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Revenue Refill

February 2013

By David Tobenkin

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When state funding shortfalls caused the bottom to drop out of institutions’ budgets, leaders immediately cut costs and upped efficiency. Now, attention turns to the other side of the equation: finding revenue to make up the difference.

The challenges are stark and growing. From 2006 to 2011, 43 states decreased their amounts of per-student funding (in constant dollars), with 17 cutting that total by more than 20 percent, according to the State Higher Education Finance FY11 report (State Higher Education Executive Officers Association). The American Recovery and Reinvestment Act provided funding to stabilize state support for education, among other interventions to achieve economic recovery in 2009, 2010, and 2011; but now such funds have largely been spent.

The initial reaction of many public higher education institutions to a steady decline in state funding, which began abruptly in 2007, was to cut every unnecessary cost and examine every possible efficiency. But as cutbacks continue and cost and efficiency limits are reached, colleges and universities are turning to the other side of the equation: ways to grow revenues and boost funding through a host of different strategies.

Higher education leaders have tried a variety of revenue-side initiatives, including novel approaches to establishing tuition levels; targeting nonresident students; ramping up philanthropy activities; capitalizing on research and public-private research ventures; and considering unconventional bond issues.

Daunting Developments

A look at the numbers makes it clear that replacing state revenue losses is no small feat. For example, the state of California supplied 47 percent of the 1991–92 budget at the University of California, Berkeley. Twenty years later, that percentage has dropped to just 12 percent of revenue, or $262 million, in 2012–13. 

At the same time, many public higher education institutions face state resistance to increasing tuition, the single most viable means of raising a significant amount of additional revenue. Other potential sources would likely produce revenue on a smaller scale. While public institutions have placed more emphasis on development, for example, philanthropy is often less robust than at private counterparts and amounts can vary significantly in size from year to year. Other areas, such as capitalization of research or partnerships with the business community, tend not to amount to large revenue streams. 

But in an environment of continuing budget crunches, incremental increases in revenues and funding from some of these alternate sources can at least help forestall more drastic cuts in program offerings. And the search for bottom-line game changers continues.

“Public universities are no longer tinkering around the edges,” says Christine Keller, associate vice president for academic affairs at the Association of Public and Land-Grant Universities (APLU), a Washington, D.C.–based research and advocacy organization of public research universities, land-grant institutions, and state university systems. “They are realizing that these appropriations cuts are not a one-year phenomenon and that they need to fundamentally change their structures, find new ways to run institutions, and new ways to raise money.” 

In the past, notes Keller, institutions made more short-term cuts, but now they are looking at new ways to raise money and better connect with the needs of the community. APLU’s financial surveys in 2009 and 2010 (including responses from nearly 115 APLU members, the combined number of unique institutions responding in both years) showed that institutions in large part had used federal stimulus funds to offset tuition. “Now that money is all gone,” says Keller, “and we are getting more information [in the 2011 survey] from institutions indicating that they are finding revenue from other sources while introducing tuition hikes.” 

The 2011 APLU survey, Keller says, found that 47 percent of respondents reported they were initiating what they hoped would be high-demand programs, such as new degrees developed in consultation with area businesses. That compares to only 31 percent of respondents in the 2010 survey reporting on such plans. In addition, in 2011, 43 percent of respondents reported that they were developing or expanding institution–private sector partnerships, compared to 33 percent in 2010.

Keller says “entrepreneurship” was the term used by respondents to the most recent survey, to describe the practice at some universities and colleges of rewarding faculty and staff willing to engage in creative business pursuits to benefit their institutions. For example, departments that were willing to expand high-demand programs and work with additional students were able to keep and reinvest a portion of the additional revenue. Also, faculty are sometimes offered incentives to pursue external funding and to develop their research outcomes into marketable applications.

Continuing With a Combined Approach

Despite some success in new revenue and funding strategies, most business officers interviewed for this article describe revenue-side approaches as only one part of an overall approach toward making up for state funding reductions. They still cite cost-cutting and operating efficiencies as part of the mix, with a decided emphasis on the latter over the revenue-enhancement efforts. 

