Securing Financial Stability: Innovative Financial Models for Higher Education

Higher education institutions (HEIs) in OECD countries face unprecedented challenges, including the rise of artificial intelligence, declining youth cohorts, and constrained government funding. Many HEIs find themselves in precarious financial situations. To remain financially sustainable, HEIs need to cover the full economic costs of their activities and invest in physical, human, and intellectual capital. This requires a shared vision, adequate funding, and a conducive policy environment.

Understanding Costs and Resources

Understanding the costs of delivering higher education is crucial for aligning expectations with available resources and ensuring efficiency. Activity-Based Costing methods can provide valuable evidence for policy making and investment decisions. For instance, laboratory-based sciences and performing arts are more expensive to deliver than classroom-based subjects. Improving the availability of reliable data on expenditure and costs across higher education systems is essential, along with refining data collection to balance usefulness with administrative burden and understanding the impact of artificial intelligence on productivity and costs.

The limitations of existing metrics for quality and the tendency for costs to reflect available resources rather than market forces necessitate careful interpretation of cost information.

Steering the Revenue Mix

The mix of public and private spending on tertiary education institutions is influenced by historical approaches to tuition fees, government policies on cost sharing, international student enrollment, and private investment. Recent trends show a decline in the share of total expenditure from student fees in many OECD countries, although some countries have seen increases. Non-household private expenditure remains limited and subject to fluctuation. While income diversification is a priority, efficiency measures and strategic planning are equally important for financial sustainability.

Public Funding Allocation

Most higher education funding systems in OECD countries provide public funding as direct grants. Australia, England, and Ireland have explicitly coordinated policy on tuition fees and funding as part of cost-sharing reforms. Denmark and Finland allocate a high share of core funding based on output and outcome variables. Performance-based formula funding can have modest effects on targeted outputs but also risks unintended consequences, such as prioritizing quantity over quality. Institutional performance agreements between government and HEIs have positively impacted institutional strategy and dialogue in many OECD systems.

Demographic Shifts and Institutional Restructuring

Given demographic changes, restructuring of the institutional network may be required to ensure long-term financial sustainability. Reshaping higher education systems and reflecting on the future objectives of tertiary education policy are important areas for further work and cooperation.

The State of Financial Health in Higher Education

Many higher education institutions are facing financial stress due to shifting enrollment patterns, changing funding levels, and increasing costs. A recent report indicated that only 63% of nonprofit higher education institutions appeared financially healthy between 2012 and 2022. Financial sustainability is not just about balancing budgets but about making strategic decisions that support institutional missions and student success.

Challenges of Over-Reliance on Student Numbers

Student enrollment has historically been the backbone of university funding, but this approach exposes institutions to significant vulnerabilities:

Demographic Shifts: Declining birth rates in many regions have reduced student populations.
Geopolitical Uncertainties: Visa restrictions and global instabilities have caused fluctuations in international student enrollments.
Economic Pressures: Rising tuition fees and student debt, coupled with affordability concerns, have diminished the pool of prospective students.

The financial strain is evident, with reports highlighting financial sustainability challenges in universities due to decreased per-student funding and closures of private nonprofit colleges.

Strategies for Financial Resilience

To build resilience and reduce reliance on student numbers, universities must adopt innovative financial models. Key approaches include:

Lifelong Learning and Micro-Credentials

Universities should offer upskilling and reskilling programs for professionals and local communities, capitalizing on the growing demand for short courses and certifications. Online learning platforms can expand access to quality education while generating new revenue streams.

Building Endowments and Encouraging Philanthropy

Endowment funds, cultivated through alumni networks and philanthropic contributions, offer sustainable revenue. Institutions should focus on long-term donor relationships and reinvesting endowment returns into institutional priorities, fostering a culture of endowments and philanthropy.

Leveraging Public-Private Partnerships (PPPs)

Collaborating with private entities on infrastructure, technology, or program delivery allows universities to share financial risks and tap into external expertise.

Issuing University Bonds

Universities can issue bonds to finance debt or investment, providing capital upfront in exchange for periodic interest payments and repayment of the principal at maturity.

Stakeholder-Centric Branding

Branding is pivotal in shaping a university’s identity, reputation, and appeal to key stakeholders. Authentic relationships, clear value propositions, and distinctive positioning are critical for fostering trust, recognition, and competitive advantage. Universities must move away from traditional metrics and build authentic relationships with stakeholders, creating genuine value propositions for different audiences and developing distinctive positioning that reflects the true character of the institution. A strong university brand fosters trust, recognition, and competitive advantage, which directly impacts enrollment, funding, and financial sustainability.

The Pitfalls of Blind Cost-Cutting

Decisions that lack supporting data, such as cutting small programs simply because they are small, often fail to consider the complex financial ecosystem of a university. These cuts can damage an institution’s brand and ultimately hurt the bottom line by overlooking hidden revenue generators and the potential for strategic reallocation. Understanding the economics of each program, including revenue, cost, and contribution margin, is crucial.

