov/surveys/bps/ -- Excel data tables available upon request)

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