Thought Leadership Series: Budgeting For Innovation (Part 3)

July 31, 2023

Series Overview

Setting budgets is one of the most important responsibilities university leaders must shoulder. Budgets serve as the practical manifestation of a university’s mission and goals, so pursuing the process thoughtfully is critical to driving innovation the right way at any institution. There is a lot more to budgeting than the numbers on the page. Successful senior leaders recognize it is one of the primary instruments they can use to shape  change, both now and in the long-term across campus and beyond.

Recently, Vinay Ganti, Senior Vice President, Strategy at Noodle, sat down with Richard (Rick) Matasar. Rick’s career spans four decades, where he served in senior positions both in central administration (10 years) and as a law school dean (20 years).  Most recently he was the Senior Vice President of Strategic Initiatives and Institutional Effectiveness at Tulane University, and before that as the Vice President for University Enterprise Initiatives at New York University. His time as a law school Dean included stints at the Chicago-Kent College of Law (Illinois Institute of Technology), the University of Florida Fredric Levin College of Law, and New York Law School.

He brings to the table considerable experience developing revenue-generating programs, discovering new ways to do traditional programming, and leveraging existing assets.  Vinay and Rick discussed the state of universities and the need to evolve given our rapidly changing society. 

Today is the second in a five-part series that will provide a comprehensive approach to how to do budgeting in a way that promotes innovation and growth in higher education. In today’s article, we will focus on establishing the right organizational culture to promote budgeting. The full series will be as follows:

Part III: Revenue and Investment Capital: Fund Your Institution’s Mission

This is the third in a five-part series of discussions with Richard Matasar, who understands the administration of universities and the steps that need to be taken for them to flourish. If you are new to this series, you may want to start with Part I and Part II, which focuses on establishing a budgeting mindset that will drive innovation and growth and then the right culture across the organization to make it a reality.

How should leaders look at money and surplus?

In a university, money is sometimes thought of as the root of all evil. After all, we are nonprofit entities and many members of the faculty and staff have chosen less lucrative careers in order to serve a mission. Others think of money as a necessary evil—we need enough to serve our mission, but seeking more is unseemly. Neither of these views makes sense: ultimately the income universities generate is critical to both fulfill the university’s mission and allow it a better future. It is not an end to pursue for itself; rather, it is a means to serve ultimate mission-related goals.

“Money” is meaningful in a university in two critical ways. Firstly, a university must generate sufficient funds to cover its core operations: academics, student service and support, ancillary services like housing and food, athletics, maintenance of facilities and grounds, etc. Simply put, to remain viable a university must generate sufficient funds to serve its baseline mission. These funds come from only a few sources: net tuition, fees for services, unrestricted fundraising, grants and government funds, and endowment income. A well-functioning university can expect that these revenue sources be relatively stable. However, without altering its current strategies, none of these sources is likely to generate substantial new funding, which is necessary if a university wishes to grow and improve. As a wise administrator once said: “No great university can cut expenses to fund long-term success.” Success depends on generating new money.

New money comes in two forms: one of which is useful but not sustaining; the other of which is recurring and sustaining. “One-time” new money is useful and can be damaging if it is treated as a stable source of funds. It should be used for something that is indispensable in the short- to medium-term (extraordinary expenses, unfunded capital expenses, seed money) but it should not be used to fund permanent changes unless it can be replaced with recurring funding. Recurring funding is the most desirable way to grow a university. It comes from relatively permanent forms of surplus, generated from enrollment growth that fuels increases of net tuition and from increasing the size of the endowment. 

Seeing new funds in this way is critical to growing universities and helping them fulfill their missions. To ensure that this happens, however, universities must first make it “acceptable” to generate a surplus and then build the surplus mindset as part of its culture. In doing so, surpluses should never be considered mere fungible “money,” to be spent at the whim of a decision-maker. Instead, surpluses must always be seen as a way to fulfill missions and goals. 

Universities often fail to acknowledge that  the generation of new resources will make impactful changes on the world, the university, and students. When they are transparent about why they seek new resources, universities make it much simpler to justify continuing to grow—whether through new program tuition revenue or endowment growth. Seen this way, university growth makes the university a more successful, contributing member of society. A university that continues to grow and support its mission is the measure of success; that should be the measure of its quest for new revenue. It’s not whether we make more money, it’s whether we do more for society.  

As an aside, universities have come to recognize that just creating revenue is often not a useful exercise in itself. That is why most well-run universities today have offloaded many services that were previously done in-house, but are run more effectively by entities that specialize in those services. Instead of breaking even or even making a small profit on those services, outsourcing enables the university to make better use of its time. It allows the university to pay attention to more academic activities and generate the surplus that will grow the institution. 

What other sources of capital are there? How can someone think about it in a comprehensive way?

As I suggested earlier, universities can generate new funds primarily through net tuition and fundraising. Both are critical but, in the long run, tuition through programs may be the most stable form of funding. Let me discuss why.‍

Fundraising: Many faculty members believe that funding improvements in the university is the responsibility of the administration, largely through more effective fundraising. More gifts clearly benefit the university immensely, whether through annual funds and unrestricted giving or through endowment gifts. On rare occasions, a sufficiently large gift can transform a university. This rarely happens, but should be sought nonetheless. Unfortunately, ordinary successful fundraising, whether unrestricted or endowment, is insufficient to fund long-term sustained mission growth. An annual fund that raises $10 million as part of a several hundred million dollar budget will not transform a university if it increases by 15% or 20%. $1.5 to 2 million dollars annually simply doesn’t allow real expenditure growth. A billion dollar endowment, raised over the entire history of the university, produces $50 million at 5%. But each new million dollars of giving only grows expenditures by $50,000. When endowment gifts are restricted (as most are), the uses of the funds are more limited. Such funds often cannot help universities solve recurring problems or invest in priorities that do not match donor interests.  