Some higher education leaders are downright pessimistic about the possibility of offsetting declines in state funding through revenue sources other than tuition. “Everyone is trying to diversify their revenue base, but I have yet to see any institution in the past five or six years of [such] attempts that has changed the basic chemistry of its revenue structure,” says Jane Wellman, executive director of the Washington, D.C.–based National Association of Systems Heads (NASH), an association of the chief executives of America’s 52 college and university systems. “I think we do ourselves a disservice by acting like we can fundraise ourselves out of this crisis. There are no silver bullets, and most institutions are getting a couple of percentage points out of diversifying their revenue sources, but none are at the 10 to 15 percent level that would really make a difference.” 

Many public higher education business officers describe such a multipronged revenue and funding approach. The University of California, Berkeley (UC Berkeley), with its dwindling state support, is a case in point. Erin Gore, Berkeley’s associate vice chancellor and chief financial officer, notes that the four traditional sources of higher education revenues include state support, net tuition fees, contracts and grants, and investment income. 

Yet many of these sources face constraints, and, says Gore, “there is no ‘fifth’ revenue stream—there are 11 [much smaller, individual] revenue streams. We’re trying to create a number of pieces. What we’re shooting for is another $100 million in revenues from these ventures, not immediately, but over time.” In part through increasing tuition generally and increasing the number of nonresident undergraduates, UC Berkeley revenues in 2010–11 grew to $2.4 billion, up from $2.1 billion the prior year.

Targeting Tuition

Tuition increases are a part of the revenue strategy at many universities, although there is pushback, particularly against tuition hikes at the undergraduate level. Yet even here, some creative institutions have found a way to make a bitter pill go down somewhat more sweetly.

Some degrees cost more. “Most of our revenue initiatives over the past several years have been in the tuition-related arena,” says Deborah Durcan, vice president for finance at the University of Wisconsin System, which has seen its percentage of budget supported by state taxes decline from 30.9 percent of the total budget in 2002–03 to 17.9 percent in 2011–12. 

Since 1996, the University of Wisconsin System’s Board of Regents has approved tuition differentials at individual institutions—tuition assessments that essentially constitute a surcharge on top of general tuition at each institution for certain programs or to support particular institutional initiatives.

At three UW locations (Madison, Milwaukee, and Superior), the differentials are added to certain majors deemed more expensive because of the required materials or higher faculty salaries. These include business and engineering at UW–Madison and UW–Milwaukee; fine arts, nursing, and architecture/urban planning at UW–Milwaukee; and natural sciences at UW–Superior. The increased amounts for resident undergraduate students vary by institution, from $60 per semester at UW–Platteville to $700 per semester in the UW–Madison engineering program, Durcan says. 

“The institutions have found by involving the students, getting their input, and giving them a sense of ownership, they [students] are more inclined to approve the fees and actually speak in favor of the differentials in front of the regents,” Durcan says. 

Business officers are also integrally involved. “We clearly discuss these proposals with business officers at all institutions at regular meetings, as we believe CBOs need to vet the increases.” 

Even this modest approach ran into problems in 2011, when the Wisconsin state legislature capped tuition at 5.5 percent and added a provision that there were to be no increases via any new differentials through the end of the current biennial period, ending in June 2013.

Reaching out to those who pay out-of-state rates. Public universities are aggressively competing with private institutions—and with each other—for international and out-of-state students, who bring vastly greater tuition potential than in-state students. 

North Dakota higher education institutions, which haven’t suffered from reduced state funding because of a prosperous shale oil industry, began in the late 1990s to develop strategies aimed at retaining in-state students and at drawing students from outside the state. The big reason is that University of North Dakota System institutions have suffered from declining high school enrollments, which have led to declines in the number of incoming students. The state has had ongoing difficulties in maintaining and increasing the number of new students at its higher education institutions.

