Survive or thrive...Survive or thrive A l igning univ ersity strategies to improve nancial health E...

Survive or thriveA l igning univ ersity strategies to improve financial health

E Y -P ar theno n E du catio n

Survive or thrive

II | EY-ParthenonII | EY-Parthenon

Colleges and universities in the US are in the midst of a challenging financial period, with a subset of postsecondary institutions already finding themselves in financial distress. Many others are seeking ways to proactively avoid ending up in the same boat. It is now commonplace to hear of universities undertaking strategies to improve their financial circumstances, from streamlining their own operations on one end of the spectrum to merging with another institution on the other end. What strategic and operational changes can a university make to correct its financial health? To find out, we analyzed the finances and operations of a group of 4-year public universities1 over a 13-year period to understand which strategic and operational levers are most closely tied to the financial health of institutions.

We found that institutions that have been financially healthy despite the stagnant enrollments and financial pressure facing the industry have some strategies in common. These institutions have a large and stable enrollment, a diversified mix of students and sources of revenue, and high graduation or completion rates. They also have had to make trade-offs between academic spending and financial health.

Introduction: strategies for financial health in a prolonged period of fiscal challenge

Exhibit 1: Strategic framework for better financial health

Large and stable enrollmentInstitutions that have large and stable enrollment tend to be financially healthier.

Diversified student mix and sources of revenueInstitutions with a smaller percentage of undergraduate and full-time students, lower tuition dependence, lower reliance on state appropriations and larger endowment relative to total expenses are more likely to be financially healthy.

High completion and graduation ratesFinancially healthy institutions tend to focus on student success and have high completion and graduation rates.

Trade-offs between academic spend and financial healthInstitutions make trade-offs between financial health and having lower student-to-faculty ratio, more tenured faculty or more research.

1 See Methodology section on page 13.

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Aligning university strategies to improve financial health

CFI and financial healthThe first step in understanding how operational decisions impact the financial health of institutions is determining how to measure financial health itself. The higher education industry already has a standardized measure called the Composite Financial Index (CFI), which is used by accrediting agencies to gauge the financial health of an institution. The CFI is similar in some ways to the Department of Education’s Financial Responsibility Composite Score, as both take into account the institution’s operating results and resource sufficiency. This index

2 The Council of Independent Colleges.3 Sources: NACUBO, KPMG, Prager.

Exhibit 2: The component ratios of CFI3

Financial ratios

Primary reserve ratio(expendable net assets/

total expenses)

Are resources sufficient and flexible enough to support the mission?

Weighting: 35%

Net income ratio(operating surplus or deficit/

unrestricted operating income)

Do operating results indicate the institution is living within available resources?

Weighting: 10%

Return on net assets ratio(change in net assets/

total net assets)

Does financial asset performance sustainably support the mission?

Weighting: 20%

Viability ratio(expendable net assets/

long-term debt)

Is debt managed strategically to advance the mission?

Weighting: 35%

condenses the financial health of an institution to a single number on a scale from -4 to 10, providing a standardized assessment of financial health that can be tracked over time and across institutions. The four components of CFI are described in Exhibit 2. A CFI score of less than 3 indicates challenges for an institution’s financial health.2 Exhibit 3 shows what strategies leaders might consider given their CFI scores. According to our analysis, the average CFI across the examined institutions has been on a downward trend since 2012; please see Exhibit 4, which illustrates how the market has shifted across major segments of financial health, as measured by CFI.

Survive or thrive

2 | EY-Parthenon

4 Source: NACUBO, KPMG, Prager.5 National Center for Education Statistics; EY-Parthenon analysis.

Exhibit 3: Strategies based on institutional CFI score4

Exhibit 4: % change in number of institutions, by financial health segment5

CFI is often used by regulators, boards of trustees and senior university leaders as a distilled indicator of financial health. As the number of institutions facing financial challenges continues to increase, the scrutiny paid to CFI and other indicators of financial health will surely increase as well. But the concept of CFI and how to calculate it is not well understood by the decision-makers across universities. Even less understood is how strategic and operational decisions made by the college or university affect CFI and the overall financial health of the institution. We describe our analysis and results to shed some light on CFI and the levers available to improve financial health in the coming pages.

