The business model and the current economy: a warning for universities and investors
As spring approaches, this is the time that deans and vice presidents of higher education across the country begin their annual budget exercise. Given the optimistic economic scenario painted by improving wages, job reports, and corporate profits, it would not be out of place to start dreaming of expanding your own little circles and coming up with bigger budgets and more hiring for your respective units, which Warren Buffett has. called 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 supporter of the idea. The problem is that universities face challenges that most companies don’t. For example, suppose the demand for your company’s product decreases. To keep your company viable and accountable to shareholders, you will reduce production. Fewer sales means fewer staff will be needed, leading to labor reductions. Despite lower revenues, the bottom line remains stable by reducing material and personnel expenses.
Let’s see what happens in a university. Suppose the demand for your product, classes, decreases, that is, fewer students enroll. The cost of materials to run a class is minimal compared to the costs of personnel and physical plant. You can’t close buildings, so your only recourse is downsizing. There is a problem here that corporations do not have. They never have a case where the few remaining customers demand that the company produce as much product as it did 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 registered for the class well in advance, even before the semester began. Their schedules and even graduation are based on it. If the class doesn’t, the students will be in an uproar and these days they have no problem letting the world know about it: online. As the news goes viral, the university will gain a bad reputation. It will affect future registrations. Any whisper of lower enrollment sends chills down the spine of top administrators.
Here is another difference between corporations and higher education providers. Corporate hires are more fungible. If you let someone go, all you need is several weeks’ notice. Not so for the academy. You can fire staff that way, but instructors are on an academic year contract. University administrators may decide not to renew a non-tenured professor’s contract after the academic year, but may not terminate it during the academic year. That means hiring and budget decisions need to be made well in advance.
In 2007 I was in the middle of this dilemma. I was the founder and chairman 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 on the “upheavals” that lead to reductions in state appropriations for higher education. Once they happened, we would provide advice on budget allocations to programs and hiring. Academic hires must be made months in advance, so timely information meant looking ahead at least six months. It was within that time period that I warned our senior management about the coming economic slowdown and real estate problems at the epicenter of the financial crisis. That message went unheeded at the time, so for the next two years our committee had to help the administration manage shrinking budgets.
The unemployment rate at the time of my warning in 2007 was 4.4%, wages were up 0.3% per month and 4.4% per year, and S&P 500 earnings were up 16% per year. GDP growth was set at 3%. Sounds familiar? There were many reasons to be optimistic, and yet the future did not unfold that way. The same will happen this year, although the main factors behind the economic stagnation will be different.
There is a financial storm developing. This time, the low pressure front will be due to demographic forces that will result in a decline in spending by the 46-50 age group, a group known as top spenders. There will be a prolonged and marked decline in consumer spending leading to a prolonged economic recession beginning this year and lasting through 2023.
The state’s general bills will decline as sales tax revenues fall and a rise in unemployment leads to lower personal tax revenues. 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 revenues will remain flat, corporate tax revenues will reflect falling corporate profits. The end result is that state support for public universities will be cut and, once again, these institutions will have the difficult task of managing their budgets by reducing staff. This is therefore not a time to dream of expanding departments, but a time to plan for downsizing.
Administrators must avoid the temptation to pass on the responsibility and use university reserves to meet the immediate challenge. Next year will be no better. In fact, this downhill process will continue to get worse and, as I mentioned earlier, will last until 2023. University officials will be forced to face music at some point, so they might as well brainstorm and come up with a 5 – 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. Stock portfolios will take a substantial hit. My advice is to heed the current stock market warning. We just went through a correction, but these are just the birth pangs of the financial storm ahead. The wise will use any rally as an opportunity to reduce stock holdings. There will be many who will scoff at me now, but when the worst of the storm hits you will want to be totally out of the stock market.
