Approaches to Managing Costs in American Higher Education

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Journal of Knowledge Globalization, Vol.8, No. 1

Approaches to Managing Costs in American Higher

Education

Mawdudur Rahman

Suffolk University

Boston, Massachusetts, USA

Abstract

American Higher Education (AHE) is at a critical juncture. There is an

increasing trend of closure or merger of smaller institutions being overburdened

with debt servicing and increasing operating costs. The present cost and

revenue troubles in AHE are due to mismanagement of costs and applications of

traditional accounting systems. Issues discussed in this paper are related to

tuition increase, cost escalation, and available alternative choices. We discussed

liquidity, stability and growth, sources of revenues and expenditures, cost

models, institutional efforts, barriers to cost controls, and cost value chain and

explored several avenues of productivity increases.

Keywords: Higher Education, Cost control, productivity, liquidity crisis in

higher education, tuition, sources of revenues, sources of expenses, value chain,

systems model, barriers to cost control, cost value chain.

.

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Rahman: Approaches to Managing Costs in American Higher Education

Introduction

American higher education (AHE) leads global education in science,,

technology, and social and business disciplines. AHE has attracted world’s best

minds and prepared countless educated men and women to excel in all areas of

knowledge for over four hundred years. Boston, Virginia and Philadelphia all

claim to be the birth place of America’s higher education1. They are still

considered as strongholds of American higher education.

Presently, American Higher Education is at a critical juncture. Some scholars

have called it as the AHE bubble; others have observed it as the death spiral, a

paradox of sustainability or the potential casualty of a disruptive economy.

Whatever ways the pundits look at the American higher education, it still enjoys

unabated growth, attracts best minds from everywhere, invests in research and

provides opportunities for innovation and entrepreneurship (NCCHE, 1998).

AHE is going through a period of critical examination, focusing on issues such

as productivity, affordability, and student success. There are noticeable

evidences of successful transition in the AHE systems to adjust to the disruptive

economy which has disturbed usual alignments in almost everything we do

today. Businesses are quick to adjust to face the disruptive challenges, but the

academic institutions are slow to respond to the environmental challenges.

For centuries, AHE has enjoyed opulence pursuing the strategy of perpetual

stability. The historical strategy of ‘no or little change’ has lost its relevance in

the context of new environment (Shannon, 2006). In recent years many authors

have studied the issues of cost management in higher education and have come

to a common conclusion that AHE costs are not well managed and therefore

need to be fixed both operationally and strategically (Adam III and Shannon,

2006; Robst, 2001; Bassett, 1983; McDonald, 2014; Martin, 2009; NCCHE,

1998; IHEP and TIIA-CREF, 2000; Jones, 2000).

AHE Institutions need new strategies and structural realignments for managing

in the new global ‘socio-econ-tech’ cultures. Though the organizational

1 College of Henricopolis or University of Henrico, near Richmond, Virginia,

was chartered in 1618, Harvard "Founded in 1636, Harvard is America's oldest

university". The College of William and Mary Virginia was the first college to

become a university (1779) or the University of the Commonwealth of

Pennsylvania" in Philadelphia.

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Journal of Knowledge Globalization, Vol.8, No. 1

structures vary among institutions, they follow a similar pattern

(Stateuniversity.com. Some AHE) institutions are meeting challenges from

environmental changes with new strategies and strategic realignments2 (ASU,

2013).

The rest of the paper is organized in seven sections e.g., methodology, liquidity,

stability and growth, sources of revenues and expenditure, cost models,

institutional efforts, barriers to cost controls, Cost value Chain and summary

conclusions.

Methodology

This paper follows a less rigorous interpretation of action research methodology.

In action research methods ‘organizational researchers are involved in

diagnosing organizations and helping them change’ (Argyris, 1993). They

actively participate in the operation within the organization.

Several alternative frameworks have been suggested for action research.

Following Chris Argyris’ definition of action research, the author’s experience

provides a basis for the cognitive data for this paper. The contents, analyses and

conclusions are based on 30 years of authors’ immersed experience of working

in the North American higher education systems as well as five foreign

universities. The contents also include data from secondary sources. Data are

experiential and subjective interpretation of events, situations, and actions the

author had encountered as an administrator, academic leader and a faculty

member. Data are generated from hundreds of meetings, interviews,

observations, and faculty and administrative actions faced by the author within

university environments for over 30 years.

2 … ASU, New University: But, unlike many of our peers, we have also undertaken a

massive reorganization of our institution. We have torn down walls between disciplines

and encouraged collaboration among diverse units. We have altered the trajectory of the

university and reevaluated the role that universities play in society, in the economy and in education at all levels. We have changed the relationship between ASU and Arizona.