One key element in improving its out-of-state numbers: North Dakota’s two research universities have significantly improved their research facilities, kept tuition relatively low, and marketed themselves to potential students in more populous adjacent states such as Minnesota.

As a result, despite a fall in the number of the state’s high school graduates from 8,606 in 1999–2000 to 7,232 in 2008–09, the number of full-time students attending North Dakota’s 11 public colleges rose from 30,972 in 2003 to 33,538 in 2012 (according to the North Dakota University System December 2012 Fall Enrollment Report). 

Bonds That Go Way Beyond

Some institutions are thinking outside the box with respect to capital funding. For example, the Ohio State University, Columbus, made news last year when it became the first public institution to issue 100-year “Century Bonds,” an effort that led to issuance of $500 million in debt that will mature in 2111. UC Berkeley recently became the second public institution to issue century bonds.

The century bonds allowed Ohio State to borrow 100-year money at a low 4.6 percent interest rate and lock it in for a century. This is less expensive than seven of OSU’s last nine bond offerings, says Geoffrey Chatas, senior vice president and chief financial officer at Ohio State. Cheaper rates are possible through offerings with shorter maturity, but Chatas says that incorporating century bonds can make sense as part of an overall strategy: “We look at the whole spectrum of how we borrow.” 

OSU is using the funds for several expansion projects, which resulted from an initial academic strategy calling for 10 years of investment in the university’s faculty and buildings. “Under Ohio state law, we can only borrow to build capital projects,” Chatas says. “When we were in the midst of a $2 billion expansion, we were looking at a broad question: How do we secure long-term financial services to fund not only the $2 billion but also other future needs? So the university developed a financial strategy that calls for a number of things beyond capital projects.” For now, the $2 billion will be used for a medical facility, research facilities, and student housing.

Not every institution can issue instruments like century bonds, says Chatas. “To borrow for 100 years you need a mechanism to manage capital in and out, and a way to repay in 100 years,” he explains. “We use special funds and an internal mechanism to reallocate the proceeds. We created a pool of semipermanent capital that we can keep investing in the university through an internal bank. For example, to fund a $700 million hospital building, we borrowed $500 million and are paying that back $25 million dollars a year for 20 years to the internal bank. When we borrowed the $500 million, we did a preissuance hedge to lock in the treasury rate; so if it moves, we know what the costs are of borrowing.” 

Basically, says Chatas, Ohio State got a check for $20 million and put $10 million in a special fund in the endowment to repay the $500 million in 100 years. “As long as the return is 3 to 4 percent per year, that $10 million will grow to $500 million in a century. Then it comes back to the bank and the bank can use it for the next project.” Chatas notes that the Century Bond strategy will decrease in appeal as interest rates go up.

Such strategies are a good fit for organizations with the long-term planning horizons of higher education institutions, says John Augustine, New York–based managing director of the higher education finance group at the investment banking unit of Barclays. “When forward-thinking universities are drawing on these nontraditional opportunities such as century bonds, real estate monetization, or privatization, a key thing they are alert to is longevity,” Augustine says. “They are threading the needle to take advantage of current short-term opportunities in a way that also supports the long-term strength of institutions. Colleges and universities have highly recurring revenue streams to manage for a long-term horizon.”

Pushing Philanthropy Forward

Some say another source of revenues—philanthropy—is recovering from the dark days of the recession, but that to optimize results, institutions must convey a message of need while avoiding the sound of desperation. 

UC Berkeley’s Gore says that the university is working to expand outreach to potential donors. “The challenge is, do you have the infrastructure built out in a big enough population base to sustain it?” says Gore. “We’ve invested more in the function of fundraising and become clearer in our communications. Five years ago there was no budget document on this. We started an information campaign noting that we were ‘not resting on our laureates’ and that neither tuition nor philanthropy was making up for the loss of state funds. We wanted to make the community and interested educational parties aware of everything we were doing to keep Berkeley great.” 

