Denison University in Granville, Ohio, is a top-tier liberal arts college with a national reputation, high endowment per student, and robust student demand for admission. Denison has implemented a strategic plan for 2015–20 that will allow us to deepen student learning—our mission—in ways that enhance student enrollment, student outcomes, institutional visibility, and all initiatives that the institution needs to remain financially healthy.
The university’s leadership has recognized that successful organizations are those that look forward during a period of strength. We also foresee that higher education—especially the segment of well-endowed, residential, liberal arts colleges—is in the midst of a period of turbulent change at least as severe as that created by the market decline of 2008.
Historical Perspective
All across our sector, the shock of that sudden recession caused concern in college business offices around the nation. For schools with healthy endowments, the plummeting economy heightened concern about the ability to support operating costs in the face of sharply decreased endowment balances. Many of these colleges looked to offset lower endowment values, and concomitant lower endowment appropriations, by increasing tuition revenue. However, the financial market decline affected not only the balance sheets of higher education institutions, but those of families as well. Schools without high endowment-to-student ratios weathered 2008 relatively well—as the low per capita endowment value meant endowment appropriation was not a significant portion of the operating budget—but soon experienced revenue pressures, as lowered asset values impacted families’ ability to pay for college, and tuition revenue was a major component of operating revenue.
As families generally had relied upon savings to help pay college expenses, their ability and willingness to pay for higher education decreased just when institutions were looking for greater net revenue per student—or at least greater net tuition revenue overall.
With total revenue driven by the formula of net price multiplied by volume, and families more resistant to higher costs, many colleges needed to achieve enrollment growth. Naturally—and unfortunately for college business officers—with many colleges fighting concurrently to grow enrollment, tuition discounts became more common and discount percentages continued to rise.
The consequence of this competition for students has persisted through today, even for schools in the topmost tiers. For example, the 2015 NACUBO Tuition Discounting Study showed an increase in the average tuition discount rate from 34.3 percent in 2004–05 to 41.3 percent in 2014–15, for all undergraduates; a similar trend was reported for first-time, full-time freshmen: from 38.1 percent to 47.1 percent in the same time period.
What Fate Awaits
Denison has been extremely fortunate that our robust gift inflow, strong endowment returns, and disciplined expense management have placed us in a stronger financial position now than in 2008, even as market pressures also have forced us to increase our overall discount rate from 50 percent to 58 percent, since 2008. While we have not experienced another sharp drop in endowment values, looking forward, Denison views the long-term horizon for higher education to include a new set of financial challenges:
Low returns on assets. Since the financial crash, Denison’s endowment earned a 9.1 percent annual return and, consequently, has recovered from 2008, and began FY2015–16 at a higher endowment level. However, industry sources such as BlackRock and Jack Bogle, founder of the Vanguard Group, forecast that average returns for the next 10 years will be lower than the strong returns realized from 2009 to 2015, which led to the recovery of Denison’s endowment. As a result, Denison is planning for an era where operating results must be a larger driver of the growth in financial health than previously.
A competitive marketplace where heavy tuition discounting for students is already prevalent. As noted previously, colleges responded to a grim revenue picture in 2008 by driving enrollment through discounting. Discount rates have not, however, declined to pre-2008 levels, and colleges cannot continue to increase discount rates to drive volume.
Increasing regulatory burdens, with consequent cost implications. Additionally, colleges now have greater regulatory burdens (see The Cost of Federal Regulatory Compliance in Higher Education: A Multi-Institutional Study, Vanderbilt University, October 2015) and face greater demands from families for information about the value of a college degree than was the case prior to 2008.
These pressures are increasing while schools face the necessity of stabilizing (or shrinking) discount rates—ideally by proving superior outcomes (value) instead of cutting student support.
The challenges identified here are not insurmountable. However, the trustees and administration at Denison believe that the landscape for liberal arts colleges will bifurcate, with growing contrast between the top and lower tiers.
Those on the one side of that divide will be institutions that lack strong market presence and solid financial bases, and will find it increasingly difficult to differentiate from competitors or provide a quality education. Such colleges will likely attract students only by increasing already-steep discount rates and will eventually either reach the point of collapse or be forced to radically change their mission and how they operate.
Alternatively, schools on the other side of the equation will successfully address these challenges, and we conclude that they will exit this period of stress in a stronger condition than when they entered. By articulating and implementing effective strategies, these colleges will end the period with strong market position, robust financial health, and outstanding educational programs.