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Rahman: Approaches to Managing Costs in American Higher Education

The Issues

Liquidity, Stability and Growth

Current and long term economic health of an organization depends on how well

an institution manages it liquidity, stability, and future growth. This information

may be delineated/ derived from questions about the AHE in three areas e.g,

a) Are the AHE institutions able to pay their bills?

b) Are they burdened with long term debts?

c) Do they have strategies to respond to the changes in the environment?

Zemensky and Massey (1990) found in most cases the answers are in the

negative.It is a common conclusion that higher education in the USA has

liquidity problems. However, Weisbrod and Asch (2010) think differently.

They argue that,

“This issue is relatively thorny because there is little good information on the

relationship between dollars of input and quality of output in higher education.

Cost data are used primarily in the budgeting and appropriation process and in

determining how much should be allocated.to higher education.”

Increasing competition to provide quality services, decreasing enrollment, needs

to use newer educational technology and threats from globalization are some of

the factors that have contributed to increasing costs and decreasing revenues.

Unlike businesses, cost efficiency has never been a priority in the education

industry. University administration is not an efficient place in cost management

as AHE administrators do not use effective management control tools that could

give measures of cost and efficiency. US higher education is not governed by

regulatory requirements like Sarbanes and Oxley Act which is required for

businesses. Therefore, there is no incentive for efficient management control

(Protiviti, 2014).

Auguste et al. ( 2010) argue that if all AHE institutions apply cost efficiency

methods, they could decrease the costs per graduate by 23% and produce extra

one million graduates by 2020 (as quoted by Eyring, 2011). The reward systems

in AHE are based on revenues and not on efficiencies. In addition, the newer

demands of the accreditation agencies (AACSB) keep adding costs in the name

of pursuing quality improvements. Heriot et al. (2012) showed that for a typical

school, AACSB accreditation increased annual expenditure by $359,054 and the

opportunity cost of $400,000. The problem is more acute for the second-tier

schools where deans feel pressure to increase enrollment and maintain faculty

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Journal of Knowledge Globalization, Vol.8, No. 1

quality to retain accreditation. Schools and accreditation agencies apply more

value to accreditation but fail to assess how much value the increasing costs will

actually add (Heriot et al., 2009; Brink and Smith, 2012). In the global market,

accreditation is a branding tool and teaching schools are now trying hard to

achieve and retain accreditation and to invest in research by recruiting research

faculty thus increasing their operating costs.

A Bain study (2012) shows that approximately one-third of the colleges and

universities are spending more than what the can afford.

The situation is summarized by Bacon (2012) as:

“Institutions have become overleveraged. Their long-term debt is

increasing at an average rate of approximately 12% per year, and their

average annual interest expense is growing at almost twice the rate of

their instruction-related expense “

Table I below shows more than 30% of the institutions are losing their equities

and spending more of their revenues in debt servicing. It is not surprising to see

that many institutions have already gone out of business. Colleges which have

well developed financial controls, heavy endowment and brand name will

remain out of liquidity danger.

Table -1 A Summary Table of Equity and Expense Ratios*

Changes Above 5% 0-5% Less than 0%

Decease in Equity

Ratio

36% 29% 35% 100%

Increase in Expense

Ratio

33% 23% 45% 100%

* Data from the Bain research (2013)

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Rahman: Approaches to Managing Costs in American Higher Education

College tuition has been increasing at a faster rate than any other economic

indicators which are used to measure changes in the economic well-being (The

Future of Universities, 2014). Figure 1 and figure 2 below reported from the US

Bureau of Labor Statistics shows college tuiton index is leading all other index.

Figure 1 College Tuition index

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Journal of Knowledge Globalization, Vol.8, No. 1

Figure 2: Tuition Index

As the figures above show, when CPI increased by 100%, college tuition

increased by 600%. We believe that there is a causal relationship between the

increase in costs and increase in price. This is not so in the case of college

tuition. Many of the increases in costs are discretionary in nature and as such

decisions to increase tuition are also discretionary.

AHE went through a period of building capacity by borrowing and expanding

administrative supports. Many smaller institutions overburdened with debt

servicing and increasing operating costs are facing the risks of closure or

merger. Over the four years period from 2008 to 2012 ten colleges closed which

is twice as many from previous four years. In addition thirty seven institutions

merged during 2013.

During the period of expansion boom many H.E. Institutions borrowed beyond

their financial capacity. Appendix 1 shows a summary of changes in long-term

debt and credit rating of 31 Massachusetts area colleges and Universities. Credit

ratings of nine institutions have been downgraded from the A range to the B

range. The average increase in debts is 44%. Harvard and MIT showed

increases in debt but their credit ratings remained unaltered.

