The Business Model and Today’s Economy: A Warning to Universities and Investors
With spring upon us, this is the time when deans and vice presidents of higher education across the country embark on their annual budget exercise. Given the optimistic economic scenario painted by improving salaries, labor reports, and corporate earnings, it wouldn’t be out of place to start dreaming of expanding your own small circles and proposing bigger budgets and higher hiring for your respective units. that Warren Buffett has done. dubbed the institutional imperative. My warning: beware!
As an academic, I have often heard high-ranking officials defend how public universities should be run using a business model. The president of my own university is a strong advocate of the idea. The problem is that universities face challenges that most companies do not have to face. For example, suppose demand for your company’s product drops. To keep your business viable and accountable to shareholders, you will reduce production. Fewer sales means fewer staff will be needed, leading to downsizing. Despite lower revenues, the bottom line remains stable by reducing material and personnel costs.
Let’s see what happens in a university. Suppose that the demand for your product, classes, decreases, that is, there are fewer students enrolled. The cost of materials to run a class is minimal compared to the personnel and costs of the physical plant. You cannot close buildings, so your only recourse is personal reductions. This is a problem that corporations do not have. They have never had a case where the few remaining customers demand that the company produce as much product as before the demand reduction. But if you have a class of 40 reduced to 30 or even 20 students, the university cannot cancel it. These students signed up for the class well in advance, even before the semester began. Their schedules and even their graduation are based on it. If the class doesn’t, the students will be in an uproar and in this day and age they have no problem letting the world know, online. As the news goes viral, the university will gain a bad reputation. It will affect future enrollment. Any lesser inscription whisper sends chills up administrators’ backs.
Here’s another difference between corporations and higher education providers. Corporate hires are more fungible. If you let someone go, all you need is a notice of several weeks. Not so for the academy. You can fire staff that way, but instructors have an academic year contract. University administrators may decide not to renew a contract for a non-tenured instructor after the academic year, but cannot terminate it during. That means hiring and budgeting decisions need to be made well in advance.
In 2007 I was in the middle of this dilemma. I was the founder and chair of the Idaho State University Budget Committee. Our mandate, as I saw it, was to stay abreast of economic developments so that we could better advise administrators of the “setbacks” that lead to reductions in state allocations to higher education. Once produced, we will provide advice on budget allocations for programs and recruitment. Academic hires must be made months in advance, so timely entry means looking forward at least six months. It was within that time frame that I warned our senior management about the impending economic slowdown and real estate problems at the epicenter of the financial crisis. That message went unheard at the time, so for the next two years, our committee took it upon itself to help the administration deal with shrinking budgets.
The unemployment rate at the time of my warning in 2007 was 4.4%, wages were up 0.3% for the month and 4.4% for the year, and S&P 500 earnings were up 16% during the year. GDP growth was set at 3%. Sounds familiar? There were many reasons to be optimistic, and yet the future did not play out that way. The same will happen this year, although the main factors behind the economic stagnation will be different.
A financial storm is developing. This time around, the low-pressure front is due to demographic forces that will result in lower spending in the 46-50 age group, a group referred to as the highest spenders. There will be a prolonged and marked decline in consumer spending that will lead to a prolonged economic recession starting this year and lasting until 2023.
The general accounts of the state will decline as sales tax revenue declines and an increase in unemployment leads to lower personal tax revenue. These are the two main pillars that fill the coffers of the State. The other two are real estate and corporate taxes. While property tax income will remain stable, corporate tax income will reflect the decline in corporate profits. The bottom line is that state support for public universities will be reduced and, once again, these institutions will have the difficult task of managing their budgets through downsizing. Therefore, it is not the time to dream of expanding departments, but the time to plan for downsizing.
Administrators must avoid the temptation to pass the buck and use college reserves to meet the immediate challenge. Next year will not be better. In fact, this downhill process will continue to get worse, and as I mentioned earlier, it will last until 2023. University officials will be forced to face music at some point, so they might as well brainstorm and think of five. or 6-year plan to deal with discomfort.
The warning is doubled for those who invest in the stock market. The same forces operating within state finances will also hamper our economy and wreak havoc on corporate profits and prices. Equity portfolios will be substantially impacted. My advice is to heed the current stock market warning. We just went through a correction, but these are just labor pains from the financial storm that is coming. The sages will use any rally as an opportunity to shrink equity stocks. There will be many who will make fun of me now, but when the worst part of the storm hits, you will want to get totally out of the stock market.