The Profit Motive... Motivates

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It is finally happening. American universities and colleges, long an upward funnel of spending, are cutting back. The WSJ reports in its Boxing Day edition that many institutions, facing the inability to raise prices any more - well, they could, but would lose many students - and the decline in state funding, have decide they actually have to make choices.

The reason they operated this way was simple: marketing.

  1. They convinced customers (students and parents) that their products (degrees) are indispensable, allowing them to raise prices indefinitely (price inelasticity).
  2. They convinced influencers (the public) that their products are an unquestionable social good, thus pressuring governmental authorities to pay more via direct (state and federal funding) and indirect (student loans) subsidies.

The very definition of economics is the allocation of scarce resources. As long as schools could increase revenues from both sides, they could increase expenses ever more on professors, administrators, paper, cars, buildings, and whatever else they wanted, while demanding ever less from those employees. With no constraints on revenue, and no profits to be paid to owners or create efficiency incentives for managers, there became no need for constraints on expenses. Resources were never truly scarce.

Marketing actually works! Until it doesn't. Even brilliant marketing has its limits; after all, the iPhone never sold for $2,000 each, even the unlocked, contract-free top model.

Granted, these cuts are just playing at the edges. University of Kansas cut $5MM in 2013, a meagre 0.88% savings from an operating budget of $569MM in 2013 for its Lawrence Campus alone. State University of New York saved $48MM over 2 years, or $24MM per year (although the article isn't clear if it is one-time or recurring)... out of a "Core Operating Budget" of $2.3BN, a savings of just 1%. The real savings and cutbacks are yet to come.

In 2008, I needed to visit a well-known university office in New York, to take care of some paperwork on behalf of a family member. The process was incredibly inefficient. When I commented upon it, many of the people involved in the process begged me to engage with the university to improve their processes. After all, I am a business consultant.

I didn't even try. I knew what the results would be.

Let's say you are the head of a group or division or an entire company. Your annual revenues are $20MM and your expenses are $19MM. If I can help you shave another $1MM off your expenses at current revenues, your annual budget goes down to $18MM, but your profit margin just went up from 10% to 20%. You are about to get a very nice bonus!

On the other hand, if you are running a university division with a $19MM budget, and I help you shave the same $1MM off your budget just went down to $18MM. Did you get some bonus? Probably not. What happened is your empire - defined at these places by the size of your budget, for which you fought tenaciously - just shrank. Unless you are the head of the entire system, you have a negative incentive to work with me to improve yourself.

I have done very little work as a consultant with universities and non-profits in general, precisely because of these negative incentives. Where I have, it has been when there was a genuine interest in improvement and the right incentives already in place.

In the end, the profit motive... actually motivates.