Higher Ed Spends $50B/Year On…Empty Space??

Mortarboard host Daniel Barwick interviews Lumina Foundation CFO Brad Kelsheimer, who describes research showing that with enrollment dropping steadily and the majority of costs fixed, colleges and universities are currently spending $50B a year on space, services, and personnel they don’t need. This interview transcript has been slightly edited for readability.

Dan: My guest today is Brad Kelsheimer. Brad is Vice President for Finance and Investments and Chief Financial Officer at Lumina Foundation, an independent private foundation in Indianapolis that is committed to making opportunities for learning beyond high school available to all. Kelsheimer oversees the foundation’s $1.3 billion investment portfolio and all other financial operations, including the foundation’s impact investment function. Before joining Lumina in June 2017, Kelsheimer spent more than 20 years in executive financial roles in both for-profit and nonprofit organizations, including higher education. He has served on for-profit and non-profit boards with an emphasis on technology commercialization, economic development, investment oversight, education technology, and community-building. He serves on the investment committee of the Independent Colleges of Indiana and on the boards of the Indy Chamber, the Indy Chamber Foundation, Main Street Plainfield, and serves as an EdTech Board Observer. He holds a bachelor’s degree in accounting from the University of Illinois, a master’s in strategic management from Indiana University, and is a certified public accountant holding a certification in investment foundations from the CFA Institute. Brad is on the show to discuss a recent report from the Lumina Foundation entitled, “Quantifying the Impact of Excess Capacity in Higher Education.” This report found that the cost of excess capacity could be as high as $50 billion annually. With a price tag like that, I knew that we needed to have Lumina Foundation on the program to discuss their findings. Brad, welcome to the podcast.

Brad: Thank you, Dan. It’s great to be with you.

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Dan: This report takes the long view, going all the way back to the mid-1950s. The steady increase in enrollment since then has produced a corresponding increase in facilities, but things began to change in 2011. What did you find?

Brad: Well, let me get to the summary findings in one second, but let me just say that what we found was that the interplay between capacity/utilization/cost within post-secondary education is significant. As we really search for underlying drivers of affordability challenges, and as you know, those challenges are fairly extreme. We’re talking about five times the rate of inflation over the last 30 years. We have been focused on peeling back layers to find underlying causes for that. The specific findings we found were: number one, from 2009 to 2019, the capacity, so number of seats in the United States post-secondary education system accredited universities, has grown 26% cumulatively. Enrollment has grown 3%. So there’s a significant mismatch between capacity growth, enrollment growth, and as a result, supply and demand. The study concludes that we have up to 5 million excess seats in the system at this time. If we cost out this excess capacity, it suggests that we’re spreading as much as $50 billion annually across either the existing student base or subsidies. The subsidies are potentially the bottom line of universities, potentially states, potentially donors, but somebody is absorbing that cost. The biggest concern in those findings is that we certainly know that in some cases, students are absorbing that cost. We also know the fragility of institutions is increasing. So the numbers that we found are fairly significant. We obviously knew that affordability was a major problem and we also knew that capacity was a driver.

I would say that the study validated some things for us. It also, frankly, set some numbers in place for us to think about. We knew that as capacity has come online over the last 50 plus years it hasn’t come online in a very efficient way. Post-GI bill, kind of starting in the fifties, we had 2000, maybe a little under 2000, institutions granting degrees. We now have 6,000 granting degrees. Enrollment has grown over that period of time significantly. However, we really haven’t attained scale or economies of scale because we have added institutions. That means we have 6,000 administrations, we have 6,000 physical facilities potentially, we have 6,000 career services, student support services. So we really haven’t captured economies of scale. We knew that capacity that came online wasn’t efficient, and that has been a driver, frankly, of cost and related affordability. We also know that this is a very high fixed-cost sector in our economy. This is fairly obvious, but just to make crystal clear, most degree -granting institutions have a significant physical plant, have tenured faculty, have other costs that are relatively fixed in nature. And the result of that is a lack of, I’ll say, nimbleness to change when demand changes. So supply tends to stick or grow, and the demand changes and that’s part of what’s driving the summary findings.

