THE BLOG
12/06/2013 06:47 pm ET Updated Feb 05, 2014

Is the College Business Model Really Broken?

When I entered graduate school four decades ago, I had no idea that one day I would be applying my economics training as a university president. Unfortunately, an advanced degree doesn't provide easy solutions to the challenging economics facing private higher education. But economics is a valuable tool in clarifying what concerns are real, what are exaggerated, and where to look for solutions.

I frequently encounter the phrase "Our business model is broken." One hears this at virtually every panel or conference, as the audience nods in agreement. The economic outlook for traditional, residential liberal arts colleges definitely has deteriorated since the Great Recession. Students and families have become more tuition-sensitive at the same time that demographics have yielded declining numbers of high school graduates. Tuition income has flattened or declined for most private universities, and Moody's has issued a negative assessment for our sector for the past several years.

However, it is easy to exaggerate or mis-characterize the challenges. Last weekend the Wall Street Journal reported an enrollment vice president's prediction that 30 percent of private colleges will be out of business in a decade. That seems high. I'd like to put a substantial wager on the under of one-third of independent colleges closing before 2023! I do not dispute that the decline in demand is real, and it is probable that some colleges may not survive. But does that mean that the fundamental business model is broken? Depends on what you mean. Seldom does anyone try to unpack the phrase.

In my observation, "Our business model is broken" conveys at least three ideas. The narrowest meaning is that our standard pricing model is obsolete. The great majority of private universities charge a gross tuition (sticker price) that is "discounted" for the majority of students through scholarships. Most colleges have responded to declining demand not by lowered gross tuition, but by increasing "discount rates." For most non-elite private colleges, the average tuition discount is above 50 percent, and it is much higher for top academic achievers. Analysts and trustees watch alarmingly as discount rates rise. It may be true that this trend is unsustainable, but it is a market outcome of declining demand and excess capacity. The problem is falling prices; discounting is simply the mechanism.

Rising discount rates don't necessarily mean that the high tuition/discounting strategy is faulty. One has to wonder: if this pricing strategy is broken, why do the great majority of private universities continue to use it? To be sure, some universities are gaining considerable attention by dramatically lowering gross tuition and financial aid. They are counting on a publicity splash that generates a big gain in visibility and applications, because eliminating merit scholarships puts an institution at a huge disadvantage in competing for high academic achievers. My point: changing the pricing strategy won't change the fact that demand is falling. The business model isn't broken, the market is just tough.

A more serious critique of our business model focuses on the underlying demand. Some argue that the traditional, residential full-time college experience is becoming obsolete, supplanted by nontraditional alternatives, enabled by technology. It follows that, in order to survive, traditional campuses must fundamentally change, switching to less-costly delivery models, e.g., on-line learning, with liberal use of MOOCs. I disagree. I believe there is an enduring demand for the residential college experience. A relative shift to new delivery methods may lower market share. But the entire sector is not going away, and it would be a great error for all of us to abandon what we do best.

Instead, we should work to make the residential college experience more valuable and less costly. Where the critique of business-as-usual hits the mark is, first, our emphasis on competing in ways that raise costs -- amenities, facilities, and proliferation of programs. Second, is the traditional university's resistance to innovation and change. This critique recognizes the considerable value of the residential college model, but calls for responding to increased price -- sensitivity by controlling costs. That is very different mindset from the pre-recession business model.

But there is a limit to this strategy, too. Most independent colleges cannot and shouldn't try to compete on cost with volume providers. Our great opportunity is to identify what really matters in the residential liberal arts experience, and then be relentlessly innovative in exploiting the potential for increasing its value. We could afford to be casual during the two decades that preceded the onset of the Great Recession. No longer. Believing that we can operate as if nothing had changed is the real breakdown of the business model.