Dynamics of Higher Education in the US

July 2007

This material was used by McKinsey & Company during an oral presentation at State Higher Education Executive Officers Conference; it is not a complete record of the discussion.

2

OUTLINE

•SCP an interesting lens for looking at higher education

•Strong historical performance driven by favorable structure and relatively benign conduct

•Performance > health (?)

•Potential shocks:–Demand, supply and environment elements all in play

–Challenges, but also opportunities

–Variability between segments on the rise

–Industry level response may be needed

3

ELEMENTS OF THE SCP MODEL

Marketing

Capacity change

Vertical integration

Internal efficiency

Financial

Technological

Employment

External shocks

Nature of demand

Nature of supply

Industry chain economics

Industry Producers

S tructure C onduct P erformance

Feedback

Source:McKinsey

4

INDUSTRY CHAIN FOR EDUCATION SECTOR

• Students (15M)

• Employers

• State general education funders

• Research funders

• Donors (major and small)

• Universities and colleges – 4,400 institutions– $350 B revenues

• Faculty (1.2M)

• Administrative/other staff

• Providers of goods/services

Input providers Producers

Customers

Source: National Center for Education Statistics IPEDS

5

HIGHER EDUCATION SEGMENTS VARY ACROSS MULTIPLE DIMENSIONS

Total

Source: National Center for Education Statistics IPEDS dataset, 2004; U.S. News & World Report “Best Colleges,” 2006; NSF Research and Development expenditures data, 2004; McKinsey team analysis

Top public research

Large public

Small public

Top private research

Other private research

Liberal arts or general

2-year/associates

For profit

Specialized institutions

Top private liberal arts

Institutions

36

349

145

20

393

445

1,253

910

623

4,224

50

Undergrad/ graduate ratio

4

6

11

1

3

24

N/A

5

3

8

37

Average SAT

1209

1041

1001

1407

1082

1054

934

1053

1061

1070

1331

1,060

3,953

349

293

1,472

609

4,549

806

323

13,512

98

Total FTE students (thousands)

Tuition and fees(thousands)

6

5

5

30

18

16

3

12

10

9

29

Student/ faculty ratio

12

16

16

6

14

15

19

18

7

15

10

S C P

6

SHARE OF ACTIVITY VARIES WITHIN AND ACROSS SEGMENTSpercent

Institutions Undergrads Grad students Research

Top public research 1 7 14 32

Large public 8 28 36 24

Small public 3 3 2 2

Top private research 0.5 1 8 24

Other private research 9 9 24 9

Liberal arts or general 11 5 2 0

2-year/associates 30 38 0 0

For profit 22 6 8 0

Specialized institutions 15 2 6 9

Total 4,224 11,952,774 1,559,295 $32.7 B

Source: National Center for Education Statistics IPEDS dataset, 2004; McKinsey team analysis

Top private liberal arts 1 1 0 0

S C P

7

Demand

•Consistent growth for education, high growth in research

•Valuable product, few/no substitutes

Supply

•Highly fragmented, diverse producer segments

•Limited international competition for US students

•Modest supply additions

Industry Chain

•Producer power varies by segment, but undemanding with the exception of faculty

•Limited information availability

Source:McKinsey team analysis

FAVORABLE STRUCTURE

8

Marketing•Growing outreach/marketing•Significant price increases partially offset by increasing discounting• Incremental product innovation

Internal efficiency• Increasing competition for top faculty•“Facility wars”•Flat to declining productivity

Limited capacity expansion •Few competitors target growth

Few vertical/ horizontal alliances at institutional level

Source:McKinsey team analysis

FAIRLY BENIGN CONDUCT

9

WITHIN U.S., PERFORMANCE HAS BEEN SURPRISINGLY STATIC

University 20061993

Harvard University 11Princeton University 12Yale University 33

Duke University 57Stanford University 56California Institute of Technology 75M.I.T. 74

Columbia University 911

Northwestern University 1213

Cornell University 1310

Johns Hopkins University 1315

Brown University 1512

Rice University 1714

20UC Berkeley 1918Vanderbilt University 20

22Carnegie Mellon University 24

University of Virginia 2321UCLA 2522University of Michigan – Ann Arbor 2523

* Moving up or down 5 or more spots in U.S. News and World Report university rankingsSource: US News and World Report; Fortune Magazine, Fortune 500