Dan: I’ve noticed in the general public that most people really do not understand the extent of the fixed costs in higher education. They think of it as just like a sort of a factory that can add a third shift or remove a shift at will. And it just doesn’t seem to work that way in higher ed.

Brad: You’re right, and this is more pronounced the smaller the institution. If you take a small private with enrollment of 2,500 students or less, and there are a lot of small privates with enrollments with 2,500 students or less, the fixed cost mix might be 70%. So 70% of opportunity is off the table essentially. The ability to be nimble is really challenging, and that has driven the translation from excess seats to the cost number of $50 billion that I threw out. Added to that, this is a highly subsidized sector industry, higher education. From my perspective, as someone in the field, that that’s a positive thing, but it comes with consequences, unintended consequences, which are that market forces haven’t been at work and the result is also lack of change and nimble activity. On this front, what we didn’t know when we set out to complete this study was the magnitude. For me personally, the $50 billion number was a bit alarming. To put it into context, as a nation we have about $75 million of new student debt annually. In an ideal world, what if we could take this $50 billion problem and correct it? That’s in a perfect world, I understand, but you get pretty close to eliminating the student debt problem in the US.

Dan: You talked about the fact that ultimately this 50 billion is being subsidized in some way. So how does a foundation like yours avoid feeding the beast? If it knows that this money is being spent on, at this moment, sort of nothing, how do you make choices about what the foundation will support in a way that isn’t just contributing to that, to paying for that excess capacity?

Brad: From a foundation perspective I’ll mention two things. One, our foundation, Lumina, is specifically focused on system-level change, meaning we take a very long view of this and our vision is that over time, systems will be appropriate to serve today’s students. The flip side of that is Lumina is very focused on attainment in the near term – we believe there’s an urgent need for talent and attainment and credentials in the United States. So we have a bit of tension on that front, and address the issue by focusing on system change and trying to find our way to underlying problems. I would say a bit of a difference between maybe the way we see this space and some others is we do not provide direct student funding. Providing direct student funding would be the most immediate impactful work we could do related to attainment, but we feel that it potentially would mask some of these underlying problems. So to answer your question specifically, we always search for the underlying problem, and that’s what we tend to focus on. And we tend to focus on thought leadership and areas like this in addition to capital deployment. But I would say if you look at the value added, I believe thought leadership might be a bit more pronounced than the capital that we deploy.

Dan: In the study, the cost-per-student metric is fascinating. Even if institutional budgets are held flat, the enrollment drop by itself increases the cost-per-student. This metric is much less widely-used or understood compared to other more familiar ways we compare schools, like tuition. I’ve had guests on this podcast who’ve said explicitly that higher education doesn’t have a way to measure efficiency – many of them, by the way, think that’s a good thing – but aren’t changes in cost-per-student a good way for schools to measure changes in efficiency? Is there a better way than cost-per-student?

Brad: Cost, and revenue per student by the way, are extremely important metrics from my perspective. I’m going to give you a little bit of a perspective from a former CFO in higher education, as opposed to CFO of Lumina Foundation. I think the tension that you’re talking about really is driven by how we use metrics like this, and I do think we have to be really cautious specifically in how we use cost-per-student. I say that because we don’t always take into account the type of experience we’re offering as an institution, and we don’t necessarily always take into account the type of subsidy that is available. I really think you have to be a master translator when using something like cost-per-student, and really driving decisions and driving vision from those types of types of metrics. I’m a huge proponent of understanding who you are as an institution, your relevance, your market, the experience you offer, and then measuring like crazy. So to me if you’re an institution and if you’re not measuring cost-per-student and benchmarking it with history, trends, and benchmarking it with your peers, I think you’re missing the boat. To your point about feedback you’ve received, first of all, there are people doing it and doing it very well, and translating it very well and using it to guide their operation. But there are, unfortunately, in my opinion, a couple of extremes. On one hand, there is a bit of avoidance, and you’ll hear a lot, “we just can’t measure that. Or if we measure, you know, we might upset legislators or we might upset our faculty, or we might upset our board, et cetera.”