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Rahman: Approaches to Managing Costs in American Higher Education

Babson College, Bentley University, and Boston College showed decreases in

long-term debt. The above analysis shows that the long-term debt burden

impacts more severely on tuition driven institutions than on heavily endowed

universities. The expansion strategies and the revenue strategies in these

financially weak universities were unsound. Perhaps these universities mis-

positioned themselves in the market place and got trapped in the expansion

haste.

A Bloomberg article (McDonald, 2014) shows that colleges with less than

1000 students, less than 50 million average assets, and less than one million

endowments are more likely to shut down. The four major reasons which put

smaller universities at risk are identified as

a) low enrollment,

b) low endowment levels,

c) high debt and deficit, and

d) deferred maintenance.

These challenges were faced by the small colleges and universities before their

doors were closed. On the other hand universities with higher endowment per

student, higher enrollments, and selective admissions policies are more likely to

survive.

Sources of Revenues and Expenditures

The revenue generating source for the public and private colleges are limited to

four items as shown in Table 2: Federal and State Grants, Student Loan, State

Appropriations and Household Spending and Municipal Bonds. However the

private for-profit-institutions has more leverage since in addition to Federal and

State Student Grants, Student Loans, Household Spending they can tap outside

revenues by raising funds from stocks and investments (Eaton et al., 2014)

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Journal of Knowledge Globalization, Vol.8, No. 1

Table 2: The Revenue Generating Source for Public and Private Colleges

Type of College Total

number

Potential Revenue

Sources

Primary Capital

Sources

Community

College

819 Federal and State

Student Grants

Student Loans

Household Spending

State Appropriation

Municipal Bonds

Public 4-Year

College

331 Federal and State

Student Grants

Student Loans

Household Spending

State Appropriation

Municipal Bonds

Private non-

profit 4-year

college

1641 Federal and State

Student Grants

Student Loans

Household Spending

Municipal Bonds

Private for Profit 1320 Federal and State

Student Grants

Student Loans

Household Spending

Corporate Bonds,

Stocks offerings,

Equity

investments

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Rahman: Approaches to Managing Costs in American Higher Education

Figure 3 below shows the sources of revenues for private and public universities

per FTE (Full time student equivalent). Federal and state appropriations and

grants play a significant role in increasing revenues in public and private

institutions. In comparison to other sources of revenues net tuition has been

increasing.

Figure 3: Sources of College Revenues

There are ten classifications of expenditures (ten cost pools) for academic

institutions, namely instructions, research, student service, public service,

academic support, instructional support, operation and maintenance, net

scholarship and fellowship, education and general and auxiliary enterprises

Figure 4 below shows FTE expenditures for each category (Delta Cost Project,

2008). The major part of the expenditure is related to administrative functions.

On the average 30% of the expenses is for instructions and instructional services

and 70% + is on managing and administration.

.

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Journal of Knowledge Globalization, Vol.8, No. 1

Increasing salary of College presidents coupled with increased number of top

administrators and their support stuffs have been cited as the main reasons for

increasing higher education costs (Mathews, 2013; Clark, 2009; Archibald and

Feldman, 2010). Millionaire presidents in academia are a recent phenomenon. It

is reported in Huffington Post that,

“A record 23 presidents received more than $1 million in total compensation in

fiscal 2008” (Huffington Post, 8 Aug. 2014)

To summarize this section I have identified the following causes for cost

increase:

1. Over investment in plant and property and deferred maintenance costs

2. Increase in long-term loans and mortgage payments

3. Increasing overhead

4. Expansion of programs

5. Higher fixed costs (and decreasing enrollment increases per student

costs)

6. Increase in administration costs

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Rahman: Approaches to Managing Costs in American Higher Education

Figure 4: Weighted FTE Student Expenditures

Increasing salary of College presidents coupled with increased number of top

administrators and their support stuffs have been cited as the main reasons for

increasing higher education costs (Mathews, 2013; Clark, 2009; Archibald and

Feldman, 2010). Millionaire presidents in academia are a recent phenomenon. It

is reported in Huffington Post that,

“A record 23 presidents received more than $1 million in total compensation in

fiscal 2008” (Huffington Post, 8 Aug. 2014)

To summarize this section I have identified the following causes for cost

increase:

7. Over investment in plant and property and deferred maintenance costs

8. Increase in long-term loans and mortgage payments

9. Increasing overhead

10. Expansion of programs

11. Higher fixed costs (and decreasing enrollment increases per student

costs)

12. Increase in administration costs

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Journal of Knowledge Globalization, Vol.8, No. 1

Accounting System in American Higher Education

The present cost and revenue failures in AHE are rooted in the applications of

traditional concepts and systems of accounting, failure in understanding or

applying the causal relationships between costs and revenues, and inadequate or

inappropriate uses of accounting tools (especially budgeting and breakeven)

