The Business School Business
If you are considering enrolling in business school, here is your first business school assignment:
- What are the key revenue sources and costs for a business school?
- How does a business school determine how much to charge for tuition?
The responses to the above questions may appear to be straightforward but the reality is much more interesting (or alarming depending on your point of view).
In a typical for-profit business, one usually examines revenues, profits, market share, or similar metrics to gauge the health and competitiveness of the business and to identify industry leaders. Businesses are eager to accept any and all customers and set prices based on a combination of factors including cost, value, and competition.
Figure 1. Three Primary Inputs Determine Prices of Goods and Services
- Cost represents the expenses and investments required to supply goods and services.
- Value measures customers’ willingness to pay for goods and services both in absolute terms and in relation to their ability to pay (affordability).
- Competition incorporates benchmark prices from competitors’ goods and services.
For non-profit business schools, profits are no longer relevant. Since leading schools limit enrollment (i.e. they intentionally restrict the number of ‘customers’) through the application process and the number of applicants routinely exceeds enrollment figures (supply is consistently insufficient to meet demand), there is little fluctuation in revenues and market shares from year to year and across schools. So how do we gauge the competitiveness of business schools absent the traditional metrics?
A commonly available metric is the selectivity of the school: What percentage of applicants are admitted? Or alternatively, how many people who aspire to be ‘customers’ are offered the opportunity?
However, there is a more interesting metric, yield: How many of the admitted applicants choose to enroll? Or alternatively, how attractive is this school’s offering relative to other possible choices (such as not enrolling in any school or attending another school) for those offered the opportunity to enroll?
The Usual Suspects
A good place to start learning about any business is by investigating the industry leaders. Ranking leading US business schools (those with enrollments of at least 200 students per entering class) based on yield reveals three distinct groups with clear separation between each group (see Table 1). Table 1 reveals a clear market leader, Harvard, along with four primary contenders: Stanford, Columbia, U Penn (Wharton), and MIT.
Table 1. Ranking Full-Time MBA Programs at US Business Schools. Source: School websites, BusinessWeek rankings
Industry leaders usually set the pace for everyone else, so let’s focus on Harvard Business School (HBS) and its financials.
HBS has four primary revenue sources (see Table 2):
- Publishing: course materials, articles, and books
- Executive education: course fees for non-degree programs
- Endowment distribution
- MBA tuition & fees
This may come as a surprise but MBA tuition and fees are actually the least significant of HBS’s four primary revenue sources. Also notice that despite its non-profit status, HBS (as well as other leading business schools) consistently generates profits.
Table 2. Harvard Business School Financials (all numbers in $M)
And The Correct Tuition Rate Is ...
Now consider how a school in this position may determine future tuition rates: What is the impact of a change in tuition on the school’s financials? The annual 5% or higher increase in the published tuition rate only changes revenue (adjusted for fellowships) by less than 1% usually (see Table 3). HBS could easily compensate for losing this marginal revenue gain by reducing discretionary expenses and its operating surplus. In other words, tuition could be held constant with little consequence to the school or its competitiveness. So, why has the tuition been increasing at 5% per year (or higher) for decades?
Table 3. Impact of MBA Tuition on Total Revenue for Harvard (all numbers in $M except percentages)
Consider the three primary inputs to prices: cost, value, and competition. As the industry leader, HBS is in a position to set prices regardless of competitive considerations: competitors have yet to demonstrate any ability to take ‘customers’ away from HBS as demonstrated by perpetual 90% yields (see Table 4). The above discussion also demonstrates that cost is not a significant factor. HBS has plenty of sources of cash outside of its own MBA students to pay for costs of the MBA program. So, we are left with value as the primary determinant of price.
Why does MBA tuition go up so quickly? Because the majority of HBS MBA students have consistently demonstrated they are willing (and able) to pay. Since tuition rates have increased far faster than median household incomes for the vast majority of the population, this suggests the majority of HBS students likely come from top earning households whose incomes have grown at sufficiently high rates in recent decades. The rest are offered need-based fellowships covering a substantial portion of the tuition. Table 4 reveals that the average net tuition after fellowships for fellowship recipients in Harvard's MBA program has remained in the $20K to $25K range for the past decade despite a near-doubling of the tuition rate over the same time frame. Based on this insight, one could argue that tuition rates could be raised even faster while increasing fellowship amounts to the point where average net tuition for fellowship recipients drops below $20K.