With respect to private fundraising, says Colette Sheehy, vice president for management and budget at the University of Virginia, Charlottesville, UVa’s efforts are helped by the fact that UVa has long made philanthropy a priority. It has one of the largest endowments of any public institution in the country.

She says the university is completing a $3 billion campaign that was announced in 2006 and that the goalpost has been extended as the amount raised rests at $2.8 billion. “The original campaign end date was December 2011, but we extended the timeline because of the adverse effects of the recession in 2008,” Sheehy says.

Commercialization of Research and Intellectual Property

Technology transfer has long been a strategy, but efforts are seeing some new twists.

Contracting to provide services. “On the revenue side, institutions are looking for new engagement opportunities to use their talents to serve cities or states in exchange for revenues,” says R. Michael Tanner, APLU’s vice president and chief academic officer. Tanner points to one such effort at the University of Illinois at Chicago, where he previously served as provost.

“The university’s College of Pharmacy has people who are very sophisticated in their ability to analyze drugs and see if different compounds might have comparable efficacy,” says Tanner. “The State of Illinois has a formulary for drugs covered by the state Medicaid program. Someone needs to assess whether a drug should be covered by the plan or not and which drug is the most cost-effective for the citizens of the state.” This takes a high level of education and expertise, explains Tanner, and for the state to run the program, it would involve either staffing up or outsourcing this function through an expensive bidding process. 

Four years ago, the College of Pharmacy and the state of Illinois agreed to establish fees to compensate the college for carrying out these services—to analyze drug requests and determine their appropriateness. “They make decisions for what drugs are covered routinely and also process requests for the use of drugs not on the Medicaid formulary,” says Tanner. “It’s a win-win: The State of Illinois can leverage the expertise of the faculty in its state public university to its benefit, and the College of Pharmacy has created a new unit where students can train.”

Jerry Bauman, dean of the college, says, “The state formulary contract allows us to engage our students and enrich the educational program with real-life experience-—an activity with a gross budget of about $4 million per year—while saving the state money on its drug costs.”

Revenue from research. In a more typical arrangement, in FY10, UC Berkeley conducted its first securitization of patent revenue, which generated $87.5 million gross and $62.5 million net to the campus through sale of its interest in a drug developed by a UC Berkeley professor, Gore says.

“Stanford is a leader in this, and historically we had to overcome the fact that we had no focus on it, whereas they had the infrastructure and the focus,” Gore says. “We are building that now.”

Meanwhile, Sheehy says that the University of Virginia has negotiated new research partnerships with private foundations and corporations. “One of them is a first-of-its kind program with the [Wallace H.] Coulter Foundation to vet promising proof-of-concept projects. The foundation gave $10 million and we matched it, and we are using the income from the endowment to seed new projects.” 

An example of such activity is Hemoshear, a start-up initiated by two UVa faculty members who are collaborating with pharmaceutical companies. Combining scientific expertise with proprietary technology, the team identifies and validates new drug targets in a way that reduces the risks associated with drug discovery and development decisions. The initial Coulter funding was $12,000, which leveraged subsequent equity investments that, within four years, have created a 22-person company that has meant jobs and economic growth for Virginia. 

Sheehy notes that the university has been trying to diversify its revenue base in research, given federal funding cutbacks. “There is opportunity,” she says, “because private companies are doing less of their own research—instead they are farming that out.” The University of Virginia has produced a 42:1 return on investment from the top 10 percent of its Coulter Foundation projects, and a 7:1 overall return on investment, says Sheehy.

Creating Internal Revenue Centers

The University of Virginia has had to aggressively ramp up alternate sources of revenue, as it receives far less state funding per student than most of its public institution peers. In 2011–12, the Commonwealth of Virginia’s general fund appropriation per in-state full-time equivalent (FTE) UVa student was $8,566, well below that of peer institutions such as the University of North Carolina at Chapel Hill ($22,105); the University of Maryland ($17,494); and the University of Michigan ($13,024).  