Below are some of the weaknesses of the AHE accounting systems:

1. Absence of an effective cost model

2. Traditional cost models- are used for bean counting and balancing

budgets

3. Budgeting is not used for motivation and control (as used in business)

4. No established relationship between cost and productivity.

Traditionally HEI’s do not have productivity measures to relate to

budget items except for the student intakes which is a revenue measure

and not a cost measure

5. Fixed and variable costs are not delineated

6. Productive and not productive expenditures are not always evaluated

7. Criteria for value added costs are not clear

8. Do not have essential data of the cost structures.

9. Trustees and faculty often are not on one team

Distrust among faculty and administration often becomes a big issue. Martin

(2011) states

“….by 2008 there were more than twice as many administrators as tenure-track

faculty at all types of institutions.”

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Rahman: Approaches to Managing Costs in American Higher Education

Figure 5: Framework or Creating Adaptive Systems Model

We have addressed the issue using three groups

1. Innovative Program restructuring

2. Use of innovative tools

3. Introduce management control systems for effective control and

employee motivation

These efforts should include all levels of the institution - individuals,

departments, and the University. It is observed that universities and institutions

which are in financial crises forget their core competencies and core values due

to external forces and market pressure. Thus they tend to lose their

differentiating advantages. The universities which have deviated from their core

missions tend to have invested too broadly and, thus, have reduced their return

on investment.

Decisions Processes and applications

Program restructuring Innovation and Change

Innovative Tools Adaptive controls and Evaluation

Management Control Systems Operating Control and Strategic

Planning

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Journal of Knowledge Globalization, Vol.8, No. 1

Examples of Institutions Taking Lead in Fixing the Issues

Conscious efforts have been taken by some institutions to control their costs and

to improve economic performance (O’Shaughnessy, 2010; Driscoll, 2012;

Marcus, 2010; Kiley, 2011). Below are a few examples:

Michigan Model for Financial Strategy and Cost Control

Michigan University (MU) by far has taken the most aggressive steps to control

its rising cost. The Michigan model is described as “diversifying revenue

streams, dramatically reducing and reallocating cost; and carefully managing

resources to protect world class students’ experience.” (Michigan Model Cost

Control and the University Budget)

Some of their measures are: Program restructuring, modifying activities,

academic review, rationalize course offering, centralize operations, e.g., IT

services, reduce services costs, let go top administrators, and eliminate auxiliary

services.

As a result of aggressive cost and revenue management, they were successful in

reducing student tuition and generate significant cost saving. Areas highlighted

for cost saving are as follows

Employee benefits, energy consumption, procurements, consolidation of

departments, reduction and reallocation of recurring costs, health care costs.

Over the last seven years MU cut the recurring expenses by $135 million and it

is an ongoing process.

An example of cutting recurring expenses at MU.is that Desk-trashes are

collected two days a week and employees are encouraged to recycle. This

resulted in the overall saving of $600,000 a year.

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Rahman: Approaches to Managing Costs in American Higher Education

Georgetown University

Georgetown’s cost control strategy includes cost center approach and

responsibility accounting. Two elements of the cost center strategy are:

- Cost Center approach, dividing each unit as a cost center.

- Cost Center status reports are prepared by department chairs,

directors.

Approaches adopted by a number of Universities such as Purdue University,

Indiana University (Bloomington), University of NH, UCLA, UPENN, and

USCLA include:

a) Responsibility Center Management (RCM)

b) Contribution approach budget

c) Distinction between direct and indirect costs

d) Responsibility center approach management

e) Supplier’s collaboration

f) Discontinue operations

g) Alternative use of skills

The most common cost reduction strategies followed by about 50% of the

institutions surveyed AGBUC (2011) are:

a) Implementing energy saving initiatives,

b) implementing hiring freezes,

c) implementing salary reduction or freezes, and

d) postponing capital spending.

Some universities are collaborating in course delivery and purchasing by

Discontinuing non-priority courses, using more eLearning courses and utilizing

qualified administrative staff to teach one course per year. Private Colleges in

Oregon and Florida- have formed insurance consortia

Barriers to Cost Management

Effective cost management depends on the management control system and

accounting system of an institution. AHE management and accounting controls

need major overhaul to achieve effective cost controls. AHE institutions need to

change these barriers.

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Journal of Knowledge Globalization, Vol.8, No. 1

All organizations face barriers to change (Argyris, 1993; Cawsey and Desca,

2007; Starr, 2011). Within higher education institutions barriers to cost controls

come from two sources: 1) Management controls and 2) Accounting controls.

