I attended the ATS CFOS conference last week and came away encouraged by many of the conversations. Like the DIAP Conference for which I serve as a Steering Committee Member, the CFOS Conference has value in both the presentations and the conversations. People are asking good questions and wanting to create models of theological education which are sustainable and highly relevant.
This is the first of three blog posts based on content from the conference. Jeff Spear, VP of Finance and Treasurer at Mount Vernon Nazarene University in Ohio led a workshop (Soundcloud) entitled Math that Matters: Pricing and Discount Considerations (PDF). He did a great job defining 5 aspects of tuition discounting which must be considered when making decisions about pricing changes. His general premise is that many institutions make decisions about pricing and tuition discounting based on what they think will happen versus the realities that exist. However, Jeff notes that there is a lot of information available regarding the impact of various financial aid strategies. With that in mind, Jeff provided some mathematical models and tools which can be used as tools for the CFO. His goal was simple – to help CFOs understand certain mathematical relationships, more effectively educate the leadership team, evaluate various options and strategies, and forecast revenues.
5 Things to Know about Tuition Discounting
The 5 aspects of tuition discounting about which Jeff believes we all need to be aware are quite good. Let’s look at them.
#1 The law of the diminishing denominator
This “law” is something that seems counter-intuitive. The bottom line is that “A price discount of 1/x requires an increase in volume of 1/(x-1) to retain the same gross revenue.” In plain English, that means that if you decrease your tuition by 1/10 (10%), you will need to increase your enrollment by 1/9 (11.11%) in order to keep the same level of tuition revenue. Often, people will say, if we decrease tuition by 10% we will need to increase enrollment by that same 10% in order to gain the same level of tuition revenue. This isn’t the case. The example Jeff provided is embedded below. Say, for example, a product is priced at $200 and you want to offer a 20% discount. The price would now be $160. Prior to the discount, you were selling 1,000 of the product. With the price at $160 (a 20% discount or 1/5) you will need to sell 1,250 of the product, a 25% increase, in order to maintain the same revenue. So, you decreased price by 20%, but had to increase volume by 25% in order to maintain revenue.
#2 Contribution margin matters (even in higher ed)
Spear refers to contribution margin as the contribution a specific program, department, course, etc., provides to the required margin for the institution. Yes, he assumes (rightly) that institutions should plan for a positive margin when budgeting. A discussion of that would be an entirely different blog post! Jeff believes, “Price declines generally result in much greater declines in contribution margin and that no matter what business is being considered, there are always some costs associated with each increment of volume.” Basically, he is saying that if you decrease price by 20% and successfully increase enrollment by 25% you are going to increase associated costs by 25% as well. Ultimately, your costs are increasing while your revenue is staying the same therefore resulting in a lower net income. His example is in in the slide deck below.
In response to this point, I would simply add that it makes an assumption that associated (variable) costs increase at a fixed rate. My experience in higher education is that very few cost are truly variable or even variable at a fixed rate. However, I believe his point is very valid. To assume that an institution will increase enrollment while NOT increasing costs is dangerous. The challenge for each school is to correctly forecast how and which costs will rise as enrollment increases.
#3 12 to 15 student per one faculty and one staff
Spear believes (and has done his own research to demonstrate) that regardless of the size of the institution, for every 12 to 15 students a school will have one faculty and one staff member. He also believes that ratio will remain relatively constant as the institution grows or shrinks. (NOTE: It is an average for the entire institution). There isn’t much more to say on this. This is his belief and he has data to back it up. My guess is that many people will disagree with his thoughts on it. HOWEVER, I would simply urge all schools to find this number for their specific school and trend it over the past five and ten years.
#4 Discounting magnifies changes
I believe Jeff’s fourth and fifth principles are spot on. They point out two factors that many institutions may miss. His fourth principle simply states that discounting magnifies changes. Honestly, his slides are going to explain this point better than I can in writing. I have included a link to a PDF of his presentation below. The basic idea is that while many believe the result of a 3.5% price increase, coupled with a 1.5% discount increase (raising price AND discount at the same time) is a 2.0% revenue increase. On the surface, this makes sense. 3.5% – 1.5% = 2.0%. However, one must remember that students are paying less than 100% of tuition and that the percentage changes impact the actual amount paid. Below are the slides. Spear has some VERY good points here.
#5 New student revenue is less than those they replace
Like the fourth principle, this principle is worth taking the time to understand very well. Typically, according to Spear, graduates have the lowest discount while new students tend to have higher discounts. The bottom line is that the returning students tend to “pay” for the new students because their packages were based on different numbers. He urges everyone to calculate their own Students to Discount Ratio (which is outlined in his slide deck). One assumption built into this principle is the idea that students receive an award “package” at the beginning of their time at the school and that the amount remains unchanged. However, I know many schools which change the amount awarded each year (mine included). This principle would need to be adjusted for those schools. The primary takeaway (for me) was the importance of finding a student to discount ratio and looking closely at the students which are graduating (and what their discount rates were) and the students that are returning (and what their discount rates were). An institution may find that while the “average” discount is 28%, those graduating only have a 20% discount rate while those returning have a 36% discount rate (therefore creating an average 28% discount). What would that mean for the institution? Does your institution have this data?
Jeff Spear’s presentation is full of great mathematical models and good questions. Above all, he ended it very well. He ended by saying that he isn’t for or against tuition discounting and he isn’t going to tell an individual school what it should do. Instead, he is simply saying that we need to know what we are doing, be able to do AND understand the math behind our decisions, and adequately inform our colleagues, communities, and boards. I think that was accomplished quite well.
What are you doing at your institution? Do you have a plan for how financial aid impacts institutional planning? Do you know how giving impacts financial aid planning? Are you developing programs and delivery methods which take account for the cost to sustain and support them? What is your pricing strategy? Is it connected to your institutional mission? How does your assessment process impact your planning?
These are great conversations and a great way to start them. Thanks, Jeff!