Speech to Financial Executives International, Houston, September 19, 2006

September 19, 2006

Thank you for inviting me to talk with you this evening.

Four years ago I moved from the University of California at Berkeley, where I had served in the administration for more than a dozen years, to Smith College. The experience of working in such different institutions -- both exemplary, both complex -- has given me a distinctive perspective on higher education.

When he invited me to speak this evening, Mark Haukohl asked me to discuss some of the financial dynamics of Smith right off the bat. I don’t think any group has ever asked me to begin an after-dinner speech that way. It’s been an interesting way to approach what I want to say tonight. I want to talk with you about what I see as the major challenges facing higher education in the United States today, and particularly in regard to women. These can, for the most part, be represented in financial terms, but before I get to the actual financial data and the issues it implies, I thought it would be useful to reflect on the ways in which colleges are and are not managed like corporations.

In many ways, colleges, and universities, are not unlike corporations.

We sell a product, for a price.

We pay attention to many of the same business trends that you, as corporate leaders, do -- demographic and geographic shifts, globalization, the pricing climate -- both its latitude and its constraints--, the financial markets, changes in our own marketplace.

We face many of the same cost pressures -- energy, health care, retirement benefits.

We compete with others in our sector -- for the best students, for the best faculty.

We strive to foster new ideas and sometimes to commercialize them.

We are run by boards and operate under many of the principles of corporate governance and accountability as do publicly traded corporations.

Of course, we are also different in significant ways.

The administration of a college or university shares governance responsibility with the faculty, most of whom are tenured, that is employed for life. Shared governance is frequently misunderstood, even by the faculty. A better description might be divided governance. The faculty has responsibility for academic and curricular matters; the administration for financial and administrative ones.

We do not seek to make a profit, and we do not, in the usual sense, seek a bigger market share by competing on price.

We operate on a principle of variable pricing. We charge students in accordance with their ability to pay. The goal of this pricing policy is not to fill all the seats, like airline ticket pricing policy, for example, but to increase access to students of all income strata. We choose our customers, and we frequently choose those who can pay less over those who can pay more.

We try to motivate our customers, and our former customers, to subsidize the customers of future generations.

In the area of investments, our policies are driven by what, in the higher education business, is called generational equity. We want the students of future generations to realize at least as much benefit from the accumulated assets of the endowment as the students of today.

And, perhaps most importantly, whether public or private, we are regarded as public property. We have multiple constituencies, all of whom see themselves as part owners. This is shared governance in the largest sense, and is one of the most wonderful and challenging dimensions of being a college president.

With this set of contrasts as a preface, let me now describe our financials.

Smith College’s annual budget, net of financial aid, is $165 million. Financial aid is $41 million. Colleges and universities all operate on the principle that financial aid, whether it comes from specifically endowed scholarship funds or the operating budget, is represented as a discount against the total fee that would be collected, were every student to pay the sticker price. That percentage, the proportion a college’s financial aid represents of its total fee revenue, is called the discount rate. It is one of the most critical figures in college and university budgeting, and I will have much more to say about it later. Smith’s discount rate is 36 percent.

Of Smith’s annual budget of $165 million, about $74 million, or 45 percent, comes from net comprehensive fee revenue. Approximately a third -- $48 million -- comes from the endowment. $22 million derives from gifts and grants, but this category includes funds of very different sources and purposes, from current unrestricted gifts of almost $11 million that go directly into the operating budget to private and federal grants and contracts of $6 million, provided for specific research projects of the faculty.

The current value of the college’s endowment is $1.2 billion. We have recently changed our endowment take-out rate methodology. We used to withdraw 5.25 percent annually of the value of our endowment, based on a rolling 12 quarter average. The Board of Trustees became concerned that this take-out rate was too high in absolute terms to protect the long-term value of the corpus and that the methodology exposed the college to too much volatility in a chief revenue source. It therefore moved to an inflation based model, in which we set an initial rate of withdrawal at 4.75 percent, which we inflate at 4 percent per year subject to a collar whereby we would never withdraw less than 4 percent or more than 6 percent of the endowment’s value. This is becoming a common model at many institutions.

Now let me turn to expenses, although some demographics are first in order. Smith has 3,000 students, 2,700 undergraduates, 300 graduate students, of whom 250 are in the School for Social Work, whose classroom work takes place during the summer. We have 285 faculty members, a student/faculty ratio of 9:1, and about 800 staff.

Higher education, especially at a liberal arts college, is a people-intensive business. About 60 percent of our budget is spent on compensation.

With the exception of renewal and replacement, our capital budget is entirely separate.