We have discussed some of these barriers below

Management Controls

Structural inflexibility

Academic and management structures are generally inflexible in educational

institutions. Roles and positions and lines of authority and responsibility of a

university are what they were traditionally (Chan, 2012; Cameron, 1984).

Management strategies in universities do not include matrix organization,

flexible organization, job rotations, or just-in-time management to increase

efficiency and effectiveness.

Trust and team work

In academic institutions, departments, administrations, and deans all work

within their silos, breeding grounds of mistrust and jealousy. Therefore, any

innovative proposals for cost control or for productivity increase are likely to be

trashed on the first sight. Moreover, cost control is a team work which can only

be achieved by multidepartment operating teams (matrix organization). As most

financial activities of AHE are centrally controlled and non-transparent, there is

no opportunity for effective team work which contributes to the growing

mistrust.

Training

Cost control is a serious discipline. In order to learn how activities of each

individual contribute to cost and productivity, some form of training program for

cost awareness is necessary. Unfortunately, AHE institutions do not have any

formal training program to orient people about their financial and cost

environments.

Bureaucracy

Academic institutions are highly bureaucratic and centralized

(Stateuniversity.com). Administration enjoys tremendous power to hire and fire

people of any ranks and decide about the raises and budgetary expenses without

any accountability to the organizational actors such as faculty and staff. (Page,

1951, Ginsberg, 2011).

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Rahman: Approaches to Managing Costs in American Higher Education

Vision

The vision of an organization defines the domain of an organization. A viable

cost strategy has its root in the vision statement. If the vision of an organization

is to be a high quality and low cost institution, it must adopt a cost strategy of

operational excellence. It is easy to lose cost consciousness if it is not implicit in

the vision statement. No AHE uses Balanced Score Card, which links visons

with the business model, as a tool for evaluation and control.

Processes and procedures

Most academic institutions have deployed very little managerial accounting

processes and procedures to focus on right information and to take right

decisions. The top administrations do not have necessary cost information to

select and to focus on activities which are critical for the success of the

organization.

Lack of Collaboration

AHE institutions use very little collaboration as tool for cost control. Functional

and geographical collaboration may help to increase productivity and control

costs. (Prat, et al.2011).

Ill-defined Responsibility and Coordination

Though department boundaries are well defined, the cost responsibly of the

department managers are not clearly defined. As budget allocations do not relate

to activities performed by departments, the cost effectiveness of departments are

not measured. There are cases of duplication of services in teaching and

administration.

Consensus Management

Consensus management is the management style in academic institutions (Adam

III and Shannon, 2006). Board of trustees, top administration or faculty senate

solves problems by majority consensus and not by leadership decisions.

Everyone tends to agree with everyone so that they keep their power and

position base intact.

Accreditation Standards and Rising Expectations

The rising expectations of the accrediting agencies like AACSB require schools

to spend significant amount money to run according to the prescribed standards.

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Journal of Knowledge Globalization, Vol.8, No. 1

Some of these costs are marginally relevant to productivity or revenue increase.

Small schools are generally adversely affected by these standards.

Management Controls

Structural inflexibility

Academic and management structures are generally inflexible in educational

institutions. Roles,positions and lines of authority and responsibility of a

university are what they traditionally were (Chan, 2012; Cameron, 1984).

Management strategies in universities do not include matrix organization,

flexible organization, job rotations, or just-in-time management to increase

efficiency and effectiveness.

Trust and team work

In academic institutions, departments, administrations, and deans all work

within their silos, breeding grounds of mistrust and jealousy. Therefore, any

innovative proposals for cost control or for productivity increase are likely to be

trashed on the first sight. Moreover, cost control is a team work which can only

be achieved by multidepartment operating teams (matrix organization). As most

financial activities of AHE are centrally controlled and non-transparent, there is

no opportunity for effective team work which contributes to the growing

mistrust.

Training

Cost control is a serious discipline. In order to learn how activities of each

individual contribute to cost and productivity, some form of training program for

cost awareness is necessary. Unfortunately, AHE institutions do not have any

formal training program to orient people about their financial and cost

environments.

Bureaucracy

Academic institutions are highly bureaucratic and centralized

(Stateuniversity.com). Administration enjoys tremendous power to hire and fire

people of any ranks and decide about the raises and budgetary expenses without

any accountability to the organizational actors such as faculty and staff. (Page,

1951, Ginsberg, 2011).

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Rahman: Approaches to Managing Costs in American Higher Education

Vision

The vision of an organization defines the domain of an organization. A viable

cost strategy has its root in the vision statement. If the vision of an organization

is to be a high quality and low cost institution, it must adopt a cost strategy of

operational excellence. It is easy to lose cost consciousness if it is not implicit in

the vision statement. No AHE uses Balanced Score Card, which links visons

with the business model, as a tool for evaluation and control.

