A host of struggling colleges and universities — the bottom 25 percent of every tier, we predict — will disappear or merge in the next 10 to 15 years.

Clayton Christensen, the Father of Disruptive Innovation, 2013

To be blunt, the higher education industry has a financial disaster on its hands. Business experts, such as Clayton Christensen and Scott Galloway, have been predicting a rude awakening in higher education. And this was before Covid-19.

As a former student, I have a lot of experience with higher education and frankly, I owe a lot to it. However, that doesn’t change the fact that the industry is in trouble. Over the next four weeks, I hope to cover my view of higher education, split into four parts:

1. Costs: How out-of-control costs have fueled the industry’s financial disaster
2. Revenues: How university revenues are becoming more concentrated and why this is dangerous
3. Covid-19: How Covid-19 is affecting the industry and why schools are getting desperate
4. Solutions: What (limited) solutions exist to break out of this crisis

This week, I will be covering Part 1, costs, and how university spending has fueled the industry’s financial disaster.

The TLDR of the Problem

Universities are stuck in a vicious cycle that is deteriorating their financial health. Here’s what’s happening:

In its simplest form, the problem is that costs are being driven upward at a rate that revenues cannot match.

The main issue with this vicious cycle is that there are no easy ways to break it.

• If universities stop increasing school spending, then they may struggle to attract students. 
• If universities stop increasing tuition, then they may not have sufficient funds to cover their costs.

Costs in Higher Education

The Big Idea: The Law of More, as coined by Bain & Company Partner Jeff Denneen, is a concept that universities are being driven to spend more and expand. These new costs, however, are concentrated in areas outside of the core objective of universities: to teach students.

While the 3% expense growth rates shown above for private and public universities may seem small, when compared to revenue growth rates of 0.6% (private) and 2% (public) over the same period, it is clear that universities are simply spending more money than they make.

Additionally, the more worrying sign is not that universities are spending more, but what they’re actually spending money on.

• A 2002-2008 study from Bain & Company found that the vast majority of new university spending is centered in areas outside of a university’s “core”¹ The “core” of a business is actually a technical term in the world of business strategy. In their book, “Profit from the Core,” Chris Zook and James Allen argue that every company has a “core business” that ultimately drives profitability. In the higher education space, despite a complex series of revenue streams, the core is simply delivering education in exchange for tuition. Be on the lookout for a post covering the insights from this book in the future! business of delivering instruction to students. Instead, universities are spending more money on ancillary services, such as buildings renovations and intramural sports. 
  

• The numbers aren’t any better today. From 2014 to 2018, instruction & research (core) expenses dropped from 42% to 39% of total expenses at public universities and from 43% to 41% of total expenses at private universities.

Why This Matters

There are two key implications of universities not investing in their cores:

1. By focusing money away from instruction and research, universities are simply not delivering a higher quality of instructional education.
   • Food for Thought: Jeff Denneen, a partner at Bain & Company, poses an interesting question on this subject. He asks, “do you think a college degree is worth more today than it was 10-20 years ago?” In my view, it’s hard to make a strong argument that it is. Even if you could, do you think it’s worth tens of thousands of dollars more?
     
     
2. Universities are becoming more homogenized. As universities invest money away from their differentiated strengths, they begin to lose their advantages.
   • Food for Thought: If you were a university president with an outstanding business school and a struggling pre-med program, what would you do your available capital: invest in the business school or the pre-med program?
     • If your gut is to choose investing in the pre-med program, you may understand how universities are becoming more similar. Schools fund their weaker programs with their stronger programs and strategically underinvest in their strengths, leading to mediocre offerings across a variety of subjects.
   • The Heart of the Issue: School officials are ignoring the fundamentals of business strategy (a series of active decisions on what to do and, more importantly, what not to do) in favor of this “Law of More” approach. By spending more with no clear focus, the industry is becoming a swath of undifferentiated, hyper-expensive universities that struggle to attract students and provide little unique value to them.  

Parting Thoughts

This wraps up Part 1 of my view on Higher Education. Stay tuned for next week’s issue in which we explore university revenues and how they are doing no better than costs.