It should come as no surprise that margin, the difference between cost and revenue, emerged in blogs 1 and 2 as a key variable in the economics of teaching. What may be less obvious is that faculty and academic administrators need to take margin seriously. Conventional wisdom says that academics should focus on mission and its associated teaching and scholarly priorities while leaving the management of margin—and by extension the use of models that measure margin—to the institution's accounting and financial people. This blog describes why the conventional wisdom is wrong: why effective academic resource management requires mission and margin to be considered together, and why this is best done by the academic side of the house.
Traditional universities are nonprofit institutions. Their goal is to serve the public interest, which they define largely in terms of their academic missions, rather than the private interests of owner-shareholders. Surpluses from operations are reinvested within the university rather than being sent to shareholders. This means academics are furthering their own professional interests when they focus on managing margins. More and better academic work is possible when margins are healthy than when inattention causes money to be frittered away, and considering program economics in isolation from quality and other mission-based priorities is a recipe for trouble. Insistence on considering the two separately confuses the university's not-for-profit decision-making criteria with the antithetical profit-making ones.
Figure 1 compares the not-for-profit (NFP) and for-profit (FP) approaches to resource management. NFP entities maximize mission attainment while observing the operational, regulatory, and market constraints that apply everywhere services are sold. They also must ensure that their overall margin (revenue minus cost for the institution as a whole) is not persistently in the red—which eventually would drive the school to bankruptcy. FP entities, on the other hand, maximize total profit (i.e., overall margin) subject to the aforementioned operational, regulatory, and market constraints. The “not-for-profit difference” comes from dislodging margin as the maximizing objective and considering it in parallel with the other constraints. Money remains crucially important to NFPs, but as a means for mission attainment rather than the overriding objective as in business firms.
The importance of mission was foreshadowed in Blog 1 (October), where it emerged as an important variable for provosts and deans to consider when choosing academic programs for expansion, contraction, or perhaps elimination. For-profit thinking tells one to expand programs when incremental revenue exceeds incremental cost (i.e., when incremental margins are positive) and contract them when the converse is true. This makes money the deciding factor for decision makers. In contrast, not-for-profits should expand programs when the value of incremental mission attainment plus incremental revenue exceeds incremental cost. This brings mission into the equation along with the two money terms that determine margin.
The mission term directly addresses the intrinsic priority and quality factors that are so important to academics. The money terms support mission indirectly, because extra resources earned can be used to cross-subsidize other academic activities. Positive margins add to the university's cross-subsidy pool whereas negative ones require drawdowns from the pool. To overlook margin in academic resourcing decision-making is to ignore these indirect effects on mission. This is almost sure to produce sub-par outcomes. More information about all this can be found in Chapter 1 of my book Reengineering the University: How to be Mission Centered, Market Smart, and Margin Conscious, and Chapter 8 of my forthcoming book Academic Resource Management for Colleges and Universities (the Johns Hopkins University Press, 2016 and 2020). These results are firmly rooted in economic theory as well as common sense. They go a long way toward explaining the market and internal economic behavior of colleges and universities.
But how can one bring mission attainment, with all its complication and subjectivity, into a numbers-driven economic analysis? I have been researching this question for some time and can offer two complementary approaches. The first is a practical “constrained choice model” that allows one to maximize the judgmentally determined mission contribution of budget-making choices subject to a constraint on total spending—just as envisioned in the not-for-profit paradigm. The model is described in Chapter 8 of my forthcoming book. It is still experimental, but experience will bring refinement as more universities begin to process their judgments about mission.
The second approach takes us back to the aforementioned program portfolio display (reproduced below), which assumes the provost or dean has assigned each of the school's 16 programs to one of five categories based on its mission contribution. The darkest-shaded bubbles indicate strongly positive judgments about the consequences of program expansion, whereas the three lighter shades indicate more modest mission contributions. The fifth category, depicted by diagonal bars with a heavy border, shows that program expansion would be antithetical to mission. (Blog 1 described how this not-uncommon situation can come about.) The assignment process is not as daunting as it might seem, and in any case it’s likely to generate useful conversation and insight.
The figure provides strong guidance about which programs should be viewed as candidates for expansion or contraction. If anyone doubts the importance of bringing the subjective judgments about mission into the analysis, just consider how the decisions would go if they were not included. Sports Management would be a prime expansion candidate, for example, and Quantitative Business Administration and Mathematical Finance might well be overlooked as being too small to make a big difference financially. It is outcomes like these that lead academics to mistrust the use of margin in resourcing decisions about teaching. However, the problem is mitigated by bringing mission into the picture in an explicit way.
William F Massy