Processes and procedures

Most academic institutions have deployed very little managerial accounting

processes and procedures to focus on right information and to take right

decisions. The top administrations do not have necessary cost information to

select and to focus on activities which are critical for the success of the

organization.

Lack of Collaboration

AHE institutions use very little collaboration as tool for cost control. Functional

and geographical collaboration may help to increase productivity and control

costs. (Prat, et al.2011).

Ill-defined Responsibility and Coordination

Though department boundaries are well defined, the cost responsibly of the

department managers are not clearly defined. As budget allocations do not relate

to activities performed by departments, the cost effectiveness of departments are

not measured. There are cases of duplication of services in teaching and

administration.

Consensus Management

Consensus management is the management style in academic institutions (Adam

III and Shannon, 2006). Board of trustees, top administration or faculty senate

solves problems by majority consensus and not by leadership decisions.

Everyone tends to agree with everyone so that they keep their power and

position base intact.

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Journal of Knowledge Globalization, Vol.8, No. 1

Accreditation Standards and Rising Expectations

The rising expectations of the accrediting agencies like AACSB require schools

to spend significant amount money to run according to the prescribed standards.

Some of these costs are marginally relevant to productivity or revenue increase.

Small schools are generally adversely affected by these standards.

Accounting Controls

Formal managerial accounting systems are not used by AHE. No costing

methodology has been developed for higher education. NCHEMS3, proposed

one in 1970 but later was abandoned in 80’s. Academic institutions are managed

by financial accounting information. Not many institutions will be able to tell

what their capacities are. Because cost control has not been a focus in the

accounting system, poor managerial cost information constrains cost effective

management decisions.

Towards a New Accounting Model

In this section we discuss cost value chain and Cost center approach to cost

management of HE.

Cost and Value Chain

The goals of higher education institutions are: provide high quality student

experience, achieve higher ROI on student’s investment, and add value for their

tuition dollar (Chan et al., 2014; Domask, 2014). We have extensively reviewed

cost cutting strategies followed by many universities. Apparently, the link

between cost and value does not exist. Cost reduction should not be viewed in

isolation as cost reduction must not end in value reduction. Increasing value per

student dollar spent should be the primary consideration of academic

institutions.

In order to apply appropriate management accounting tools, educational

institutions should classify all costs within a department as direct and indirect

costs and controllable and non-controllable costs. The costs should also be

identified as value added and non-value added costs with regards to the services

3 The National Center for Higher Education Management Systems http://www.nchems.org/.

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Rahman: Approaches to Managing Costs in American Higher Education

each department provides. Which means services of each department must be

measureable as shown in Table 3

.

Table 3: Higher Education Cost Structure

Direct

Costs

Indirect

costs

Direct Costs Indirect costs Value

added

Non-

value

added

Fixed Costs

(Capacity

Costs)

Direct to

Depts.

Indirect to

Depts.

Controllable by

the Depts.

Controllable

by other Dept.

Direct and

Indirect

costs

Direct

and

Indirect

costs

Variable

costs

(Operating

costs)

Direct to

Depts.

Indirect to

Depts.

Controllable by

the Depts.

Controllable

by other Dept.

Direct and

Indirect

costs

Direct

and

Indirect

costs

The above framework is the first step to design a new management accounting

system for higher education. The cost should be classifieds in all department by

six major categories, i.e.; Fixed costs, variable costs, direct costs, indirect costs,

value added costs and non- value added costs.

Cost Center approach and Value Chain

In a new accounting model value added and controllable costs are the key. It

requires application of cost center approach to capture costs by categories. As

previously mentioned, educational activities are classified as ten cost centers

(Delta Cost Project, 2008). 1. Instruction, 2. Students Service, 3. Academic

Support, 4. Institutional Support, 5. Net Scholarship and Fellowship, 6.

Education and General, 7. Operation and Maintenance, 8. Auxiliary Enterprise,

9. Research, and 10. Public Service. These cost centers can be linked in a value

chain by asking the question: how does each function, sub-function or task add

value to the students to justify spending the tuition dollar on it. As an example,

one major suburban university proudly publicizes; “our cafeteria serves the best

food in town.” A parent commented, “I do not want to pay for the best food I

would rather pay less tuition for the second best food.” Definitely, increase in

cost for the best food or for the campus swimming pool for the visiting parents

does not add value to this parent for increased tuition.