Big movers*

University of Pennsylvania 416

Dartmouth College 98

Washington University in St. Louis 1118

University of Chicago 159

University of Notre Dame 1825Emory University 2025

Georgetown University 2317

U.S. News and World Report Best National University Rankings

S C P

10

U.S. HAS DOMINANT SHARE OF TOP INSTITUTIONS

1

2

7

Top 10

9

8

5

8

20

Top 50

32

31

59

24

54

Top 200

ROW

Asia

Europe,non-UK

UnitedKingdom

UnitedStates

Times Higher Education rankings1

Shanghai Jiao Tong rankings2

2

8

Top 10

37

Top 50

22

4

5

57

69

164

43

167

Top 500

ROW

Asia

Europe,non-UK

UnitedKingdom

UnitedStates

17

18

56

22

87

Top 200

S C P

1 Based on peer review (40%), faculty/student (20%), citations/faculty (20%), recruiter reviews (10%), international faculty (5%) and international students (5%); >500 rated as excellent

2 Based on Staff winning Nobel Prize and Field Medal (20%), staff citations (20%), articles in Nature and Science (20%), Science and Social Science citations (20%), alumni winning Nobel Prize and Field Medal (10%), size of inst. (10%); >2000 universities scanned and >1,000 universities ranked

Source: The Times Higher Education Supplement; Shanghai Jiao Tong Academic Rankings of World Universities; McKinsey team analysis

11

HIGHER EDUCATION CAPTURING A GROWING SHARE OF PHILANTHROPIC SUPPORT

1,281

770

597

1990-1994

2000-2004

1980-1984

1980-1984

2000-2004

8.0

10.1

1990-1994

9.8

110% increase

U.S. Philanthropic Contributions$ 2005 Billions

Higher Education SharePercent

Source: Giving USA, Council for Aid to Education, Center on Wealth and Philanthropy, AFRC Trust; McKinsey team analysis

130

76

49

1990-1994

2000-2004

1980-1984

Contributions to Higher Ed$2005 Billions

170% increase

S C P

12

Federal obligations for R&D; by performer$ billion; Percent of total

UNIVERSITIES HAVE COMPETED SUCCESSFULLY FOR R&D FUNDING

S C P

13 56

48

1984

24

47

18

Intramural

Universities and

Colleges

102.721

42.225

67.235

6

23

5

Industry

Other

University FFRDCs*

2004

8

39

24

27

6

1994

CAGR 1984-04

4,5%

3,9%

3,5%

7,6%

3,5%

6,6%

* Federally Financed R&D CentersSources: National Science Foundation/Division of Science Resources Statistics; team analysis

13

ACADEMIC RESEARCH HAS ECONOMIC AND SOCIAL VALUE

Academic Research

Knowledge Creation

and Growth1,3

Economic growth &

job creation1

Innovation &

Invention2

Graduates & Trainees

1 Lynch and Aydin, Literature Review of the Economic and Social Impact of Higher Education Funding, 20042 AUTM FY2002 Licensing Survey3 Zerhouni, NIH At the Crossroads, U.S. Congressional Joint Economic Committee, “Benefits of Medical Research and the NIH”, 2000

Contracts,Collaborations & Consulting

S C P

14

HIGHER EDUCATION PROVIDES HIGH ECONOMIC VALUE AND ACCESS TO THE FASTEST GROWING JOBS

Lifetime earnings 1

$ Thousands

27

23

33

Associate’sBachelors

No college

Masters/Doctorate

Degree requirements, 2004-20142

Percent

53

17

Of all fastest growing jobs (n=30)

Note: Grad school is weighted average of Masters, professional and doctorate degrees. Includes opportunity cost of salary forgone during education. 1 U.S. Bureau of Labor Statistics2 Hecker, Daniel, “Occupational employment projections to 2014”, Monthly Labor Review, February 2002; McKinsey team analysis