A score of 3 or higher indicates financial health

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

Financially challenged Financially stable Financially healthy

Deploy resources to achieve mission

Allow experimentation with new initiatives

Focus resources to compete in the future

Direct institutional resources to allow

transformation

Re-engineer institution

Consider substantive programmatic adjustments

Financial exigency; large liquidity and debt issues;

consider programs to conserve cash

10%

Financiallychallenged

Financially stable

Financiallyhealthy

-7%

-3%

10%

5

0

-5

-10

%change innumber ofinstitutions

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Exhibit 5: Variables with significant correlation to CFI

MethodologyUsing the wealth of data available in the National Center for Education Statistics Integrated Postsecondary Education Data System (IPEDS), we examined the impact of a range of variables on an institution’s CFI score and therefore its financial health. The focus of this analysis is four-year degree-granting institutions, and we limited the analysis to institutions with sufficient data to conduct the analysis. With these limitations, we were able to examine 423 public institutions from 2003 and 2015, approximately 62% of US public institutions.

While this sample is limited to public institutions, we believe these trends can broadly be applied to private not-for-profit institutions as well.

Using the financial variables available within IPEDS, we derived CFI scores for each of the institutions as a holistic measure of financial health. We then tested over 50 publicly available operational metrics in a regression model to understand which of those variables are correlated with CFI at a statistically significant level. From the 50 tested, we identified 11 variables that are most important to consider for financial health given their high correlation to CFI, shown in Exhibit 5 below.

Large and stable enrollment

1 Enrollment magnitude

2 Enrollment growth

Diversified student mix and revenue sources

3 Undergraduate enrollment as percentage of total enrollment

4 Full-time student enrollment as percentage of total enrollment

5 High tuition dependence

6 High reliance on state appropriations

7 Size of endowment relative to institution’s total expenses

High completion and graduation rates

8 Graduation/completion rates

Trade-offs between academic spend and financial health

9 Student to faculty ratio

10 Workforce mix (higher proportion of non-tenure and non-tenure track faculty)

11 Research spend as percentage of total expenses —

Variables that are positively correlated with CFI Variables that are negatively correlated with CFI

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Description

The scale of academic operations, as measured by enrollment size, is important to the financial health of institutions. Smaller institutions struggle disproportionately with balancing their budget, and low enrollment may be considered a risk factor for financial distress in and of itself. There are a number of reasons why an institution may want to maintain its small size. On the other hand, some institutions may wish to grow but struggle to attract additional enrollments. Either way, leaders should keep in mind that increasing the scale of their institution is likely to improve financial performance. Regardless of size, positive growth in enrollment is also correlated with good financial health.

Strategic implication

Grow enrollment organically

• Pursue new programs targeted at specific known opportunities in the market.

Grow through collaboration

• Develop strategic pathways to your university through partnerships with community colleges or international pathway providers.

• Broker more transformative arrangements with other institutions through a creative partnership or a merger or acquisition.

Large and stable enrollment

Growth and scale help to improve revenue with higher CFI.

1 Higher enrollment is correlated with higher CFI.

2 Growing enrollment is also correlated with higher CFI.

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Description

We found that the higher the proportion of the student body that is undergraduate, the lower the financial health of the institution. Similarly, a higher proportion of full-time students is correlated with lower financial health. This highlights one of the existential challenges facing traditional residential institutions. In the pursuit of attracting residential students in this flat-enrollment growth market, universities have invested in facilities, dorms and student life experiences. Further, regardless of residential status, full-time undergraduate students require significant student services. These capital investments and associated debt costs, along with the ongoing operational costs of supporting these students, have strained university budgets, and many schools have found that these investments have not led to the anticipated increase in enrollment.