So you now have a snapshot of the financials of a private liberal arts college. Just as a point of interest, but essential for understanding some of the challenges of higher education in this country, financials at Berkeley would look very different. Both the size of the student body and the budget are larger by a factor of 10; Berkeley has 30,000 students, and a budget of $1.5 billion. However, size is not the only contrast. The student/faculty ratio is double, or about 20:1. Grants and contracts for research compose approximately a third of the budget, in contrast to 3.5 percent of Smith’s. Federal overhead is consequently a major revenue source. Tuition and fees net of financial aid represent about 14 percent of the budget. Endowment income is about 3.5 percent of the budget. Notice that the percentages of the Smith and Berkeley budgets deriving from endowment income and from contracts and grants are exactly flipped.

Despite the major differences in the revenue streams and financial structure and incentives of the budgets of these very different kinds of institutions of higher education, they face similar challenges. The most significant -- for the institutions themselves and for the country -- is the relationship between cost, affordability, and access.

Remember that I said, in comparing a college to a corporation, that colleges choose their customers. They do this for several reasons -- a belief in equity of opportunity and a conviction that the value of the education all students receive is enhanced by the ability and the diversity of their fellow students. If a Lexus dealership operated like a college, it would sell its cars not necessarily to those who could afford them but to the best drivers. This would not be a profitable strategy for a car dealership, and it involves significant financial challenges for colleges.

Like a Lexus, tuition, room, and board at private colleges is beyond the financial reach of the great majority of American families. The comprehensive fee -- tuition, room, and board -- at Smith is $43,438 per year -- only about $3,000 less than the 2005 United States median family income. We’ve done a rough calculation at Smith; we estimate that students from families who pay the full comprehensive fee -- full-pay students in college lingo -- come from the top 10 percent of American income distribution. To put that figure another way, 90 percent of households in the United States cannot afford the cost of a private college.

Fortunately, many colleges in the United States, like Smith, have generous financial aid programs, most of which commit to meeting the full financial need of all admitted students, according to a set of federal guidelines. 61 percent of Smith students receive need-based financial aid; the average Smith grant is $21,000.

That brings us to the financing of the aid budget, and the complex calculus it involves. Institutions need to balance the need they have for revenue with the discount that financial aid represents. That is why the discount rate is so critical a figure in college financial planning. There are basically three ways in which colleges control this figure.

One is by considering ability to pay in a certain percentage of admissions decisions. Smith considers ability to pay in about the last 5 percent of its admissions decisions. Smith thus is not need blind, although it has a higher percentage on students on financial aid than many colleges that are need blind.

The second is by a practice called “gapping,” in which colleges do not meet the full need of each admitted student. (Smith does not engage in this practice.)

The third is merit aid -- a practice increasingly prominent in the education market place, in which colleges give scholarship awards to students who do not have financial need in order to entice them to enroll. I’m sure you understand why this practice is attractive to institutions. A student with, say, a $10,000 merit award, brings $33,000 to the college; a student with an average financial aid award to $21,000, brings $22,000. (Smith has a very small merit aid program for top admissions prospects, linked to an opportunity for independent research.)

Why is this important? The economic constraints and incentives work against equity of opportunity. This is the most serious challenge confronting American higher education today.

In a provocative new book soon to be released by the University of California Press,Tearing Down the Gates: Confronting the Class Divide in American Higher Education and Society, Peter Sacks argues that over the past thirty years, gaps in access to higher education have significantly widened between students of affluent backgrounds and students of low to modest economic means. Students from upper middle class families saw their bachelor’s degree prospects nearly double in this period, but the prospects of students from the lowest US income quartile have stayed stagnant, at 6 percent.

Even more striking is the fact that the most outstanding students from the bottom economic quartile have less of a chance of going to college than the low scoring students from the top economic quartile.

The attendance disparities are sharpest in the most selective colleges and universities. Students from the lowest economic strata are concentrated in community colleges and in proprietary schools. Although community colleges are rightly praised as providing opportunities for low income students, only 21 percent of students from the lowest income quartile actually transfer to a four-year college or university.

Only 3 percent of the first year students at the nation’s 150 most selective institutions come from the lowest socio-economic quartile; 75 percent come from the highest. Over the thirty-year period from 1970 to 2000, students whose parents did not go to college declined precipitously from 25 percent to 9 percent of the students at highly selective colleges.

There is a notable gender disparity in these figures. It is significantly more likely for low income females than low income males to attend and to graduate from college. Indeed the median income of the families of male college students is $10,000 greater than the median family income of female college students.

Smith College has a proud story to tell in relationship to socio-economic diversity. As I said earlier, 61 percent of our students receive need-based financial aid. 27 percent receive Pell grants, the federal financial aid grants for the lowest income students, a figure than places us second among private liberal arts colleges in the United States (after Berea College, which only admits financially needy students). Almost a quarter of our first-year class come from families in which neither parent graduated from college.