Table 4. Harvard MBA Enrollment, Tuition and Fellowship Statistics
Given the industry leader, HBS, has chosen its tuition, what should other business schools charge: more, less, or the same? It would be difficult to justify a higher tuition than HBS for a comparable program: The cost of HBS faculty, staff, and facilities are the highest in the industry. Similarly, the value offered and the competitiveness of the program are considered to be industry leading by a consensus of prospective students (based on number of applicants, selectivity, and yield).
Since HBS chooses to limit supply, there is substantial demand for alternatives. Other leading business schools satisfy this demand by offering their own programs at comparable tuition rates to HBS. Why offer a lower tuition when demand far exceeds supply? Of course, as non-profits, the primary constraint is revenue can not deviate from expenses by a substantial margin. Given fixed revenues, any anticipated deficit (expenses greater than revenues) is not sustainable and has to be addressed by reducing expenses. Similarly, any anticipated windfall (revenues greater than expenses) has to be compensated by manufacturing expenses.
Bundling and Subsidies
A typical business school has a variety of offerings (or lines of business) including the traditional full-time residential MBA, undergraduate BA, part-time MBA, executive MBA, PhD, non-degree executive education, on-line programs, endowment/gifts, publishing and research. Each line of business may incorporate its own bundle of services although tuition is usually associated with courses while the other services are usually provided without additional charge as part of the bundle (See Unbundling the MBA for a more detailed discussion).
Each service relies on the school’s resources (faculty, staff, facilities, etc.) to varying degrees. For example, a 60-student MBA course may require a large classroom and a lecturer with support from one or more teaching assistants while a 5-student PhD seminar requires a small conference room and one or more tenure-track faculty. Each course also incorporates its share of the respective degree program’s bundle of career services, social events, etc. so those costs need to be added to determine total costs for the bundle. In this way, one can determine the total bottoms-up cost for providing the full bundle for each line of business and compare the total costs to the total revenue generated.
If a particular line of business has higher revenues than costs, it is a profit center for the school and is subsidizing other lines of business (recall the school has non-profit status so it is not supposed to be generating substantial total profits across all lines of business). If the line of business has lower revenues than costs, it is being subsidized by other lines of business. Any resources not fully utilized (once all lines of business are taken into account) create an additional cost burden for the school. In other words, fully productive resources are subsidizing under-utilized resources.
Subsidies may or may not be desirable. For example, one can classify subsidies as progressive or regressive. A progressive subsidy can represent older generations subsidizing younger generations (‘paying forward’) or alternatively, wealthier students subsidizing less wealthy students (whether through students in the same degree program paying different out-of-pocket costs or students in a later-stage degree program subsidizing students in an earlier-stage degree program). A regressive subsidy represents subsidies moving in the opposite direction: younger generations subsidizing older generations or less wealthy students subsidizing wealthier students.
It is unusual to find situations where there are no subsidies of any kind present.
Let’s illustrate with some examples:
Most business schools (at least the more established ones) usually have substantial endowments which subsidize other lines of business (a progressive subsidy). Non-degree executive education also usually generates profits which can be used to subsidize other lines of business (also potentially a progressive subsidy).
On the other hand, most business schools are not significant recipients of scientific research grants (unlike, for example, engineering and life sciences disciplines). So the research line of business and the PhD program are usually subsidized by other lines of business (a regressive subsidy if funding is coming from another degree program). For example, at UC Berkeley’s Haas School of Business, tenured and tenure-track faculty spend only 25% of their time on teaching in undergraduate and masters degree programs (Figure 2) while the remainder of their time is devoted to research, administration, executive education and external activities.
UC Berkeley allocates teaching loads as follows:
1 semester-unit course (15 hours of instruction) = 8.5%
2 semester-unit course (30 hours of instruction) = 12.5%
3 semester-unit course (45 hours of instruction) = 16.5%
There are also variations in subsidy patterns across schools:
For example, Harvard Business School’s Publishing arm is its largest revenue source and subsidizes the school’s MBA and PhD programs. In effect, Harvard Business School Publishing provides a funding vehicle to allow other business schools to subsidize Harvard Business School’s degree programs through purchase of course materials (a regressive subsidy using the above terminology).