Dan: I’ve definitely heard all three of those.

Brad: I’m of the opinion that you absolutely can measure, and, and frankly, faculty appreciate transparency. I think faculty can be part of the solution if transparency exists, so I just don’t buy that argument. I think, unfortunately there’s another extreme, which I can talk about from personal experience. I think people that enter higher education, especially in the financial side from traditional finance careers – was one of those people – our instinct is to jump in and really focus on bottom lines. I think you have to be obviously very culturally aware. I’m not telling you or your listeners anything on that front, but there’s a big difference between saying, “our vision is a balanced budget” or saying “our vision is something XYZ informed by finance.” I’m seeing more and more institutions just frankly state, “Hey, right now our vision is just a balanced budget. We’ll think about a broader vision, a bolder vision, once we balance our budget.” That to me is a very, very difficult way to drive change at the micro-level at an institution. So there’s a little bit of over-measurement, or lack of translation going on at one end, there’s a little bit of head-in-the-sand going on in the other hand. And frankly, don’t see a lot in the middle saying, “We’re going to measure this. We’re going to translate it the right way. We’re going to compare against the right peer set,” et cetera.

Dan: In the study, you do offer three possible solutions to address excess capacity and decreased cost-per-student. You say that states or systems or institutions can do one or more of the following. (I’m sorry, I’m going to give you some lengthy information from your own study, mostly for the benefit of our listeners.) The first is to grow enrollment and utilization to expand, to serve non-traditional learners and to meet changing workforce demands. The second is to share more – groups of institutions could create partnerships to share academic programs or back-end services to drive efficiencies and reduce costs. The third is to take capacity offline – to merge with other institutions or to close programs, schools, or entire institutions, which reduces overall capacity and increases utilization. Each one of these faces barriers; that third one makes me chuckle, because it seems like the third rail, you know? What do you think is the most feasible? In other words, if you were to offer a prescription, what would it be?

Brad: Let me give you a first of all, an unsatisfying summary. I think it depends a lot on the sector. I think it depends even more on leadership, but broadly speaking, number one and two are both voluntary moves. Growing enrollment and utilization, there’s a voluntary component to, “am I willing to make, if I come to it, the investments that might be necessary there? And if so, I can move forward voluntarily there.” Share more, also voluntary. Number three is often involuntary. Certainly, in a subsidized sector, the incentive to merge, to close, to take capacity offline, is less feasible, frankly. One and two, I think are very feasible to a certain extent, and three is not impossible. We’re going to see more and more activity on this front, as almost everyone is calling for, and maybe I can speak to that in a minute. Here’s what I think from a sector perspective: I find the demand side a no-brainer for regional publics and community colleges. There should not, in my opinion, be a board president of a regional public or community college that isn’t thinking about how to better serve adults through re-skilling, degree completion programs, et cetera. The levers are pretty few here, and this is a lever where I think the tools have improved and there’s some exposure to just the sheer numbers. We have 36 million Americans right now with some college and no degree, who need completion, we have 80 million Americans who need some type of upskilling and we need to make sure that we are really putting in place the infrastructure – and by infrastructure, I don’t necessarily mean buildings – the infrastructure to support that. So growing enrollment through those measures, from the regional public perspective, that’s the group and the sector that I think have just a great opportunity to own that sector. I think that’s feasible. You might have to be branded differently. You might have to be a special-purpose entity sitting alongside a regional public. I think we’re going to have to get creative as institutions to really hit number one. But to your question, I think it is feasible, and I think we’re going to see some early leaders in this space doing things differently. Community colleges obviously have been going after that market for some time. I think you’re going to see regional publics go after it, and I think community college just will do a better job. The rewards are pretty big on that first one.

