In 2010, I was appointed to be the school head at The Gunston School (MD), a day school for ninth- to 12th-grade students. Newly minted after the 2008 economic crisis, I was like a baby who learned to walk before crawling. I understood the concept of “net tuition revenue” before I learned about “gross tuition revenue.”
“Oh that,” said the school’s business manager during my first year, as if describing a quaint old house. “Gross tuition is just the number we would theoretically have if everyone paid full tuition.”
After 2008, new school heads often entered schools where things previously enjoyed in excess-—students, tuition dollars, applications, and faculty morale—were now in short supply. Indeed, during my first NAIS conference after my appointment, I ran into a fellow new head who glumly shared, “I feel like I’ve taken over the Titanic after it hit the iceberg.”
Yet despite the difficult economic climate, over the past seven years, Gunston’s enrollment has grown more than 45 percent, net tuition revenue has increased 33 percent, and we now enjoy a robust waiting list.
While a combination of factors contributed to our growth, we believe a key factor has been the school’s disciplined tuition constraint—2 percent or less for seven consecutive years—as well as a multilayered “theory of tuition” that guides our tuition decision-making.
Tuition costs are not out of control, but tuition prices are.
Private college tuitions and independent school tuitions are first cousins, and one of the great myths is that the net cost of college attendance has risen substantially. Nothing is further from the truth. Indeed, in inflation-adjusted terms, we live in an age of profound higher education net cost stagnation, if not deflation.
According to a January 2014 report from the St. Louis Fed, The Rising Cost of College: Tuition, Financial Aid, and Price Discrimination, “The ‘sticker price’ for a college education has risen three times faster than inflation since 1978. However, when we adjust for inflation, expressing the cost in terms of constant dollars, and account for financial aid (which reduces the overall cost), average tuition and fees have remained basically unchanged.”
The Fed study also refers to the College Board report Trends in College Tuition Pricing 2013, which shows that, despite a $6,000 rise in college sticker price from 2003 to 2013, the actual net tuition collected by colleges decreased by more than $1,000. (See the net price stagnation chart below.)
The College Board chart also clearly shows the growth of a staggering gross tuition price bubble at private higher education institutions. Over the past 20 years, a 47 percent gap has grown between gross price and net price.
Imagine if a car salesperson quoted a price that was nearly 50 percent more expensive than the true sales price, offering a starting price of $44,000 for a car they’re willing to sell for close to $22,000. Yet this is the current pricing model for private colleges.
Meanwhile, independent schools, with our growing financial aid budgets and rising discount rates, generally continue to march in the same direction. The 2016 NAIS study Tuition Trends in Independent Day Schools finds that average day school tuition prices have risen 42 percent in real dollars over the past 10 years; not surprisingly, financial aid has risen 39 percent since 2003.
Moving forward, schools seem to have a clear choice: Do we continue to grow the gross-net gap, feeding the bubble, or do we attempt to bend the price curve? At Gunston, we believe that maintaining or growing the gross-net gap is a losing strategy.
Net Price Stagnation
Average New Price for Full-Time Students at Private Institutions Over Time
Note: The published average price for tuition and fees has increased 69 percent since the 1993-94 school year, while the average net price for tuition and fees has risen only 22 percent (adjusted for inflation).
Source: Baum, Sandy, and Ma, Jennifer. Trends in College Pricing 2013. New York, The College Board, p. 21. (c) 2013. The College Board; collegeboard.org.
It’s hard to regurgitate the apple.
Gunston has a distinguished trustee emeritus who built one of the largest apartment rental businesses in the region. As the board’s resident pricing expert, he understands the long-term value of a 1 percent change in revenue. He never fails to quip during our annual tuition-setting meeting: “We only get one bite at the apple.”
This apple metaphor is vivid, but I don’t think it goes far enough. Unlike the apartment rental market where customers expect north-south price fluctuations based on a variety of factors, independent schools operate in a much narrower “price = value” environment. Therefore, price-cutting is viewed, quite reasonably, I think, as a high-risk strategy. While I tip my cap to schools like Utica College and Seton Hall University, which have “reset” (aka, lowered) their tuition, I do not believe it is a feasible strategy for most schools.
The alternative is simple: sticker-price discipline. Freezing or constraining tuition at a rate equal to or lower than inflation is the equivalent of a price reduction, or a value gain, depending on how the other elements of the program evolve. For example, at the same time Gunston constrained tuition, we executed the largest capital campaign in school history, resulting in major upgrades to our academic, athletics, and waterfront facilities.
Tuition price constraint can initially feel like a thankless and Sisyphean strategy, but we view the tuition-setting process as the agricultural equivalent of tree farming rather than seasonal crop farming. After five years of flattening the inflation-adjusted cost of the Gunston educational experience, coupled with the perception of our growing value, we closed our gross-net gap by 5 percent and have seen a much richer “harvest” of potential students and families.
With each tuition decision the board makes, we understand that we not only bite into an apple that already has multiple bites (past price growth) but also has a finite number of bites remaining (the future price ceiling).
When a bubble is expanding, we ignore behavioral economics at our peril.
If one is convinced—as we are at Gunston—that an industry-wide tuition price bubble exists, what is to be done?
Robert Shiller, the 2013 winner of the Nobel Prize in Economics, is best known for predicting the tech stock bubble of 2000 and the 2008 housing bubble. He is an expert in the field of behavioral economics, and his book Irrational Exuberance chronicles the features of bubbles and the psychological factors that help fuel them.
Shiller shows that human beings are particularly poor decision-makers in the realm of “intertemporal choice”—decision-making in the present where the effects of the decision are felt far into the future—and are often unwilling to sell losing investments if it means a nominal loss. Thus, even if it is painfully and optically clear that a bubble has emerged, we tend to hang on until it is too late, thus exposing ourselves to a dramatic market correction.
