College Pricing and Harvard

Harvard recently flexed its $35 billion endowment, and the higher education community in the U.S. publicly applauded and privately grumbled.

Just to recap briefly in case you missed the drama or, like me, initially yawned it off as merely another illustration of the inanity of college pricing in the United States. On December 10^th, Harvard announced it had revised its financial aid policies with three new features designed to make Harvard more affordable for middle- and upper-middle-income families (see here). The three new initiatives are:

• Harvard will no longer consider home equity when determining a student’s need for financial assistance.
• Loans will no longer be a component in the mix of aid offered to students.
• And, most notably, the price of a Harvard education will be capped at 10% of family income for “families with incomes above $120,000 and below $180,000 and with assets typical for these income levels.” At present, the expected family contribution is zero for families with incomes of $60,000 or less. This policy will remain intact. Families with incomes between $60,000 and $120,000 will also benefit from a cap, but on a sliding scale between 0% and 10%.

According to Harvard, the impact of these changes on pricing will be substantial. Families affected by the new home equity policy should expect to see the price of a Harvard education decline by an average of $4,000. And the new zero to 10% standard should reduce Harvard’s cost by one-third to one-half. For example, Harvard estimates that a typical family with income of $180,000 would pay about $18,000 compared to more than $30,000 under the current awarding policy.

I’m not going to try to summarize the reactions to this announcement, because I want to move from this point in a different direction. But the reactions were entertaining, to say the least, and included: consternation that $180,000 could be considered upper-middle-income; concern that Harvard’s shift would increase the degree of family haggling over pricing at other institutions; claims that Harvard had masked, in an altruistic cloak, the awarding of merit financial aid to students whose financial need did not warrant it; and assertions that Harvard had taken preemptive action to thwart attempts now in Congress that would require non-profit colleges and universities, as a condition for maintaining their tax-exempt status, to annually distribute a minimum percentage of endowment to operations.

If you’d like to follow these reactions, here is a cross-section of responses (New York Times, Boston Globe 1, Boston Globe 2, and Inside Higher Education).

As I read these stories, I started to wonder just how much impact a $35 billion endowment could have on pricing. The answer is that Harvard could, if it so chose, redefine college pricing … which is probably a fearsome thought for presidents of colleges and universities who compete with Harvard for students and yet do not enjoy multi-billion dollar endowments.

That is a conclusion I reached after spending several days mired in the intricacies of Harvard’s Financial Report for Fiscal Year 2007 (here, pdf). I don’t mind telling you, this was not easy. The audited financial report includes 22 pages of notes that provide detail to the 4 pages of standard statements. Harvard is a complex institution and its financial statements reflect that fact.

I believe I have accurately interpreted the financial information, but there undoubtedly are nuances that I’ve missed. So you should probably view the story I’m about to describe as true but not exact. If anyone would like to pursue this summary in greater detail, I’ve also included page locations in Harvard’s financial report. The dollar amounts in my story are expressed in millions. So $3,247m is actually $3,247,000,000. And please note that we’re speaking about the whole university here and not just the undergraduate college, for example.

Harvard’s fiscal year runs from July 1 to June 30, so the financial statements I reviewed refer to the year from July 1, 2006 to June 30, 2007. During that time, revenues used for operations came from five sources (p16). These were student income (e.g., tuition, room, board); sponsored research (e.g., external funding from the federal government for research); gifts given for current use; investment income, including endowment income distributed for operations; and other operating income (e.g., rentals, royalties, publications, etc). About 20% of the $3,211m total operating revenues came from net student income (i.e., student sources after removing scholarship aid to students). A similar percentage (20%) came from sponsored research. Investment income provided about 38% of total operating revenue, while gifts for current use and other operating income contributed 7% and 15% respectively.

This, of course, is a revenue distribution that most private non-profit colleges and universities can only envy. A mere 20% of Harvard’s annual operating revenue is dependent on the vagaries of the student marketplace. Tuition-dependent institutions are much more the norm in the U.S.

As I read the reaction around the country to Harvard’s announcement, I kept returning to the same question. What would it take for Harvard to become totally independent of student income? Could Harvard afford to offer all students a free education?

The answer is yes. And the degree of financial pain it would inflict on Harvard is minimal. Here’s the rest of the story.

In fiscal year 2007, the largest single category of Harvard’s operating revenue came from endowment income ($1,044m or about one-third of total operating revenue; p16). Stated somewhat different, Harvard distributed over a billion dollars in one year from endowment to general operations. So we’re not talking small potatoes here.

But by distributing another $658m from endowment to operations (p16), Harvard could have eliminated the need for any student income. That is, no student in undergraduate, graduate, continuing education, or executive education study would have needed to pay tuition, room, board, or fees. Their education would have been free.

If solely based on financial considerations, Harvard could increase its endowment payout to operations by the $658m with minimal impact. Each fall, the Harvard Corporation approves an endowment distribution rate (p30). This rate is stated in an obscure way as dollars per unit of market value at the beginning of the fiscal year. For fiscal year 2007, the endowment distribution set by the Corporation was 4.3%. Meaning that about 4% of the market value of Harvard’s endowment at the start of the fiscal year could be available for operating revenue. The market value of the endowment was $29,219m on June 30, 2006 (p17).

As I mentioned previously, Harvard actually distributed $1,044m of endowment income for operations. This amount is 3.6% of the market value of the endowment at the start of the fiscal year. By increasing the endowment distribution to 5.8% (i.e., another $658m), Harvard could have provided a free education to its students during fiscal year 2007.

The value 5.8% is significantly greater than the target identified by the Corporation, but it is also near the range planned for the future. As stated in the financial report, “in an effort to accelerate progress on priority initiatives, the University recently increased its targeted aggregate spending rate range to between 5.0% and 5.5% of the endowment’s market value annually” (p5). The use of the word “aggregate” refers not just to the payout for operational use but also includes what Harvard calls a “strategic payout” to provide funding for key programs and goals.

Clearly the provision of free education is not one of Harvard’s goals, but the fact that the Corporation would consider a range of 5.0% to 5.5% means that finances alone would not prohibit Harvard from redefining its pricing structure to achieve institutional goals.

There’s no doubt that an additional $658m is a considerable amount of money, but it also needs to be put in context. The market value of Harvard’s endowment increased by $5.7 billion in fiscal year 2007 (from $29.2 billion to $34.9 billion; pp16-17). Endowment would still have been $34.2 billion after covering all income from student sources with income from endowment.

Harvard enjoys huge latitude for future price movement. Of course, some of this latitude is constrained by factors other than finances, so I don’t think we’ll see free and Harvard mentioned together any time soon. That much is clear.

But just as clearly, if college costs ever truly become a national concern, Harvard does not provide a healthy model for the rest of U.S. higher education to follow. The path to less costly higher education does not lie through multi-billion dollar endowments. Rather, it depends on educating students differently.

Originally posted 02-Jan-2008 by Gary M. Lewis on http://garymlewis.typepad.com/educational_imaginations.

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