The most effective fundraising is laser-focused on university priorities, especially those that are somewhat speculative or involve taking risk. Given how risk averse universities are, some things cannot be done using current funds. University constituents can be quite hesitant to use funds in a current budget if the project is not traditional or entrepreneurial. In such cases, outside fundraising support may be the most effective source of funds. For example, many universities have found donors willing to fund an innovation center or an internal venture fund. In some universities, outside funders have supported controversial DEI (diversity, equity, inclusion) projects. The development office needs to understand these types of initiatives to find donors who will seek to support these needs that otherwise would be difficult to fill. Doing so can both help the university and give donors a stake in helping the university do things they care about.

Growing Net Tuition from Programs: As I have suggested, fundraising is not the most effective way to grow sustainable, new revenue in a university. Rather, I suggest that the best and most effective way to generate such revenue is through programming. One of the core missions of a university is to deliver education to students and charge them tuition. In virtually every university this is the primary basis to generate funds. The same $50,000 of revenue that is generated by a $1 million endowment may be the equivalent of growing enrollment by one to two students. Such students pay tuition over the length of their degree programs—anywhere from one to five years. In a four-year program, that $50,000 will ultimately become $200,000—the equivalent of a $4 million endowment. The simple math tells us that growing a program or establishing a new program of 100 students increases the gross revenue substantially, even accounting for the marginal costs of growing enrollment. Moreover, unlike other entrepreneurial activities, offering degree programs is the core expertise of the university. That is why this becomes a far more sustainable model for producing surplus that can be invested in growing the university and helping it fulfill its mission.

However, many universities balk at investing in new programs or spending resources to grow existing programs, especially if they are close to reaching their budget break-even points. They fear that investing in something new may fail and the investment capital will be lost. The only way to alleviate these concerns is to create a rigorous model for building new programs. Such a model requires that the advocates for the program in question provide a business plan showing the program’s intended market, the potential demand for their version of the program, an analysis of the competitive landscape, and a projection of its value to students. Although the research for this analysis may best be done by outside firms, the investment can later be recouped from program revenues. But unlike investment in stocks, bonds, private equity, or other vehicles, academic programming is the university’s area of expertise.

Nonetheless, universities still need initial funds to begin such programs. Let me give a few strategies to do so, one requiring donor support and another using university funds. Let’s look at the donor approach: Instead of asking a donor for $1 million for a new program, which would be used up completely, the university should frame the gift as seed funding. Those doing the asking should explain that the university’s current funds are already committed elsewhere and that the only way to kick off the new program is with new money. The ask is that the donor gives seed money to allow the university to launch a particular program. The university can promise to replenish the initial investment out of program revenues over a set time period. Once the gift is replenished, it might become seed money for the next program or even be repurposed by the donor. In this way, the gift keeps on giving. The seed gift is a way of creating a recurring fund that will replace that million dollars annually with revenue generated through new traditional or online programming. That is a completely different conversation to have with a donor than asking for a one-time gift; it is an investment strategy. Good academic programs post returns of net tuition at a much higher rate than an endowment, with margins anywhere from 10-50%. Faculty members may not understand, but donors do. 

Another strategy that universities may use involves creative use of their unrestricted funds.  Most mid-tier and upper mid-tier schools have a “quasi-endowment” that is invested with the endowment, but unrestricted in how it may be used. Since the funds are unrestricted, the university might also spend the principal, something that cannot be done with an endowment gift. The funds can then be used to seed new programs, which allows the university to create an income stream through new programming. Proceeds from the new revenue generated from the program can then repay the investment, first by annually making up the loss of what was being spent from the quasi-endowment and, over time, the entire investment. For all intents and purposes, current expenditures can be maintained and the quasi-endowment can be made whole, so long as the new programs are successfully initiated in a disciplined decision to launch them. Given the margins that new programs can generate, this may be a much more lucrative investment than traditional endowment investments.

Finally, as a last resort, universities can borrow seed funds at market rates, which may be higher than using the other methods previously suggested. Even at a higher cost of funds, such borrowing can be repaid from program receipts, so long as the university is willing to accept some level of risk. 

How can universities approach risk?

Today there is a real fear-based approach to risk. Many universities hire CFOs who do not think creatively. It is the CFO’s job to consider how to maximize the ROI of assets: to take tolerable risk as opposed to protecting what there already is. One of the most significant risks for a “break-even” type of school is that if it has a bad year, there is no safety net. For example, Tulane was doing fairly well financially before Hurricane Katrina hit. This was an existential threat to the university’s future since it reduced revenue to nothing. There was a risk that revenue would continue to be nothing. COVID was another such threat. Some places profited by taking on risk. Doing nothing is a risky strategy in the long run because your competitors are likely to do creative things. Stasis is not an option. Conversely, if you don’t want to take risks, there are no rewards. However, a university needs analysis based on data, based on projections of where the market is going. Most academics frequently ask if Yale or Harvard are doing the same activity. If not, these academics will often consider it too risky. But that is precisely the wrong approach. In industry the idea is to do what is new, not copy what is already done. That must be baked into the process of new program decision-making. 

It comes back to whether the university has a clear set of strategic goals and mission-oriented outcomes that it wants to solidify for the future. If one can’t articulate those, finance must become an ally to figure out how to pay for these initiatives. Unfortunately, at many universities, the first one who comes in the provost’s door gets the dollar. This is a bad system. However, the converse—asking everyone for an idea—will also fail. A place that is indifferent to how it spends its money is not going to be successful. Therefore, as with most things in a university, risk is built to support mission and the decision to spend wisely is tied to articulated goals.

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