Strategy on a Firm Foundation
Denison chose to construct a new strategic plan designed to maintain the university’s position in the group that flourishes. The plan’s key components center in instruction and student development, built on a strong financial base—the kind of financial health that is a prerequisite for the plan. Unlike for-profit corporations, with the singular goal to maximize returns to owners, nonprofit colleges must balance two opposing goals: (1) fulfill the inherently expensive mission of supporting and educating students, and (2) generate sufficient net revenue to perform their mission in perpetuity.
Ensuring that the entire campus understands the importance of financial health and how it is monitored is foundational for embarking on a new strategic plan even in a calm environment. To create this campuswide consensus, Denison’s senior administration relies upon an internal finance committee, comprising faculty, administrators, and hourly staff, to raise, discuss, and disseminate information on financial issues. Additionally, we have made extra efforts to hold campuswide forums and author internal papers on the importance of the financial stability that underpins the strategic plan.
At Denison, we believe that such financial stability is based on four components: current net revenue, revenue growth, growth of net financial assets, and reinvestment in infrastructure.
Current Net Revenue
Net revenue is typically defined as revenue, less expenses, for the current fiscal year. This measure is considered adequate if revenue equals or exceeds expenses, with two caveats: (1) in addition to costs, such as salaries, that are annual cash expenditures, expenses include allocations adequate to maintain the college’s infrastructure; and (2) ideally, a modest (2 to 3 percent of revenue) surplus is generated. This is the traditional concept of a balanced budget and, as the measure most readily impacted by management, it is often the most commonly referenced operating metric.
Emphasizing the two caveats is a critical piece of our ongoing message to the campus; it is essential that the campus understands that a budget is not truly balanced if deferred maintenance increases significantly year after year—deferred maintenance is a liability as constraining as debt. We also ensured that the campus understands that moderate surpluses, on average, are key to withstanding unexpected downturns and providing resources for programmatic investments.
Revenue review. As a liberal arts college, Denison has a relatively small revenue stream, with the majority of revenue deriving from student charges. Net tuition and room and board revenue comprise approximately 65 percent of operating revenue, with gifts and endowment appropriation providing the majority of remaining revenue.
Major revenue components include the following:
- Net tuition (gross tuition or "sticker price" multiplied by the number of students attending, less financial aid, including both merit- and need-based awards). For 2015–16, Denison’s gross tuition was $101 million and financial aid was $58 million, resulting in $43 million of net tuition revenue, or nearly half of total revenue.
- The strategic plan is designed to increase revenue by deepening and improving student learning outcomes, as net tuition revenue is the single largest component of Denison’s revenue stream and, for the reasons noted previously, the one that we most need to ensure will grow at least as quickly as our costs.
- Room (charges for students staying in Denison-owned housing). As a four-year residential college nearly all (98 percent) students are housed on-campus.
- Board (charges for students on a Denison meal plan). In all, approximately 85 percent of students are on a college meal plan. Some seniors in apartment-style housing prepare meals on their own, and they are not on a college meal plan.
The chart indicates net tuition, room, and board in areas with a patterned fill, as these revenue categories are the ones paid by students or families. In aggregate, these charges are approximately 60 percent of Denison’s operating revenue, and ensuring robust growth for them is key to our long-term financial health. - Endowment (the operating support appropriated from the endowment, per the spending rule). As a well-endowed college, Denison receives 31 percent of its operating revenue from the endowment. This appropriation (or "draw") includes unrestricted funds and all but the most highly restricted individual endowments, providing support for expenses such as faculty, athletics, and financial aid.
- Gifts (revenue that consists primarily of unrestricted annual fund contributions, which support general operating expenses). Gifts to endowment (primarily bequests), restricted for capital or supportive of tightly restricted expenses (such as private grants), are not included in the operating budget, although they are an essential component of the college’s total revenue picture.
- Other (revenue that is derived mainly from the bookstore and other fee-for-service activities). Such revenues nearly always are offset by commensurate expenses and result from activities closely associated with core educational function rather than auxiliary activities operated for a profit.
Expense elements. Denison’s expenses are largely fixed in the short-term and primarily comprise compensation. Educating students at a residential college remains a relational endeavor, with a commensurately high proportion of costs directed to employees. We’ve found that educating the campus about the components and proportion of our expenses is an essential element in generating consensus on prioritizing activities. That is because most members of the campus community have been unaware of the scope of expenses it takes to operate a residential college. They needed this information to understand that not all new activities could be immediately funded without additional revenue or reductions elsewhere. However, the strategic plan is not designed as a way to cut expenses; changing what you do may be strategic, but doing it efficiently is tactical.
