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The Buck Stops Elsewhere

January 2013

By John R. Curry, Andrew L. Laws, and Jon C. Strauss

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In spring 2013, NACUBO will release an update of Responsibility Center Management, first published in 2002. The original publication explained a budgeting method called responsibility center management (RCM), in which the CFO delegates to individual academic units the control of revenue in exchange for financial responsibility, including indirect costs.

Why the new version? Having studied the growth of the RCM budgeting model, coauthors John R. Curry, Andrew L. Laws, and Jon C. Strauss found that the fewer than a dozen institutions that used RCM in 2002 has grown to well over 50 institutions self-reporting that they use such a model. “Not surprising, given the times,” they note, citing a 2011 Inside Higher Ed survey, “interest in responsibility center management among public universities is soaring, with more than 21 percent of public doctoral institutions reporting that they use the RCM model.”

In this book preview, the authors explain the basics of RCM, compare the method with more traditional budget models, and provide a case study that gives insight into the significant changes involved in moving to responsibility center management—and just why it may be worth the effort.

Responsibility center management (RCM) was developed and has evolved over some 35 years in response to multiple forces: changes in the external environment, including the larger economic context; needs within universities to achieve a balance between academic authority and financial responsibility; desires to unleash and provide structure to entrepreneurship, both latent and demonstrated among faculty members and deans; the need to have realistic measures of the quality, cost, and growth of administrative services; and the increasing imperative to understand the full costs of academic programs and to relate them to outputs—courses, credit hours, and research volume generated, among others. 

Following is a brief discussion of the evolution of the three most common approaches to budgeting, including RCM—and the attendant strengths and weaknesses of each. A case study explaining the ways that Ohio University, Athens, applied RCM to its customer service efforts provides a practical example of this decentralized approach (see case study sidebar, “RCM Optimization via Customer Service”).

Environmental Dynamics

Driving the evolution of budgeting practices are the changing economic and political contexts of recent decades. Indeed, ad hoc responses to external stimuli and growing environmental complexity have given rise to organizational adaptations, which in turn have inspired thoughtful rationalizations and new approaches to budgeting. 

While there have been many forces in play, the following are relevant to the study of RCM’s evolution:

In addition, new market forces have been at work, bringing added economic complexity and the potential for diversified revenue growth. Successfully adaptive organizations, including universities, become complex in proportion to the environments they confront. 

New markets also have brought new stakeholders—new “owners”—and their influence on institutional direction, while demands for accountability have increased: from federal funding agencies, to corporate underwriters, to bondholders and rating agencies, to donors, and alumni. 

A 2011 Inside Higher Ed survey, which included questions about the type of budget model respective institutions employed, found that just over half of the surveyed institutions noted that their model reflected more than one described model, suggesting hybrid implementations and/or alternative implementation for operating units within a single institution. 

For the approximately half of the remaining 2,350 two- and four-year colleges and universities (each of which enrolls 500 or more students), the three most common approaches to higher education budgeting were likely to include: (1) incremental, (2) formula and/or performance based, and (3) revenue-centered budgeting, also called responsibility center management. 

The Incremental Budgeting Model 

The most common among higher education institutions, this model is characterized by central ownership of all unrestricted sources. It is a top-down approach to budget development, with the view that the current budget is the “base” to which increments (salary and inflation adjustments, new faculty positions, and so on) are added to build next year’s budget. 

The budget development process typically begins with the provost, the CFO, and the central budget office projecting next year’s unrestricted revenues, primary sources including: tuition (enrollment levels and price increases); recovery on grants; investment income (unrestricted endowment distribution and return on invested cash and fund balances); and unrestricted gift flows. Appropriate levels are also determined for salary pools and inflation adjustments for nonsalary expenditures. The difference between projected revenues and projected expenses becomes the pool available for incremental programmatic allocations. 

The central administration issues a budget call letter to deans and administrative directors, typically describing the decision parameters governing top- and bottom-line budget projections, the resulting availability of new resources—or reduction in current resources—to address new needs and initiatives, and the priorities (sometimes derived from a strategic plan) that will govern budget decisions. Deans and directors then prepare budget (expense) letters itemizing line-item requests that are reviewed in budget hearings, with final decisions made by the provost and/or CFO and the president.

When projected revenues are less than projected expenses, the budget call letter will typically impose an across-the-board percentage of reduction targets, asking deans and directors to describe actions they will take (and the consequences to their programs) to meet their reduction targets.

These centralized, incremental models have had remarkable staying power for several reasons:

Formula/Performance-Based Budgeting (F/P) 

In this budget model, budget decisions are also made centrally but on the basis of policy formulas or metrics that relate inputs such as enrollment or research volume or outputs such as graduation rates to budget expenditure levels. Input-based metrics are typically designed to provide equitable funding across units by incorporating measures of activity levels. The output-based models are designed to reward mission delivery. According to the 2011 Inside Higher Ed College Business Officer Survey, 26 percent of institutions use formula funding models and 20 percent use performance funding models. However, as we saw earlier, many institutions report the use of more than one model, suggesting high adoption rates of hybrids.

Resources flow to academic units in one of two ways. 

Institutions often modify such models by the incorporation of weighting schemes. The most common is a credit-hour weighting to account for differential delivery costs of instruction. A second common modification involves the portion of resources to which metrics apply. Not all university activities easily lend themselves to funding via input or output measures; central administration, for example. Thus, a portion of the total unrestricted pool needed to pay for administrative services reduces the pool available for funding for academic units. 

Similarly, not all academic activities easily tie to units of input or output—research and public service, for example. Consequently, the formula/performance-based models are often confined to small margins of overall activities. 