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Journal of Knowledge Globalization, Vol.8, No. 1

The author has developed a value chain model to classify the costs in value

centers using Porter’s (1985) concepts of value chain as shown below:

Figure 6: Higher Education Value Chain Cost Model

Value added costs increase productivity and generate revenue. The goal of this

model is to find out the value added activities in academic institutions. For

example, costs of activities which are needed to maintain and run a classroom

are value added activities and costs of adding additional classrooms are

productivity increasing costs. In this model we have focused on five groups of

cost activities in higher education and proposed to create six activities cost

pools. To start the process one needs to examine each cost pool to find out the

value added and non-value added activities and eliminate the non-value added

activities. All value added activities are added to arrive at the total costs of

giving instructions which will ultimately enable a student to get the education

they are paying for. Eliminating non-value added activities is not an easy task.

There are non-value added activities in direct and indirect costs. Student

surveys, parent surveys and alumni surveys should generate data on their

preferences and help identify value added activities. Institutions are different.

24

Rahman: Approaches to Managing Costs in American Higher Education

Each institution should develop its unique cost functions to maximize the

benefit/ cost ratio. Until now, cost of education system is production driven and

not customer driven. Universities do not critically examine where they can

increase costs and where they can reduce costs. When they face financial crises

they cut costs across the budget lines and perhaps unwillingly hurt the quality

and long term health of the institution.

Productivity Increase and Alternative Capacity

Costs and productivity are closely related. Any discussions of cost should

include references to productivity and capacity. In cost accounting the

consideration of cost, volume and profit relationship is an important subject for

cost control decisions. In this section we consider some alternatives for

productivity increase which will lead to cost reduction per FTE student.

Semester versus Trimester system

There are many alternative approaches to productivity increases in higher

education such as: expand the capacity, trim the non-value added costs, add new

and efficient product design, consider opportunity costs for all decisions, and

evaluate more than one alternative.

The 15 week academic semester has a lot of slack time (non-value added time)

which can be trimmed by trimester system. Colleges operating on trimester

system feel that there are a lot of slacks in the 15 weeks semester course models

(CollegeXpress, 2014). CollegeXpress site has listed more than 50 colleges and

universities on trimester system which include: University of Michigan, Ann

Arbor, University of Toronto, Simon Fraser, William Carry, and Metropolitan

College, New York. Changing from the 15 week semester system to 11 week

trimester system will increase the capacity and reduce FTE costs. Universities

can offer three trimesters a year instead of two semesters a year.

Under trimester system Faculty teach three terms of 11 weeks and work within

their 9 months teaching obligations. They will teach five to six courses every

year as per their contracts. Students can graduate from 3 to 3 1/2 years assuming

they take 4 courses per trimester. Summer courses will even expedite the

graduation time.

Assuming the undergraduates students take four courses per trimester, they will

take 14 course per year (11 week Trimester: 4 course X 3 terms + 2 for

summer=14 courses per year). Students can complete 48 three-credit courses or

122 credits in three years. It will even be shorter if they take five courses per

25

Journal of Knowledge Globalization, Vol.8, No. 1

term. They can save almost one full year of their time. They save on-campus

housing and living expenses and the university saves one year of capacity where

they can bring a new class. Graduate students with first year courses waived will

graduate in two trimesters, which is significantly less than one year.

Change to trimester will have significant impact on revenues and costs, such as:

a) Increase in tuition revenue by 25% per year without any

increase in capacity costs

b) Increase higher contribution margin per dollar of tuition revenue

c) Students spend 25% Less costs to graduate- make university

financially more attractive to the students

d) More research time available for faculty during the term when

they teach teaching 2-2-2. In semester system a research teacher

teach 3-2 load. More cost saving for the university.

Online Delivery Alternatives

In addition to trimester, institutions should consider using online learning and

blended learning as alternative capacity sources and to reduce costs of operation.

Many schools are seriously considering online education as a part of their core

business and new revenues. According to Docebo (2014) research, online

market is to grow over the next 10 years. The five-year compound annual

growth rate is estimated at around 7.6% and revenues should reach $51.5 billion

by 2016. Online education grew at a cumulative rate of 10% over ten years.

One-third American students took at least one course online in 2010. In 2010

six million students took online courses.

Another alternative is MOOC. MOOC movement has opened the global market

of higher education to a larger audience which was previously unknown. The

big three MOOC providers, Udacity, Coursera and Edx provide education

everywhere to everyone. These providers partnered with big and top

universities, like Harvard, MIT, Stanford, and U. Penn etc., which make them

very appealing to prospective students. MOOC enrollment is more than one

billion students which will soon reach two billion.

26

Rahman: Approaches to Managing Costs in American Higher Education

Sumamry and Conclusions

Higher education institutions in the USA are facing serious liquidity problem.

Increasing competition to attract new students, providing quality services,

decreasing enrollment, investment in new educational technology and

globalization, all contribute to increasing costs and decreasing revenues.