This choice clearly has costs, and is an easier one (though by no means painless) to make with an endowment the size of Smith’s. I believe that there are steps we can take, both as a country and as a higher education community, that will address the opportunity gap in higher education, but before I do, I’d like to spend a little bit of time on a question I am frequently asked -- why does college cost so much?

Part of this answer was revealed at the beginning of my talk: higher education is a personnel-intensive business. We spend our money on people. The people we employ are highly educated, and we compete for the best and brightest among them. In large part the dedication of the lion’s share of our budget to compensation explains why the higher education price index, or HEPI, inflates at a higher level than the more familiar consumer price index.

However, there are also factors within the world of higher education that create incentive for cost and price increases.

The simplest way to put this is that prominent among measures of institutional quality, as reflected in college ratings like the ones developed by US News and World Report, are measures of institutional wealth. Let me name just four of them.

Student/Faculty Ratio. Lower ratios are seen as indexes of quality. (Higher student/faculty ratios are a principal reason for the more economical structure, and lower cost, of state universities.)
Faculty compensation
Financial resources (endowment per student)
Alumni giving

Succeeding in this economic model is the most difficult at smaller private undergraduate institutions -- liberal arts colleges -- where the fixed costs of running a college are distributed among a smaller student body.

This demographic and financial challenge is reaching a breaking point, somewhat obscured by the fact that the pace setters in higher education -- the top schools in the US News rankings -- have such significant institutional wealth that they are somewhat insulated from its impact. I believe that the following steps would work together to increase equity of access and contain costs:

Greater federal investment in financial aid for needy students. Pell grant amounts have not changed in five years. We must increase the federal subsidy of college costs for our neediest students.
Greater state investment in state university and college systems. Although sticker shock is greatest at private colleges and universities, prices have risen more dramatically in the public sector, in large part through a growing conviction that a college education is a private not a public benefit. Our state colleges and universities do the lion’s share of the work of higher education in this country. They are an efficient model and one of our greatest national resources. In the past fifteen years, we have seen a significant replacement of public funding by tuition costs. This hurts poor kids, and diminishes the equity of opportunity that these great systems were designed to create.
Dial down the ratings game. As long as we have influential ratings systems that reward wealth, we create an incentive to raise costs and prices.
Place less emphasis on the SAT. Extensive studies at the University of California in the late 1990’s showed that the SAT alone, when controlled for academic high school performance record, only had predictive value for first semester freshman grades. The strongest correlation with SAT scores is income. The SAT’s, far from being a leveling tool, tend to reinforce the role income disparities play in determining access.
Create a public service loan forgiveness program, structured like ROTC, imagined like the Peace Corps, that enables students to exchange work for debt by engaging in public service, here or abroad..
Standardize and regulate financial aid packaging to put pressure on institutions to reduce the use of merit aid. Since an anti-trust case was brought against MIT and other institutions in the late 1980’s, colleges have been prohibited from discussing their packaging strategies. This ruling, intended to protect the consumer, I believe has had the unintended effect of ratcheting up costs. Creating the circumstances in which colleges and universities can have full and frank discussions of financial aid policies and strategies would have a healthy effect.
Work with community colleges to create more opportunities for students to transfer to colleges in the private sector.
Increase collaboration and sharing across the higher education sector. Smith belongs to a Five College Consortium in the Pioneer Valley including Mount Holyoke College, Hampshire College, Amherst College, and the University of Massachusetts, that enables us both to enrich programs at lower cost and to avoid costs by sharing services. We could do even more, and so could higher education as a whole.

Higher education in the United States is the finest in the world. Its preeminent position results from several factors:

First, the sheer number and variety of institutions.
Second, the system of land grant colleges and universities that grew up in the last third of the nineteenth century. The enormous expansion of this system after World War II gave the United States the most extensive set of opportunities for higher education in the world.
Third is the synergy between the university system and federally sponsored research. The growth of state universities, in particular, was fueled by the enormous expansion of federally sponsored research, beginning in the years immediately before World War II and continuing since then. This system -- of generously funded, peer reviewed, federally sponsored research, overseen by the NIH, the NSF, the DOE -- had provided the basis for the astounding technical and scientific innovation of the country over the past 70 years, and it provides a critical financial pillar for universities. (Remember, a third of Berkeley’s budget is sponsored research.)
Fourth is the synergy between universities and business. When I worked in the administration at Berkeley, the campus hosted numerous visits each year from teams of government officials, scientists, and business leaders from countries around the globe, seeking to understand and copy the set of relationships between government, universities, and business.
And the final is its openness to international students, particularly on the graduate and professional level. Through its recruitment of international students, the United States has greatly expanded its own talent pool and has developed a powerful tool for international understanding and good will. Some years ago, an op-ed piece in the New York Times argued convincingly that the modernization of the Soviet Union, and its ultimate collapse, owed much to the opening of doors of American universities to Soviet exchange students in the 1970’s, students who then returned to their home country with progressive economic ideas.