S C P

3,627

Bachelors only

4,509

Grad school

$1.2M

$0.9M

2,444

High school only

15

HOWEVER, INSTITUTIONS ARE NOT MEETING NEEDS OF ACCESS AND AFFORDABILITY

Source:NELS: 88/00; Education Policy Institute’s 2005 Global Higher Education Rankings; National Center for Public Policy and Higher Education’s 2006 National Report Card; McKinsey team analysis

85

81

64

88

77

69

67

51

27

12

13

15

31

46

$0-24,999

$25,000-49,999

$50,000 and up

Income

White

Black, not Hispanic

Race/ ethnicity

Hispanic

Asian/Pacific Islander

Graduate high school with a diplomaPercent

Of population, graduate collegePercent

75% high school

graduation rate

27% overall college

graduation rate

16

TRENDS AND POTENTIAL SHOCKS

1.Increasing numbers of highly digital, frequently non-traditional students

2.Price-cost-productivity squeeze

3.Globalization

4.New paradigm competitors

5.Accountability

Source: McKinsey team analysis

17

TREND 1: MORE NONTRADITIONAL STUDENTS

U.S. undergraduate students2

2004, 100% = 14 million

Traditional

12%

13%

7%

8%

11%

48%

4 year, full-time,<25 years

2 year, full-time,<22 years

4 year, full-time,25+ years

2 year, full-time,22+ years

4 year,Part-time

2 year, part-time

1 Chronicle of Higher Education 2006 Almanac; McKinsey team analysis

Non-traditional

Public 4-year(16% growth ’94-’04)

Public 2-year(18% growth)

18

HIGH GROWTH RATES PAIRED WITH EMPHASIS ON COLLEGE READINESS COULD DRAMATICALLY INCREASE ENROLLMENT

2004

U.S. population at high-school graduation age 1

2014

High-school graduation rate

Percent of high-school graduates college ready

College-ready graduates per year

1 US Census Bureau (http://www.census.gov/population/www/projections/natsum-T3.html)2 “The Silent Epidemic” (Bridgeland, et. al) March 2006 gives 68-71%3 Gates Foundation goals, largely consistent with Spellings recommendations 4 College readiness defined by Greene and Winters (2005) as the basic skills and qualifications necessary to be accepted by a 4-year college: (1)

graduate from high school with a regular diploma; (2) minimum level of academic coursework; (3) basically literate (pass NAEP reading test). Most recent data from 2002

4.1 million

4.2 million

70%2

85%3

34%4

66%3

1.0 million

2.3 million

130% increase in college-

ready students

19

DIGITAL GENERATION WILL EXPECT A DIFFERENT COLLEGE EXPERIENCE

Source:Teen Research Unlimited

Teen time spent on mediaPercent, hours per week

55

9

6 5

18

1412

18

1715

20

19

17

9

7

6

5

4

7

8

10

1216

7 10

33

2004

4

23

Cell Phone

Online

Console Games

PC Games

Home Video

TV

Recorded Music

Radio

Books

Magazine

Newspapers

1998

4

2007

56 55 55

20

0

5,000

10,000

15,000

20,000

25,000

1976 1983 1990 1997 2004

TREND 2: PRICE-COST-PRODUCTIVITY SQUEEZE

1 College Board, Trends in Student Aid (2004)2 National Center for Education Statistics IPEDS dataset, 2004; McKinsey team analysis

Average tuition and fees1

Real 2004 dollars

Public

Private

S C P

34% growth ’94-’04

48% growth ’94-’04

33.5%

15.3%

21

University Endowments$ billion; Percent of total; Top 100 Universities

60%

21

19

79

1995

64%

20

16

218

2005

Top 20

21-50

51-100

CAGR

9.9%

8.6%

Total growth

157%

128%

11.7% 196%

10.6% 175%

Sources: NACUBO Endowment Survey, 1995-2005; team analysis

THE RICH ARE GETTING RICHER

22

INSTITUTIONAL COSTS ARE CONTINUING TO RISE

121

50

22

16

28

-3

61

105

14

16

42Top public research

Large public

Small public

Top private research

Other private research

Top private liberal arts

Liberal arts or general

2-year/associates

For profit

Specialized institutions

Average 54

21

97137

41

32169

73

29

52

150

Increase in instructional cost per student 1984-20041

Percent, adjusted for inflation

Increase in administrative cost per student 1984-20041

Percent, adjusted for inflation

1National Center for Education Statistics, IPEDS dataset, 2004 and 1984; McKinsey team analysis