Institutional leaders must be judicious in making investments that capitalize on the strategic advantages of their institution and attract students through a differentiated offering.

Strategic implications

Graduate program growth

• Determine whether there are programmatic areas where the institution has strength but is lagging in the market.

• Assess whether existing graduate program offerings have a clear enough value proposition in the market, combined with strong marketing, recruitment and enrollment practices, and a strategic approach to financial aid.

• Identify potential adjacent programmatic opportunities.

Part-time/flex/hybrid/online growth

• Assess whether the format of the institution’s programmatic offerings is in line with evolving student needs and market trends, or falling behind in terms of flexibility (which could range from full online to hybrid to evening/weekend flex options).

Important considerations

• While part-time and graduate programs may not require the same investment in physical infrastructure as traditional residential programs, they do require other forms of investment. The profile of graduate and part-time students is different, and investments in digital infrastructure are needed to support online and flexible arrangements for these students. Further, more flexible forms of mentorship and advising from faculty and staff may be needed.

Diversified student mix and revenue sources

Serving traditional full-time undergraduate students is costly.

3 A higher mix of undergraduate enrollment is negatively correlated to CFI.

4 A larger percentage of full-time students is negatively correlated to CFI.

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Description

Tuition and state appropriations are the primary sources of revenue for public institutions. However, the m o r e co ncentr ated an institu tio n’ s r ev enu e is in these two streams, the lower its financial health. A heavy reliance on these volatile sources of income means that any shock to enrollments or state budgets (as occurred in the Great Recession) leaves universities particularly vulnerable to financial distress. Having a m o r e div er se set o f r ev enu e str eam s eases the financial burden caused by inevitable fluctuations in these two primary revenue sources.


Identify alternative revenue streams

• There are concrete strategies university can consider in diversifying their revenue sources, thu s decr easing the shar e o f r ev enu e f r o m tuition and state appropriations. Strategies that institutions have employed have included:

• Credit-bearing revenue (e.g., high school student enrollment)

• Non-degree program revenue (e.g., summer sessions and camps)

• Facilities utilization (e.g., event income)

• Products and services (e.g., library or gym subscription outside the institution population)

• For additional information on increasing revenue diversity, please see our publication on alternative revenues on our website: www.parthenon.ey.com/alternativerevenues.

Concentrated revenue sources are correlated with lower financial health.

5 High tuition dependence is correlated with low CFI.

6 High reliance on state appropriations is also correlated with low CFI.



www.parthenon.ey.com/alternativerevenues

Description

Not surprisingly, having an outsized endowment for the size of the institution is one of the strongest factors that positively affects financial health. Endowment proceeds support the operations of the university, supplementing tuition, state appropriations, and other sources and dampening the impact to the university when those sources of revenue drop as they have in recent years.


Engage alumni early and in line with their interests

• Developing an overarching alumni engagement strategy to build an engaged alumni base is an important long-term lever. Engaged alumni are more likely to become donors who can contribute to the endowment.

Protect the endowment

• This includes strategies such as ensuring that the annual draw-down of the endowment is at a sustainable level, as well as having a plan to recover endowment if the principal has been used to cover a necessary expense.

Grow the endowment

• Universities often have a wealth of physical capital sometimes not optimally leveraged for the use of the institution. Outside of donor contributions, endowments are often strengthened by transferring university assets to a more liquid form. Institutions that have undergone densification strategies have used proceeds from land or building sales to fund large portions of restricted endowment. Proceeds from public-private partnership arrangements have been similarly invested.

Endowment is king.

7 Endowment size (as a % of expense) is one of the strongest factors that positively affects CFI.

S u r v iv e o r thr iv e

8 | E Y -P ar theno n

Description

Investing in strategies to increase graduation rates is well aligned to the mission of any institution. Though these strategies require real investment of scarce resources, achieving an increased bachelor’s degree graduation rate is ultimately correlated with a higher CFI. Not only do students remain enrolled for a longer period, generating more tuition income for the university, but the reputational benefits improve the institution’s ability to recruit more, higher-quality students. This demonstration of quality may also translate to a higher willingness to pay by students and families.