America’s college and university system -- in my view, one of the greatest achievements and most powerful strategic advantages for our country -- is subject to increasing competition, as countries, particularly in Asia, emulate this model. In my visits to universities in Asia, I have been impressed by how focused they are at being the best in the world and how clearly they imagine how to get there. The United States can no longer depend on being the most coveted destination for international students. That’s a concern for me, and should be for all of us.

The trends that I have been describing this evening -- state disinvestment in higher education, the reduction in access for students with fewer economic resources, and the greater difficulty international students have in coming to the United States to study because of changes in visa policies post 9/11--are putting our competitive status at risk.

In closing, I want to focus on a special case -- science and mathematics. I am sure that many of you have read Tom Friedman’s recent book, The World Is Flat. In his book, Friedman describes an alarming numbers gap. In 2004, the National Science Board reported that the number of American 18 to 24 year olds receiving science degrees has fallen to 17th in the world, down from 3rd, just three decades ago. Of the 2.8 million bachelor’s degrees in science and engineering granted worldwide in 2003, 1.2 million were earned by Asian students in Asian universities, 830,000 in Europe, and 400,000 in the United States. In engineering alone, Asian countries are now producing eight times the number of bachelor’s degrees as the United States. United States graduate enrollment in science and engineering remains below where it was a decade ago.

This worrisome story has a disturbing gender dimension. Women now make up almost 60 percent of the college population and almost 60 percent of bachelor’s degree recipients. Yet they are severely underrepresented in many fields in science. In engineering and physics, for example, women represent only 20 percent of bachelor’s degrees.

We cannot solve the national problem of degree production in science and engineering until we address the gender gap, most importantly, in engineering.

In this arena, Smith, has taken a bold step. Seven years ago, the college established the first-ever engineering program at a U.S. women’s college. This coming May we will graduate our fourth class; this spring we will break ground on a new building for engineering and science, a so-called “green-design” building that we plan as a model for environmentally sustainable building systems. In a very short time, engineering has emerged as a popular major at Smith, even attracting students from other disciplines who had never considered the field before enrolling at the college. Many coed institutions are looking to emulate a teaching model like ours that attracts, rather than weeds out, talented female students.

While Smith’s engineering program is, indeed, pioneering, data show that women’s colleges have unusual success in motivating women to become scientists and engineers. Women attending women’s colleges major in the sciences in larger percentages, and they go on to graduate study in larger percentages. Studies of women’s attrition in science and engineering identify the most important factor as peer hostility. Women’s colleges, with their communities of supportive peers, and larger numbers of women faculty, who serve as role models and mentors, create conditions for women to succeed in science.

What do we need to do to increase the numbers of women, and men, studying science and engineering? The key lies in K-12 education, and, particularly, in the training of many of our teachers responsible for instruction in science and mathematics. We need to improve the teaching of science and mathematics in K-12. The case is simple: if your teacher is uncomfortable with mathematics, and doesn’t understand it very well, the chances are you won’t either. Meanwhile, we must create multiple paths of entry to college work in these disciplines, enabling students to make up work they have missed or understood only marginally.

Mark originally asked me to talk about “Women and the World of Higher Education.” I have taken advantage of the speaker’s license to talk more generally about the challenges we all face in higher education because they are so critical, for men as well as women. However, in closing, I would like to turn to the subject of women’s education worldwide. Smith and Mount Holyoke colleges have together founded an organization of the presidents of women’s colleges from around the world. We have met twice so far, once at our campuses in Massachusetts, and once, this past January, in Dubai, where Dubai Women’s College served as our host. One of the surprising and impressive things that I have learned through this organization is the number of women’s colleges that have been recently founded in the Middle East -- in Dubai, in Saudi Arabia, in Pakistan, in Bahrain, in Abu Dhabi. In addition, there are women’s colleges, less than ten years old, in Bangladesh and in Kenya. The growth of these institutions recalls the development of women’s colleges in the United States in the last third of the nineteenth century. The founders of these new colleges in the Mideast, Africa, and Asia believe that their countries cannot make the kind of economic progress they envision without providing opportunities for women’s professional development.

Our keynote speaker for our first conference was the Nobel prize winning economist, Amartya Sen. In his work, Sen argues that the single most powerful indicator of the welfare of a country is the educational level of its women. We all have a stake in women’s education worldwide, and we have a powerful stake in it here at home.