Strategic Resource Allocation and Program Optimization

Instead of focusing solely on cuts, institutions should prioritize strategic resource allocation. This involves careful management of course offerings, optimization of faculty workload, and reinvestment in growth initiatives. Optimizing faculty time and workload is essential, as is reclaiming unaccounted-for faculty time and optimizing release time to ensure it aligns with institutional priorities.

Revenue Generation and Growth

While cost reduction is essential, it’s equally important to focus on revenue generation and growth. Growth, in the form of increased enrollment, provides a powerful lever for reducing cost per student credit hour and generating additional revenue. Benchmarking data can be invaluable in identifying growth opportunities and areas where institutions are under-resourced compared to their peers.

Benchmarking for Financial Vitality

Benchmarking plays a crucial role in achieving financial vitality. It allows institutions to compare their performance against peers and identify areas for improvement in cost per student credit hour, program performance, and overall financial health. Benchmarking data can guide institutions to optimize course scheduling, adjust faculty workload, explore alternative instructional models, and align resources with student needs and market demands.

A Balanced Approach to Sustainability

Ultimately, financial sustainability requires a balanced approach. Institutions must combine strategic cost reduction with revenue generation and growth initiatives, all while maintaining a focus on student success and educational quality. This involves:

Understanding Cost per Student Credit Hour
Implementing Strategic Cost Reduction
Balancing Cost and Student Success
Focusing on Program-Level Performance

Addressing Financial Pressures

Colleges and universities are grappling with intensifying financial pressures, compounded by uncertainty surrounding funding sources. Institutions are taking action to mitigate costs, such as implementing hiring freezes and considering campus closures. It is increasingly important to analyze and understand the underlying factors that contribute to their fiscal health.

Revenue Sources

Most revenue comes from tuition and fees and government funding. Decreases in either of these sources can significantly impact financial sustainability, and alternative revenue sources are rarely sufficient to fully compensate for potential losses.

Cost Reduction Efforts

Historically, cost reduction efforts in higher education have focused on administrative functions, leaving fewer levers to pull in these areas. Over 60% of total expenditure comes from academic spending, meaning that any attempt to meaningfully reduce costs must involve evaluating opportunities within academic functions.

Labor Costs

Labor costs, which include salaries and benefits, represent a significant portion of total expenses across all segments, averaging 56%. Academic labor makes up over 70% of salary expenditures, and over half of that is instructional salaries.

Budget Models

Universities with budget models that foster active participation in resource management from unit leaders will have a running start in reaching collaborative, data-informed judgments to stabilize revenues and costs. At the highest level, budget models typically fall into one of two categories: centralized or decentralized.

Centralized Budget Models

Universities with centralized budget models generally pool operating revenues into a single account from which expenditure authority is allocated to the university’s component units. Each unit’s annual funding allocation is a blend of funds that is generally disconnected from its original sources. Centralized budget models simplify a university’s funding allocation process by creating stability. Units receive an annual budget to spend that is largely immune from swings in their actual funding generation or financial margins. This dependability allows unit leaders to direct more attention to their unit’s mission delivery but provides little incentive to pursue growth and efficiency.

Decentralized Budget Models

Decentralized budget models link a unit’s activities to the funding it receives and create stronger incentives for unit leaders to pursue growth, innovate new offerings, and identify opportunities for efficiency. Under these models, funding flows to colleges as revenue rather than a base allocation. While decentralized budget models provide more financial independence and opportunity to units, they are more complex to operate. Unit leaders function as “CEOs” of their units, requiring them to devote more time and resources to understanding and actively managing the financial drivers of their functions.

Implementing Change

Decentralized budget models take time to fully design, implement, and prepare all stakeholders for sustained success, but taking the initial steps toward a decentralized approach can bring near-term benefits. Even early on, this effort can elevate the financial literacy and data fluency across units, leading to greater engagement as institutions make important decisions about how to transform. Encouraging collaborative, data-driven budget decisions in response to deficits is necessary to prepare for successful change.

Key Steps for Change

A case for change: Defining and quantifying the case for change in more specific terms will align stakeholders on the challenges ahead and help coordinate a unified response.
Consistent data sets: Access to reliable data is critical for establishing common assumptions and starting a dialogue on potential change.
Collaborative scenario planning: Successful change in higher education requires an approach with clear channels for stakeholder input.
Clear and transparent communication: The impacts of budget decisions touch constituents across an institution. Leaders should communicate regularly with deans, faculty, and other stakeholders so everyone understands the methodology behind budgeting and any updates to the process.
A framework for monitoring impact: To evolve the budget model over time, institutions need to be intentional about tracking financial trends and progress.

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