HBS does not have a part-time MBA program. At schools with part-time MBA programs, such programs usually subsidize other lines of business (subsidies could be progressive or regressive depending on the use of the funds). To make matters worse, tuition in part-time MBA programs are typically higher than full-time MBA programs. The higher rates have little to do with the value offered in relation to full-time programs or the cost of offering part-time programs. In fact, part-time MBA programs usually offer less course selection, fewer networking opportunities with classmates and alumni, and little organized recruiting activities for students seeking more experienced and targeted positions than the typical full-time MBA student. The justification for higher part-time MBA tuition rests entirely on the target demographic and their willingness to pay: older, more experienced students, likely with higher incomes and savings, who are reluctant to give up two years of income to go back to school full time. Non-profit business schools are behaving like profit-maximizing firms by extracting as much tuition as possible from these students.
What Is the Real Cost of Business Education?
When university administrators state the cost of higher education is going up, they are referring to the cumulative effect of all of the considerations cited above. What they actually mean is the price of higher education is going up and costs simply have to match the higher prices. There is no longer any direct relationship between the administrators' stated cost of higher education and the true cost of a specific degree program. Anyone who is interested in determining the real cost of a specific degree program needs to do a bottoms-up calculation.
One such calculation for UC Berkeley's part-time evening/weekend MBA program is illustrated in Table 5a: this estimate shows only about 40% of student tuition and fees collected by the evening/weekend MBA program go towards services provided to students enrolled in the program; the remainder of the tuition and fees subsidizes the school’s other businesses and/or pays for underutilized, irrelevant, and/or unnecessary resources.
Note, we have even yet to address recent trends such as online education or the use of modern business processes and management techniques to improve the operations of business schools. Even with traditional classroom instruction and legacy business processes and management techniques, a part-time MBA program could be provided for about 60% below the current offered price.
Table 5a. Bottoms-Up Estimation of Cost of UC Berkeley Part-Time Evening/Weekend MBA Program
Table 5b. Bottoms-Up Estimation of Cost of UC Berkeley Full-Time MBA Program
 Salary information for University of California employees is publicly available.
 Classroom rates are estimated from community college facilities rental rate sheets. UC Berkeley uses facilities such as these to conduct classes whenever higher priority events such as Cal football games conflict with classroom instruction.
 Degree program tuition is for three years and is available from the school's website.
Since many students in the part-time MBA program get tuition reimbursements from their employers (usually up to $12K per year or $36K over three years), the net out-of-pocket cost of tuition for students in the program should be about $15K (or $5K per year). Any deviation from these estimates represents behavior along the lines discussed above.
Table 5b provides similar estimates for the Full-Time MBA program. The key differences between the programs are:
- Total enrollment is 500 full-time (250 students X 2 years) vs. 750 part-time (250 students X 3 years).
- Units required to graduate are 51 units for full-time vs. 42 units for part-time.
- Tuition is $116K for full-time vs. $128K for part-time.
As a result, the full-time program could be offered for about half of the current offered price.
$uch a Deal
Given the variety of degree and non-degree programs offered by business schools, it is helpful to compare prices and costs across programs and schools by calculating normalized values per hours of instruction. Table 6 illustrates normalizes prices and costs for a variety of programs. Even as absolute prices drop for short-duration and online courses, the price per hour of instruction actually increases. Non-degree programs also usually do not offer any of the alumni networking and career services of degree programs so the value to prospective students is diminished.
Table 6. Normalized Prices and Costs per Hour of Instruction for Various Business Education Programs
At this stage, if you are considering enrolling in any business school program, you have a decision to make: If money is of no concern and you have not identified better uses of your time, attending business school could be a good choice. However, if money is an issue (especially if you need to finance a substantial part of the education through loans) or if you have concerns about the relevance and benefits of the typical program, it is preferable to seek alternatives. Since any significant reduction in price per hour of instruction or deviation in the actual offerings clearly requires a drastic departure from the traditional behavior exhibited by leading business schools, these alternatives are likely to exclude traditional business school offerings. That will be the topic for another post...