Shiller notes that “bubbles are essentially subtle social-psychological phenomena,” and like tech stock and housing prices, current tuition rates seem to be a clear case of what he terms “obvious mispricing.” Such mispricing is the result of a “speculative epidemic” and “herd behavior” that results when people “anchor their opinions in ambiguous situations on arbitrary signals that are psychologically salient even though they are obviously irrelevant.”
In the case of an independent school, such an arbitrary signal would be the tuition rate decision of a peer school. So, if in the next discussion of your school’s tuition pricing, someone argues in favor of raising tuition because “the school down the street raised tuition by X percent,” consider heeding the words of the world’s foremost bubble theorist:
Errors of human judgment can infect even the smartest people, thanks to overconfidence, lack of attention to details, and excessive trust in the judgments of others, stemming from a failure to understand that others are not making independent judgments but are themselves following still others—the blind leading the blind.
Finally, Shiller demonstrates that bubbles often do not “catastrophically pop” in the classical sense, but often deflate slowly and painfully, often obscuring the scope of the damage and pain until it is too late.
2030, the Rule of 72, and backwards tuition design.
To understand the impact of poor intertemporal choice-making, it is worth asking a diverse group of community members this question: “What do you think will be an appropriate tuition for our school in 2030?”
Currently, Gunston’s tuition is approximately $25,000 (which is about $5,000 beyond what most constituents agree is the appropriate current market price). The typical answer to the above question was, “It should be about the same.” Few people could envision a 2030 tuition north of $30,000; $35,000 was considered ridiculous, $40,000 seen as nonsense-squared, and $50,000 would be the tuition equivalent of exceeding the speed of light.
Yet using the Rule of 72, future tuition-growth foolishness is easily projected. The Rule of 72 is a simple equation designed to determine how long it will take for an investment to double in value. To find the answer, divide 72 by the annual return rate (say 6 percent); in 12 years, thanks to the power of compounding, the investment doubles. This equation works wonderfully for conceptualizing the impact of tuition growth. An annual 1 percent rise means that it will take 72 years for tuition to double, 36 years at 2 percent, 24 years at 3 percent, 18 years at 4 percent, and so on.
Using my own school’s current tuition of $25,000 as an example, the results of different tuition growth rate choices using the Rule of 72 can be seen in the table on page 54. Over the past 10 years, NAIS day schools in the 50th percentile have had an annual tuition-growth rate of 2.7 percent.
As can be seen, even if tuition grows below the current rate of inflation (2 percent), Gunston will reach the $30,000 mark
Use inflation to stop inflation.
The most straightforward way for a school to avoid the tuition price bubble is to benchmark the tuition to the current inflation rate. If tuition price growth exceeds the current inflation rate, a school continues to feed the bubble’s expansion; meanwhile, if tuition growth is pegged at a rate equal to or below inflation, the bubble’s growth is stemmed.
Yet currently only 31 percent of NAIS day schools surveyed agreed with the statement: “We set tuition so that we do not outpace inflation.”
The financial aid gold rush is a paradigm shift for financial aid.
Take a moment to see the world from the perspective of a Generation X parent. I speak as a member of this tribe. We are a generation—like the millennials behind us—that overpaid for college and continue to manage our educational indebtedness. We also sustained financial damage in both the tech and housing bubbles. We know a bubble when we see it, and having grown up in “free agent nation,” we understand how little loyalty we can expect from employers and institutions. Thus, as we shop our children from school to school, we’re not always looking for the perfect fit at any price, but the best possible fit at the best possible price.
The good news, as reported by many outlets, is that Gen X parents are generally not the helicopter parents of the previous generation; the bad news is that Gen Xers clearly understand that we’re in the midst of a financial aid gold rush, and they’re going to hammer schools until they get their fair share of financial aid. And here’s even worse news: many Gen Xers had their kids in their mid- to late 30s, so these kids are just starting to make their way through our schools.
These parents clearly see our schools as “obviously mispriced.” Do we really want to continue to raise our prices at a rate higher than inflation?
“Backfill revenue” is the revenue growth engine of the future.
Like a private college, Gunston is a four-year institution; therefore, the pain of adjusting our “obvious mispricing” could not be delayed.
In 2011, Gunston’s board decided to pursue what we call “an aggressive net tuition revenue strategy.” In a stagnant economy, we flooded the zone with financial aid to attract strong students, created what we called a “2 percent body fat” budget, froze salaries, grew class sizes modestly, and committed to raising tuition at a rate equal to or lower than inflation. These were
painful but necessary changes.
Within three years, financial aid went from 20 percent to 40 percent of our budget, and our goal was to intentionally seek the floor of our net tuition revenue per student and then rebuild our value equation from there. Now, as other elements of the program have been enhanced, rather than simply capturing additional tuition dollars from sticker-price growth (though we currently require that all families, no matter their rate of aid, pay the additional inflation-targeted tuition rate growth), we are reducing our overall financial aid expenditures.
Thus, a 2 percent growth in tuition can result in a 3 percent growth in revenue, simply by clawing back 1 percent of the financial aid budget each year. At the current rate of progress, we estimate that we will equalize our price/value ratio by the early 2020s.
Meanwhile, rather than expanding enrollment to match the growing number of applicants, we are constraining enrollment to maintain sufficient demand to absorb any future economic shocks.
Finally, don’t worry, be happy—education is still valuable.
As Derek Bok, former president of Harvard University, says, “If you think education is expensive, try ignorance.” Although independent schools and private colleges have created a sticker-price problem that may be difficult to resolve, our product—education—remains deeply valuable. At Gunston, we believe that as long as we maintain a strong correlation between value and price, we will continue to grow and thrive.