- Wages, salaries, and benefits. These expense categories include salaries and hourly wages, overtime costs and student wages, as well as all benefit costs (Social Security, retirement contributions, medical insurance, and so forth). Coincidentally, total net revenue received from families to attend Denison is equal to compensation expense; while costs of activities and of operating Denison’s facilities are funded by revenue sources other than that charged to families.
- Supplies and services. This is the largest noncompensation budget category, comprising a wide array of goods (general items such as office supplies and consumables for athletics and facilities services) as well as services, such as information technology software fees, legal, and outsourced labor.
- Board. Denison outsources food service operations, so this cost represents labor and associated costs in addition to actual food. While net board revenue was 3 percent of the overall budget (revenue and expenses budgets were equal, at $111 million), this margin excludes the unallocated costs of equipment and utilities, as well as depreciation of the dining locations.
- Debt service. The interest costs of Denison’s outstanding debt were $175 million as of June 30, 2016, and do not include principal repayments.
- Repairs /plant renewal/equipment. Expenses of 7 percent of the total budget, or $8 million, are split between $500,000 for repairs, $2 million for equipment, and $5.5 million for building renewal. With approximately two million square feet of building space, Denison should reinvest approximately $11 million–$14 million on an annual, average basis. Denison has been achieving this target through a combination of operating allocation ($5.5 million); gifts earmarked for capital (as previously noted, major gifts for capital are not reflected in operating revenue); and use of bond proceeds.
Revenue Growth
Obviously, forward-looking institutions must achieve not only a balanced budget in the current year, but plan for the future by ensuring that subsequent budgets also are balanced and adequate to maintain financial health. Consequently, revenue growth must be at least equal to expense growth, which must not be left unchecked, forcing revenue to increase commensurately. Oft-cited measures of revenue growth are net tuition revenue per first-year student and the corresponding discount rate.
Consistent with the industry, Denison’s revenue growth per student has been moderate over the recent period. From 2007–08 to 2014–15, net tuition revenue per student increased at a compound annual average growth rate of approximately 0.5 percent. Net tuition revenue per student showed a stronger increase from 2007–08 to 2015–16, which is arguably the first year that the marketing impact of our strategic plan affected demand).
However, the annual growth rate for this period was still only 2.7 percent. For most of the intervening periods (2007–08 to 2012–13, for example), average annual growth rates for net tuition revenue were in the range of only 1.2 percent to 1.8 percent, much lower than the normalized expense growth over the same respective periods.
Expenses per student (total on-campus student enrollment) for the same period, 2007–08 to 2014–15, have grown more quickly than net tuition revenue per student, due to the inexorable rise of costs (primarily compensation, and particularly benefits, expense). Expenses per student during this period exhibit low volatility, but the average annual growth rate of 3 percent is, unfortunately, higher than the growth rate of net tuition revenue per student.
While it is less than ideal for normalized expenses to grow more quickly than normalized net tuition revenue, Denison has fared well over the period, due to growth in other revenue streams.
- Endowment returns. From 2009 to 2015, returns were 9.1 percent per year, and the endowment appropriation consequently has grown by more than 4 percent per year from 2007–08 to 2014–15. This growth has helped balance out net tuition growth that was slower than student charges, and permitted Denison to generate balanced budgets and a minimal amount of deferred maintenance.
- Auxiliary revenue. Primarily room and board per student also grew faster than expenses over this period, by 3.9 percent per annum. Like endowment appropriation, growth from this revenue category has exceeded expense growth and offset net tuition revenue growth rates that lagged the expense growth rate.
- Gifts to capital projects. Additionally, Denison has benefitted from strong gifts to capital projects over this period that have augmented Denison’s financial health. Generous alumni have provided invaluable support for the preservation of Denison’s campus.
In aggregate, the significant growth in nontuition revenue has permitted Denison to strengthen its financial position over the period.
That revenue growth will continue to exceed expense growth in the coming years is not certain. The drivers of expense growth are likely to continue into the foreseeable future. However, it is less likely that the recent trend in revenue growth will similarly continue: The market forecast for annual endowment returns is significantly below recent actual returns, and families are much more resistant to the 3 to 4 percent increases in room and board charges than they were at the beginning of the period.
Consequently, it is imperative for schools such as Denison to reverse the trends of merit aid provided to affluent families and thereby generate adequate growth in net tuition revenue for future years. Our strategic plan is designed to enact just such a reversal: We are focused on a series of aligned strategies that are designed to deepen student learning, while also improving student outcomes and documenting the success that Denison alumni enjoy in five-, 10-year, and longer-term periods after graduation. We are also focused on better telling this story. Denison is ensuring that the institution adheres to its mission and proves its value to families with the ability to pay for attendance without significant merit aid.