The sharing more and even mergers… Small privates have to be thinking about sharing. I’m talking about natural collaborations that may not be back office. Back office collaborations are always nice, always great, and there are a number of examples of those that exist across the country. They’re not going to drive, I think, the results that we’re talking about here. My sense is some collaboration across programmatic areas is overdue. Mergers are interesting if done from a position of strength. Carnegie Mellon would not be here if not for a merger from some positions of strength. So it’s feasible. The impact of just sharing back offices, I want to highlight, those economics are tough, and I think feasibility of that unfortunately is going to be a bit involuntary. So the incentives won’t be there until they have to be.

Dan: I’ve noticed that psychologically the barriers to merging services seems strong in higher ed in particular. Higher educational institutions sort of pride themselves on the distinctiveness of their schools or their programs. And they often seem to see sharing as some sort of sacrificing of their own sort of brand or uniqueness. And then of course, coupled with that, it seems to me that there’s a very heavy emphasis on autonomy, and it feels like cooperative agreements are perceived as taking away that autonomy. I’ve observed attempts at agreements or some sort of sharing that fall apart immediately once people realize they will have to compromise in some way; that there will be a down a downside as well as an upside.

Brad: Yeah, no question. And let’s talk about those obstacles for a minute, because I think you’re right on. I believe there is a tipping point here at some point where those obstacles start to wane a bit, but we haven’t hit it. There’s no question. The biggest obstacle to all three from my perspective is leadership. And I’m not saying “bad” leadership; I’m saying maybe misaligned incentives. If I’m hired to be the president of a small private, or a regional public, I’m fighting a market share war every day. My survival and the institution’s survival depends on that market share. If you think about trying to partner with your competitors, right or wrong, this is a highly competitive industry. Any industry with a misalignment between the supply and demand that we have causes competition. In our case, because of subsidy, that competition doesn’t translate to reduced pricing, it translates to investment and market share war. So as a president, I’m focused on my institution in the market share war. There really aren’t rewards to partnering. Secondly, presidents don’t stay in place very long. So you have to come in and hit the war with a bang, and oftentimes you don’t have time to build those relationships for partnering. I think the average tenure is certainly less than five years at this point. The third point is, and this is a bit tongue in cheek, but it is true that football teams matter. That pride you’re talking about, the autonomy, that’s a real thing and you’re not going to see Alabama and Clemson partner anytime soon, I don’t think. Finally, the path to leadership doesn’t necessarily run through strategy, finance, et cetera. As a college president, I may not be skilled in thinking through this particular strategic option and how to develop those partnerships in ways that make us more financially sustainable.

Dan: Let me ask a specific question about the issue of closing institutions. Schools take great pains to quantify the economic benefits that they provide to their communities. Can the argument be made that these benefits offset or outweigh some level of inefficiency that’s caused by facility underutilization? When you say that there’s $50 billion being spent currently on essentially nothing, I’m wondering if a school can argue that their share of that 50 billion is somehow being offset by the benefits they are providing to the wider sphere.