Understand retention patterns

• Institutions should take a close look at their retention to understand where and when students are dropping out, and design appropriate interventions and supports to increase retention.

Invest in retention (people, processes and systems)

• Institutions are leveraging their digital ecosystem to improve retention and graduation rates by harnessing data to identify retention problem areas and deploy digital interventions to improve outcomes. Exhibit 6 below shows how the creative uses of the institution’s data-rich environment can help to diagnose and intervene, ultimately improving graduation rates.

Exhibit 6: Illustrative use of digital environment to improve degree completion

Reorganized 90 specific majors into broad “meta majors,” allowing students to explore at the start before narrowing focus

Created adaptive learning courses to better meet student needs

Leveraged predictive analytics to develop student advising program

Academic data on student major switches indicated that, on average, students cycled through 2.5 major changes

Financial data indicated that major switches extended time and cost of student degree

Solutions developed due to integrated approach

Data inputs from a variety of systems

Academics Services Infrastructure

Large public university

High completion and graduation rates

Student success is a win-win.

8 Bachelor’s degree completion rate is positively correlated with CFI.

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Description

Universities exist to fulfill their missions of teaching, service and research (in the case of research institutions). Faculty are perhaps the most important component to driving this mission, particularly tenured faculty who are invested in the institution over the long-term. Institutions seek to improve the delivery on their mission often by hiring new faculty, or improving student access to faculty through smaller class sizes.

This investment in the mission does not, however, come without its trade-offs. Personnel costs at universities can be overwhelming, representing nearly 60% of the operating expenses of a university. And smaller class sizes mean more teaching faculty are required. Institutions that are able to operate with a lower percentage of tenure/tenure-track faculty and a higher student/faculty ratio are able to reduce their cost of delivering education.

Striking the balance between quality and financial health can be challenging. Instructional costs, being such a large portion of expenses, are often under scrutiny. At the same time, faculty often feel that their institution could benefit from adding to their ranks. The right balance can be different for each institution.


Managing spend on faculty while maintaining quality of both the student and faculty experience is a delicate balance. Potential strategies to improve allocation of faculty can include:

• Optimize faculty workload (teaching and research load) and class allocation.

• Often, the size of a class is pedagogically intentional. In many cases, however, classes are unintentionally small or poorly distributed. The institution can work to examine its class offering and schedule to reduce the number of unintentionally small class sections.

Consider distinct roles and career paths for faculty

• For example, an institution could consider faculty who specialize in teaching, while others might specialize in research.

Invest in technology enablers

• Typically, decisions to adjust overall student/faculty ratio need to be supported by additional technology changes to support new classroom dynamics. New methods of engagement, such as flipped classrooms enabled by technology, allow students to cover material asynchronously, freeing up time with the professors to focus on discussions and advising/mentorship.

Trade-offs between academic spend and financial health

Investments in faculty need to be balanced with an ability to fund those faculty.

9 Higher student/faculty ratio is correlated with higher CFI.

10 Higher percentage of faculty who are non-tenure and non-tenure track is also associated with higher CFI.

Survive or thrive

10 | EY-Parthenon

Description

Many institutions are setting their strategic goals for research around the achievement of Carnegie status, a measure driven largely by research expenditures. A number of state-level incentives have also been legislated to encourage and enable public institutions to increase research spending as a percentage of total expenses and develop robust research horsepower. While there are a number of intangible benefits to spending in research, the investment required in building the physical and human capital resources needed to win bids for external research is high, and according to our analysis, may contribute to overall lower financial health. Targeted research strategies that go beyond “more research dollars” can help institutions focus their investment in research infrastructure on areas where the institution has higher chances of success in securing external funds.


Avoid a one-size-fits-all approach to research

• Institutions should not pursue “more” research for the sake of research and rankings.

• Instead, institutions should target research opportunities that align to current areas of strength at the institution.