Growth of Net Financial Assets
The plan is focused on creating a sustainable financial model for the future in the following ways: (1) strategies are designed to increase demand among families that can pay 50 percent or more of the tuition, allowing the college to reduce the discount rate without decreasing academic quality or diversity; (2) the plan was built by leveraging existing resources as a way to set a bold agenda for expanding the curriculum, enhancing career exploration programs, and developing innovative campus life programs with reasonably small investments; and (3) strategies and tactics were designed so that the strategic plan would be financed by contributions through a comprehensive campaign, thereby not layering on more costs to the operating budget.
Clearly, the endowment plays a key role in asset growth. For schools with large endowments, such as Denison, a given year’s endowment return may vary dramatically from operating results in other years; in addition, endowment returns are not necessarily correlated with strong enrollment, a manageable discount rate, or expense control.
In 2015–16, for example, Denison generated a budget surplus of approximately 2.8 percent, but experienced an endowment return of negative 5.9 percent. Although this difference was only 3.1 percent, it resulted in a large change in Denison’s net wealth. Denison’s operating revenue in 2015–16 was approximately $111 million—and so the strong operating surplus of 2.8 percent equated to $3.3 million in net revenue. Since Denison’s financial assets were $816 million, the negative return equated to a loss of $47 million, far outweighing the operating surplus on a dollar basis.
Because endowment returns can vary significantly from year to year, change in financial assets should be measured over the long term (five- or 10-year periods), and one-year changes should be viewed within the context of long-term averages, particularly if schools have constructed an aggressive, high-volatility investment portfolio. Additionally, the change in endowment values result not only from returns, but also from gift additions and the appropriation used to support operations. Gifts to endowment and capital are important additions to institutional assets, but are large and volatile enough that they are excluded from operating measures.
Ideally, net financial assets should grow moderately on a real basis (after inflation). Expenses in higher education primarily comprise compensation-related expenses, which historically have grown more quickly than the broader measure of inflation; hence the goal of greater-than-inflationary growth in assets. Additionally, colleges need to grow financial assets at rates that exceed inflation—even the inflation for compensation expense—to be able to accommodate new areas of study (such as adding computing and biochemistry programs) and increasing infrastructure demands for current areas of study.
Denison includes endowment appropriation as operating revenue, but changes in financial assets are not included in the traditional metric of the balanced budget. Because endowment growth is a function of the appropriation for operations—which is incorporated in the operating budget, while endowment return and gift inflow are not—asset growth should be viewed as a separate measure of financial health.
As with expense containment, the strategic plan is not focused on endowment growth; however, like expense growth, endowment growth is a critical tactical underpinning of a plan that requires significant investment in the programs necessary to provide an outstanding education, as these investments will require funding in perpetuity.
Reinvestment in Infrastructure
Colleges such as ours must provide adequate physical and technology infrastructure to support the current services and plan for future ones. Failing to adequately fund infrastructure results in growing deferred maintenance and unfilled capital needs. This is as much a liability as debt, and like debt, it must be repaid at some future point.
From 2007–08 to 2014–15, Denison’s level of plant and equipment, net of annual depreciation, has grown from $186 million to $255 million, an annual average increase of 4.6 percent. Colleges must balance overbuilding with the need for a robust infrastructure for existing activities; a reasonable balancing point is Denison’s rate of growth, which is slightly greater than that of inflation.
Past Performance, Future Expectations
Denison is managing its resources to balance four competing priorities: (1) funding the costs required to provide an outstanding education; (2) maintaining the infrastructure required to meet needs of our current students and faculty; (3) growing assets—specifically financial assets—to provide for unexpected expenses or revenue shortfalls; and (4) creating the financial flexibility to invest in new programs and initiatives that enhance student learning and outcomes.
Denison has stewarded its resources very well over the long term, as well as during the recent period. But like many colleges in this economic environment, we face a combination of factors going forward—a high discount rate, low expectations for returns on financial assets, and increasing regulatory and cost pressures—that make the near future every bit as stormy for higher education as what we experienced in 2008. We believe, though, that with careful planning and sound business management, Denison is well positioned to build upon its strengths and complete its strategic plan, which will allow us to expand the curriculum; reinvent the career exploration process; deepen student learning; and support our faculty and staff as teachers, scholars, and mentors.
DAVID ENGLISH is vice president for finance and management, Denison University, Granville, Ohio.