Use Your Margins to Support Your Mission

June 30, 2022

The following article is an edited excerpt from Resource Management for Colleges and Universities by William F. Massy.

One of the biggest barriers to the adoption of academic resourcing models has proved to be concerns by faculty that doing so will “turn the university into a business.” As a former professor myself, I can understand that concern. Part of this stems from the view that margin, which plays such a central role in academic resourcing models, equates to profit, and that profit has no place in a traditional academic institution. The case against the proposition is very strong, but its demonstration requires considerable explanation. 

The Not-for-Profit Paradigm

Traditional universities are not-for-profit institutions. The goal of these institutions is to serve the public interest rather than the private interests of owner-shareholders. A well-run business will respond more strongly to the demands of the marketplace than will a not-for-profit university, which seeks to balance these demands with “intrinsic values” derived from its own mission. Both types of entities also must take account of the technical and behavioral laws that govern people’s ability to produce (what economists call the “production function”), and also the governmental regulations and political objectives that both enable and constrain the entity’s decision-makers. It is the balancing of mission, market, and money that distinguishes a not-for-profit from a profit-maximizing organization.

The image below compares the not-for-profit paradigm with its better-known for-profit counterpart. Not-for-profit entities maximize mission attainment, but their ability to do so is not unlimited. They must observe the operational, governmental, and market constraints referred to earlier. They also must ensure that their overall margin (revenue minus cost for the institution as a whole) isn’t persistently in the red—which eventually would drive the school to bankruptcy. Conversely, for-profit entities maximize total profit (i.e., overall margin) subject to the aforementioned operational and market constraints. For-profits can go bankrupt, too, if they suffer large sustained losses. The “not-for-profit difference” comes from dislodging margin as the maximizing objective and putting it on the same basis as the other constraints. Money remains crucially important to not-for-profits, but in a very different way than for for-profits. It’s a means for mission attainment in universities, whereas it is the overriding objective in business firms.

What Does Being Not-for-Profit Mean?

Imagine a “classic” liberal arts college that offers two kinds of courses: the traditional humanities, arts, and sciences courses for this kind of institution, and a program of business courses. First, suppose the college is in financial equilibrium with both programs at their optimal size according to the not-for-profit decision rule, and that this has resulted in surpluses from business that cross-subsidize the liberal arts courses. One might ask why the college doesn’t expand business to increase its operating surplus, which then would allow it to expand or improve the quality of its liberal arts program.

The answer (based on the aforementioned equilibrium) is that expanding business would reduce the college’s values more than expanding liberal arts would increase them. In other words, business’s incremental contribution to mission is negative and larger than the incremental positive contributions of the liberal arts programs that benefit from the cross-subsidies. It’s business’s negative incremental mission contribution that deters the college from enlarging it despite its positive margin. The argument goes like this:

“Our business courses are profitable, but we don’t want them to dominate the college’s sense of itself.”

Now suppose the college falls on hard times financially due to sharp losses in the value of its endowment, but that neither its margins nor its fundamental values have changed. Getting to a new equilibrium may well involve expanding the business program in order to minimize the consequences for the liberal arts. What’s happened is that the weighting of value in the college’s decision rule (“l”) has gotten smaller as financial urgency has increased, which has made the revenue term more important.

Traditional universities must pay close attention to their margins because money is what permits them to fund their programs. Cross-subsidies, which play the role of dividends to shareholders in for-profit entities, enable not-for-profit institutions to fund programs at levels that would not be supportable in the marketplace alone. Financial stringency reduces traditional universities’ ability to subsidize programs to the point where markets, and only markets, dominate their program offerings. In other words, universities teetering on the edge of bankruptcy must prioritize moneymaking over their mission-based values in order to survive. Ironically, academics who try to “purify” their university by eschewing the management of margin risk hastening the day when money must be prioritized over mission. 

William F. Massy

SENIOR CONSULTANT

Dr. Massy develops new concepts and models for Gray Associates, advises on existing models and client applications, writes a blog series, and participates in webinars and other presentations. He is an emeritus professor and former vice provost and vice president/CFO of Stanford University, and has been a consultant to higher education for more than 40 years.

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