Brad: That’s a fascinating question. I probably don’t have a great answer, but I would argue, yes, absolutely, a case can be made. I had a meeting this morning with an executive at a regional public who shared with me state economic impact for the regional public of about $475 million. A small private in the Midwest probably could be expected to provide economic impact of certainly north of a hundred million dollars, and that might be local economic impact. So there’s no doubt that one set of losers, if an institution does close in the community – other losers are many, students, particularly in education deserts could be losers – if you take numbers like $475 million and say, we have chronic deficits of $10 million a year, but we’re providing $475 million of economic impact, the math feels like a no-brainer: why wouldn’t the state just fill that gap? My view is that there has to be a reckoning at some point, and while filling a $10 million deficit at one school doesn’t seem like a big deal, if you take that across 6,000 schools, at some point we have a public model that likely isn’t sustainable. Politically, I also don’t know that it’s feasible. Most town-gown relationships are viewed as, frankly, the town giving and a college or university receiving. Colleges and universities don’t pay taxes on all of their activity. They certainly do on some, and colleges and universities bring in a lot of good and some trouble, so those relationships are tough. The likelihood of communities stepping in to fill that gap, despite the math – and you’re exactly right, it just makes sense – but despite that math, I think that’s less feasible frankly than growing enrollment, sharing more, or taking capacity offline. It’s just a tough play. I will say there are some creative after-the-fact activities on this front. I sit on a task force with another foundation, the Robert Wood Johnson Foundation, where we’re exploring impact on communities that come from closures and specifically we’re looking at communities of color and smaller rural communities. The impacts, obviously, are significant. We’re looking for solutions. So it’s a bit after the fact, but what happens once these schools close? Are there re-use possibilities, et cetera? I would say I’m optimistic there are, but if they were really good re-use opportunities for facilities, for example, frankly communities would have already attracted those as a sidecar to the university. So the most vulnerable populations of schools are those that are small, under a thousand enrollment, that makes logical sense. And the majority of those schools are in rural areas, and rural areas depend tremendously on these schools. So it’s a really tough topic, and I think as we’re talking about this entire issue, I think is a great one to be on the table.

Dan: Well, I apologize that my last question to you might be a bit depressing, but it’s hard not to come away from this report with a fairly grim picture. Assuming that two things happen: first, that the birth dearth and subsequent drop in college enrollment will happen on schedule from 2023 to 2026 or thereabouts and cause further enrollment drops, and second, that this sort of facilities arms race will continue forcing colleges to spend more to replace aging facilities that are aging out because they were constructed when enrollment boomed 30 to 40 years ago, won’t then the utilization problem boom as well? When I read the report, I thought to myself, you’re really showing the utilization problem in its infancy. If so, what sorts of forces would act to correct that problem if it booms?

Brad: First of all, would agree that things are very grim without correction. I maintain a position of optimism here because I believe the events of 2020 likely did more for the optimism around correction than the last 20 years combined. There are a couple of reasons I’m optimistic: one, this is painful, but the painful reality has set in. I think we’re going to see more and more institutions make that tie between institutional strength and student experience and student affordability. They really will understand that hey, we’re impacting students here without correction. So that’s one thing. The second thing is we have an interesting evolution of technology. Adoption rates of technology, as you know, are challenging in higher education, but we have direct investments in 15 technology companies that range from core sharing platforms, to wraparound services, to non-degree credential providers. We saw an explosion of momentum in 2020; schools that had to act differently did. I’m hopeful that this idea of correction was pushed forward in 2020. Technology will help. I think the reality that’s setting in will help. Every industry that has gone through a consolidation, which is almost every industry. Public utilities is a great example of an industry that has struggled with consolidation but has done it as the proper incentives have come online. Healthcare obviously has different drivers, but has gone through consolidation. I’m hopeful that consolidation can take place from a position of strength where this doesn’t result in 25% closures. Hopefully there’s some emphasis on those the first two solutions, growing enrollment utilization and sharing more. Maybe blindly I have optimism, but I do have optimism.

Dan: My guest today is Brad Kelsheimer. Brad is Vice President for Finance and Investments and Chief Financial Officer at Lumina Foundation, an independent private foundation in Indianapolis that is committed to making opportunities for learning beyond high school available to all. He’s been discussing the recent report, “Quantifying the Impact of Excess Capacity in Higher Education,” which can be found on Lumina Foundation’s website at luminafoundation.org. Brad, thanks so much for being on the program and lending us your expertise today.

Brad: Thank you, Dan. I really enjoyed it.

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