23

Change 89-2004Percent

Sources: National Center for Education Statistics,IPEDS dataset; team analysis

DECLINING PRODUCTIVITY

-1.2

-6.7

-7.4

-2.9

-5.7

-5.8

5.6

-15.2

-3.4

-16.0

-3,2

Student per faculty; FY2004Ratio

7.0

21.2

13.9

16.1

19.5

15.7

11.9

15.4

9.4

6.3

Top public research

Large public

Small public

Top private research

Other private research

Top liberal arts

Liberal arts or general

2-year/associates

For Profit

Specialized institution

15,1Average

24

0.70

12.60

1.30

1.70

7.30

7.30

5.40

17.70

TREND 3: GLOBALIZATION

Globalization as the process of economic and social integration that intensifies competition and gives rise to innovation by:

• Opening of geographic, capital, labor and other resource boundaries

• Increasing exposure to ideas, concepts, processes and organizations

20032008

IT services

Retail banking

Packaged SW

Pharma

Offshoring

0

5

10

15

20

1999 2000 2001 2002 2003 2004

Rising global competitionMillions of students, 1999-2004

U.S.

China

CAGR

4%.

25%

India 6%

Europe 2%

25

HIGHER EDUCATION RESPONSE TO GLOBALIZATION

Source: McKinsey Quarterly

Potential institutional responses

•Expanding international recruiting

•Shifting research agenda

•Globalizing the student experience

• Internationalizing faculty

•Establishing a central office to guide thinking

•Enhancing global presence

Key issues

• But international students represent less than 5% of demand for US institutions

• Needs vary greatly by segment

• Will these actions alter structure or conduct balance?

26

TREND 4: NEW PARADIGM COMPETITORS

• Distance learning offered by 17% percent of schools in 2000-2001

• Online education growing part of long-term strategy

• 7% of postsecondary students completed studies over the Internet

Source: The Chronicle of Higher Education, 2006; New York Times, “Degrees of Acceptance”; National Center for Education Statistics; “Growing by Degrees”, Allen and Seaman, 2005; McKinseyteam analysis

• 96% of companies prefer traditional degrees to online degrees

• 75% prefer traditional degrees over hybrid (partial online)

• However, 50% of another survey showed equal value for online and face-to-face instruction

• Federal student-aid available for distance-learning institutions as of February 2006

• Credentialing by testing may prove to be boon

Growing market

Increasing credibility

Removal of regulatory barriers

27

ADVANTAGED ATTACKERS?

University of Phoenix Open University (UK)

• For-Profit owned by Apollo Group

• Applied professional education for working adults

• 255,000 students, 28% purely online

• 28% increase in students since 2003

• 250 campuses/learning centers

• 110 degree programs, completed in as little as 20 months

• Extensive use of technology

– Electronic textbooks, Online Library

– Simulations, virtual organization sites

– WritePoint SM

• Nonprofit, created by UK Government

• Open access to all looking to learn

• 200,000 students, most part-time, 25,000 live outside UK

• Wide range of courses, certificates, degrees

• High student satisfaction and rated 5th best in UK for teaching quality

• Extensive use of technology

– Cassettes/DVDs– TV programs– Online – Conferencing system– Home-kits

• Expanding to Africa

Source: Apollo Group, OU website

28

TREND 5: ACCOUNTABILITY

Improve college readiness and other “pathways” to higher education

Bolster funding and streamline financial aid processes

Reward and measure productivity and efficiency

Better track and communicate student learning outcomes

Incent innovation and collaboration (e.g. shared IT resources)

Expand reach to adults and improve vocational training

Increase support for research funding, especially target subjects

Source: Commission on the Future of Higher Education; McKinsey team analysis

29

FINAL THOUGHTS

•Trends consistent with broader global trends in many industries

•New era of fracturing along segment lines

•Real need for paradigm change in the “vast middle” as the cost model is deeply flawed

•As many opportunities as threats with some institutions better positioned to break out

•Sector response valuable in several arenas– Embrace some Spellings recommendations– Recognize need for multiple paradigms