That has led to efforts to “insulate” its leading graduate school programs from the vagaries of funding shortfalls. “We have done things with our graduate business school and law school to make them more self-sufficient,” says Sheehy. “One thing we have had in place for more than 15 years is a tuition-driven, self-sufficiency financial model [at these schools] driven by market-based tuition. The agreements were implemented in order to protect the national standing of both schools.” This is an activity-based budget, or responsibility center management model, explains Sheehy, where the school is credited with all tuition; pays not only its direct costs, but also facilities costs; and pays a tax on revenues to central administration. She explains, “State support is then redirected to support the remaining academic programs.”

Sheehy says that as part of the arrangement, the two graduate schools were allowed to raise in-state tuition to within $5,000 of the out-of-state rate, “which is still somewhat of a discount for the in-state students, but not like the differential of 3.5 times between in-state and out-of-state students at the undergraduate level.” The additional funds were used to hire the needed faculty, maintain competitive salaries, and enhance student services in a way that allowed each school to remain in the top 10 to 15 schools in its category. “We were able to do that,” says Sheehy, “because the state is less concerned about what in-state students pay for graduate education, whereas they are very focused on the cost of undergraduate education.”

Vendor Arrangements That Pay Off

Public institution business officers continue to enhance vendor arrangements in ways that increase institution services and foster access to campus communities for mutually beneficial marketing purposes.

Similar to its long view on Century Bonds, the Ohio State University is rethinking the terms of its contracts with vendors for campus services. Last year, the university entered into a 50-year contract for a private contractor to manage 32,000 parking spaces on campus. Following a yearlong request for proposal, the winning bidder paid the university $483 million to manage its parking needs, Chatas says. “We put that money into an endowment to fund new faculty hires, student scholarships, sustainability projects, and the arts and humanities. New faculty will be in the areas of global health, food safety, energy, and the environment.” Chatas says securing approval for the transaction took 18 months and included an effort to engage campus stakeholders regarding the usefulness of such an arrangement and to then persuade the board of trustees to sign off.

Other universities are following suit. Sheehy says that the University of Virginia has also engaged in aggressive negotiations with vendors and has partnered with its external bank to generate additional revenue for the institution. “For procurement, our centralized cost center aggressively negotiates rebates and cash discounts with vendors and uses an electronic payment method through the bank that produces rebates. In total, a number of different procurement and payment strategies have generated $1.5 million in new revenue per year,” Sheehy says.

Turning to the Community

Some institutions are also turning to partnerships with local communities to fund educational programs. Portland Community College (PCC), Oregon, is in its second year of a program called Future Connect, devised as a way to improve student outcomes by working with selected high school students prior to their graduation. The program is funded in part through $380,000 in matching funds from the City of Portland, says Kristin Watkins, PCC’s associate vice president of college advancement. (For details, see sidebar, “Finding a Willing Partner Right in Your Neighborhood.”)

Part of the key to establishing the program was a mayor who believed in the benefits the project would bring to the city and a college president who was sensitized to the issue. “Portland’s then-mayor, Sam Adams, wanted to put money into this because he thought it was important to have a well-educated populace,” says Watkins. “Our president, Preston Pulliams, who only went to college because of a $600 Rotary scholarship, wanted to expand access to education to low-income students.” 

The fact remains that, despite all these creative efforts to refill coffers once kept supplied largely by state appropriations, revenue-generating programs are only part of an overall solution. Perhaps a game changer, suggests Wellman, will be in electronic course delivery, depending on how those courses are priced. “If 30,000 people enroll at 10 dollars per class in an introductory course, that could make a difference. In the meantime, we need to pay attention to cost cutting and to spending—as well as to increasing revenues.”

DAVID TOBENKIN, Washington, D.C., covers higher education business issues for Business Officer. 

Some say another source of revenues—philanthropy—is recovering, but that to optimize results, institutions must convey a message of need while avoiding the sound of desperation.

The University of Virginia has had to aggressively ramp up alternate sources of revenue, as it receives far less state funding per student than most of its peers.