Leverage the power of collaboration

• Collaboration with other institutions may place the collective capabilities of the group in a position to win external research bids.

• Collaboration across disciplines within an institution presents the option to pursue cross-disciplinary funding opportunities.

Reaching research preeminence is a costly endeavor.

11 Magnitude of research spending (as a % of expenses) is correlated with lower CFI.



ConclusionDecision-making in today’s higher education institutions is complex and requires thoughtful trade-offs as leaders deploy scarce resources in pursuit of multifaceted missions. While financial implications are just one aspect of every decision, it is critical to understand the impact of various decisions on the institution’s financial health. Indeed, some of the findings above imply a negative financial impact of actions that support the mission of the institution. However, understanding the key drivers of CFI, a broadly accepted indicator of financial health of higher education institutions, can help to illuminate the financial impacts and trade-offs of strategic decisions. Integrating this perspective into everyday decision-making can aid institutional leaders in charting a path that is aligned to their institution’s mission and financially sustainable in today’s challenging marketplace.

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AppendixMethodologyUsing data from IPEDS, we constructed a multi-variate time-series cross-section regression model to quantify the impact of institutional characteristics and operations on CFI. We examined more than 50 metrics of institutional characteristics and operations to test which have a statistically significant relationship with CFI. Our sample included all four-year, degree-granting public institutions with data available for all years between 2003 and 2015 (n=439). In addition to the key variables identified as the most important drivers of CFI in the report, the model controls for many other characteristics, including admissions rate, admissions yield, degree of urbanization and percent of students on federal aid. We also control for overall trends post-Great Recession, which in general have damaged CFI across all institutions.

Characteristics of institutions included in the CFI analysisWe sorted the 439 public higher institutions in our sample by their CFI score and categorized them into quartiles based on this score. The table below provides some demographic characteristics of each of the quartiles.

Highest Lowest

Quartiles by CFI 1 2 3 4

Total fall enrollment (headcount) 17,140 16,912 13,145 10,143

Annual enrollment growth, 2010–2015 1.0% 0.3% -0.5% -1.1%

% of full-time, first-time undergraduates receiving federal grant aid 36% 39% 45% 50%

Bachelor’s degree 6-year graduation rate 54% 54% 48% 44%

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2018 Ernst Young LLP. All Rights Reserved. EYG no: 03858-183GBLED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.ey.com

About EY-ParthenonEY-Parthenon professionals are global leaders in strategy consulting. EY-Parthenon teams are committed to bringing unconventional yet pragmatic thinking together with clients’ smarts to deliver actionable strategies for real impact in today’s complex business landscape. Innovation has become a necessary ingredient for sustained success. Critical to unlocking opportunities is the EY-Parthenon balance of strengths specialized experience with broad executional capabilities to help you optimize your portfolio of business, uncover industry insights to make investment decisions, find effective paths for strategic growth opportunities and make acquisitions more rewarding. EY-Parthenon methodologies, along with a progressive spirit, can deliver intelligent services for clients, amplify the impact of strategies and make EY-Parthenon consultants the global advisors of choice for business leaders.

About the EY-Parthenon Education teamsEY-Parthenon Education professionals have an explicit mission and vision to be the leading strategy advisors to the global education industry. To achieve this, significant investment is made in dedicated management and team resources so that the global EY-Parthenon education experience extends across public sector and nonprofit education providers, foundations, for-profit companies and service providers and investors. EY-Parthenon professionals have deep experience and a track record of consistent success in working closely with universities, colleges, states, districts, and leading educational reform and service organizations across the globe.

For more information on the EY-Parthenon Education practice of Ernst & Young LLP, and our team, please v isit parthenon.ey.com.

AuthorsKasia LundyManaging Director Ernst Young LLP

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Emily FoxSenior Associate Ernst Young LLP

1 213 9 3938emily.fox parthenon.ey.com

Samantha Fisher Vice President Ernst Young LLP

1 61 4 8 463samantha.fisher parthenon.ey.com

http://www.ey.com

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