Both formula- and performance-based models provide an objective method for making budget decisions, and they are easy to understand. They also incorporate data as justification for funding decisions. Metrics allow for the easy measuring and rewarding of success. Input formulas can promote internal funding equity and redistribute resources from shrinking to growing programs—if applied symmetrically. Output formulas can promote mission. By combining both kinds of metrics, institutions can work toward optimizing their respective models. 

Like all good things, however, these models have their limitations. 

The development of F/P models is difficult, given that simple formulas may be too simple, program unit costs are not always easy to ascertain, and academic quality considerations (not to mention politics) mediate most any metric design. 

Since central administrators apply the metrics, they may be unwilling to confront the politics of budget reallocation implied by the metrics. The upside is easy, and the downside fraught with the same issues as reducing a base budget in a nonmetric-based system—with the central administration being the bearer of the bad news that the formulas require taking budget back.

Responsibility Center Management (RCM)

This model, also known as revenue-centered budgeting, provides incentives for all entrepreneurial activities, not just management of input and output metrics. The approach transfers revenue ownership and allocates all indirect costs to units whose programs generate and consume them respectively. The model uses subvention—that is, centralized resource redistribution—to achieve balance between local optimization and investment in the best interest of the university as a whole.

This approach attempts to address the weaknesses inherent in the other common approaches and reflects institution leadership’s need to address fragmenting markets and engage more entrepreneurs in the search for revenues. For example, RCM recognizes the schools, departments, and individuals engaging most directly in enrollment and research markets by formally sharing portions of tuition and research-related revenues among schools and departments. Such devolution of revenue ownership is intended to aid local entrepreneurship and growth in both the deans’ and the university’s top lines. 

Typically, the indirect costs supporting instruction and research—facilities and administration—are made explicit and allocated to the schools and auxiliaries according to space occupied and estimates of administrative services consumed. The difference between (1) the school’s revenues and (2) the sum of direct and allocated indirect expenditures is funded through allocation of university revenues from central administration sources: for example, central shares of tuition and unrestricted research revenues, state appropriations, unrestricted investment income, or direct expenditure taxes. This “difference” is typically a function of priorities governing annual budget development, and a recognition of differential unit costs of instruction across units, which typically charge common tuition per credit hour. 

In exchange for shared ownership of tuition and research-related revenues, deans and directors take responsibility for the bottom-line impact of revenue variances. If revenues exceed budget plans, they flow to the bottom line and all or a portion are carried forward. Similarly, revenue shortfalls are repaid through local expense holdbacks during the year, reductions in fund balances, or payments from future years’ budgets.

The budget development process begins typically with a budget call letter from the provost and/or the CFO in much the same way as incremental budgeting. The letter outlines the top-down estimates of universitywide revenues, with first-order estimates of key planning variables: tuition increases, salary pool requirements, nonsalary inflation adjustments, and the like. Other issues, such as prospects for state funding, or unusual benefits and utilities costs, are taken into account as well. The letter goes on to describe central priorities guiding allocations to each responsibility center of university revenues for the coming year(s), and estimates of changes in indirect costs and the resulting allocations of university revenue (subvention) and indirect costs.

At this point, the RCM approach diverges materially from centralized approaches from the responder’s vantage. Deans and directors prepare budget proposals (as opposed to simply requests for more money) that:

Budget Meetings Under the RCM Model

In developing their proposals, deans now put their own shares of revenues into play. Once this takes place, budget meetings take on a very different character, including the following elements.

The provost’s and CFO’s decisions about changes in university-revenue allocations to schools can be in the context of proposed single-line items that comprise an increment, or in the context of a proposed block grant derived from a high-level business plan proposed by a dean, or as limited-term underwriting of a new initiative. Decentralization of revenue ownership recognizes increasing market stratification and complexity, creates incentives for top-line growth, and distributes revenue authority and responsibility more broadly. Distributed ownership of revenues enhances local options to deal with local budget issues. The frequency of requests to the provost for more money decreases, allowing more time for focus on larger strategic issues. Conversations between provost and dean are now two-way. 

Distributed ownership of revenues forces broad understanding of external and internal tuition and research markets, and should ultimately lead to intelligent engagement and useful responses. And, open discussion of internally provided facilities and administrative services can lead to increasing efficiency, and sometimes broadly supported additional resources to enhance services when the right cases are made. Outsourcing options may be considered as well.

In sum, the degree of engagement in how the university works financially—and the relationships among budgets, academic outputs (teaching, research and service), program quality, and the roles of administrative support services—are vastly increased. 

Some Drawbacks of RCM

As with the other budget models, some weaknesses can result from the revenue-centered perspective.

Of more concern is the fact that many universities using RCM report that they have devolved too large a percentage of revenues to schools and departments, thus reducing the central ability to underwrite strategic initiatives and otherwise steer the institution. Compounding this is the fact that, just as with base expenditure budgets, the schools’ shares of university revenues in RCM can succumb to the entitlement disease. 

Also related is the potential for schools to develop and offer rogue courses or programs that may generate revenues but are either of poor quality or inconsistent with the university mission. The natural and potentially creative tension between central and local perspectives and priorities often provides rich context for conversations about the common good. 

General administration, information technology, development, student services, and library costs are all almost equally contentious, a function of the legitimacy of a variety of possible allocation rules, and local desires to perform and fund their own customer-specific versions of central services.

Considerable evidence suggests that the allocation of indirect administrative costs has not significantly contributed to intelligent debate about the right distribution of service functions between central providers (where scale economies are possible) and local units (where unique customer needs dominate). Deans complain about excessive costs without commensurate services; central providers complain about inadequate funding and excess demand, but persist in their monopolistic ways. No one brokers the debate, or diffuses it with good data. Too few consequences ensue.

In 2010, state appropriations represented only about 60 percent of educational revenue per student.

The creative tension between central and local perspectives and priorities provides rich context for conversations about the common good.