University administration is not efficient in cost management and in the use of

effective management control tools that could give them good measures of cost

and efficiency. Institutions are facing decreasing equity ratios and increasing

expense ratios. There is an increasing trend of closure or merger of smaller

institutions which are overburdened with debt servicing and increasing operating

costs

For all AHE institutions the major source of revenues is tuition. The present cost

and revenue trouble is rooted in the applications of traditional concepts and

systems of accounting, failure in understanding or applying of the causal

relationships between costs and revenues, and inadequate or inappropriate uses

of accounting tools (especially budgeting and breakeven). Academic

institutions should create a new accounting systems model. In this paper we

proposed an Accounting System Model. We addressed the issue from three

directions: embracing program restructuring, use of innovative tools, and

effective management control systems.

The financial crises of AHE institutions stem from inadequate management

accounting controls. Management control obstacles include structural

inflexibility, process and procedures, consensus management, inexplicit vision,

bureaucracy, training, ill-defined responsibility, lack of collaboration,

accreditation standards, and rising expectations

A cost value chain model was derived from the ten categories of higher

education costs to implement a value added cost accounting system. Finally, the

paper explored several avenues of productivity increase. It was shown that it is

cost effective to switch from 15 week semester to 11 week trimester which can

bring significant increase in productivity for institutions and reduce cost of

education for the students. It may result in increase in tuition revenue without

any increase in capacity costs and generate higher contribution margin per dollar

of tuition revenue. In trimester system undergraduate students will potentially

spend 25% less time and money to graduate, and the faculty will get more

27

Journal of Knowledge Globalization, Vol.8, No. 1

research time. Online learning, blended learning, and MOOC provide additional

options to increase capacity and cost reduction. Many AHE institutions have

started strategic rethinking and have adopted management controls needed to

respond to the changes in the environment.

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Rahman: Approaches to Managing Costs in American Higher Education

Appendix -1

Credit rating

Bond &

Mortgage

(million

dollars)

Credit rating

Bond &

Mortgage

(million dollars)

1 Amherst College Aaa 310,107,600 Aaa 175,079,650

2 Babson College A3 110,992,663 Aaa/VMIG 1 124,882,195

3 Bentley University A3 139,200,000 A3 151,811,000

4 Berklee College of Music A2 261,052,631 A2

5 Boston College Aa3 753,253,000 Aa3 614,302,000

6 Boston University A2 1,246,633,000 A3 1,267,123,000

7 Brandeis University A1 266,648,000 Aa3 210,728,000

8 Clark University A2 83,566,000 A2 83,898,000

9 College of The Holy Cross Aa3 156,915,000 Aa3 177,324,000

10 Emerson College Baa1 256,533,605 114,094,518

11 Emmanuel College Baa1 77,556,516 Baa1 83,747,959

12Franklin W. Olin College of

EngineeringA1 158,977,000 A1 157,982,000

13 Hampshire College Baa2 24,320,945 Baa2 27,103,866

14 Harvard University Aaa 18,333,765,000 Aaa 17,440,713,000

15Massachusetts College of

Pharmacy & Health SciencesA2 117,890,910 A3 134,573,166

16Massachusetts Institute of

TechnologyAaa 2,460,002,000 Aaa 1,335,393,000

17 Merrimack College Baa3 38,005,734 Baa3

18 Mount Holyoke College Aa3 113,915,000 Aa3 90,660,000

19 New England Conservatory Baa1 21,403,458 Baa1

20 Northeastern University A2 733,526,000 Aaa/VMIG 1 698,360,000

21 Simmons College Baa1 184,674,000 Baa1 163,091,864

22 Smith College Aa1 165,242,000 Aa1 174,890,000

23 Springfield College Baa1 64,815,724 Baa1

24 Stonehill College A2 90,185,146

Aaa/VMIG 1

and A2 78,976,388

25 Suffolk University Baa2 357,403,508 Aaa 56,700,000

26 Tufts University Aa2 646,805,000 Aa2 349,809,000

27 Wellesley College Aa1 249,020,000

Aaa/VMIG 1

and Aaa

156,938,000

28

Wentworth Institute of

Technology Baa1 87,630,000 Aa2/VMIG 1

92,550,000

29 Wheaton College Aa3 42,000,000 A2 23,887,410

30 Williams College Aa1 294,735,441 Aa1/VMIG1 262,003,384

31

Worcester Polytechnic

InstituteA1 199,803,000

Aaa/VMIG 1

and A1 141,789,000

28,046,577,881 24,388,410,400

Increase in LTD 3,658,167,481

% Increase 0.149996142

As of June 30, 2012 As of June 30, 2008

Credit Rating For Colleges and Universities in Massachusets

Institutions