Four years ago, Moody’s credit rating agency downgraded higher education as an industry from stable to negative. Today, that negative credit rating remains in place for the higher education sector.
In good times, the financial model for higher education did not produce enough direct margin to fully fund operating expenses related to serving students. Institutions are falling further behind in their competitive position and they are underinvesting in many areas that are critical to their long-term future. College and university budgets are typically balanced through underinvestment in areas critical to our success. The areas of underinvestment may include a lack of new product development, failure to fully fund depreciation, relying on outdated technology, not filling head count deficiencies, or paying employees below market wages.
A focus exclusively on a balanced budget can provide an institution with a false sense of security. Institutions may be proud of running a tight ship, but may not realize the constraints it places on services and quality that leads to deterioration of revenue. Continued underinvestment in critical areas is usually not visible to boards, but it represents a severe quality of earning issue for an institution and for higher education more broadly. Boards should be aware of their quality of earnings and underinvested areas, as this is an important fiduciary responsibility.
Affiliations vs. Mergers
With a broken business model, the consolidation era that began before the emergence of the COVID-19 pandemic is now accelerating. Over the past three years, approximately 100 higher education institutions have announced a merger, closure, or affiliation. Oftentimes, closure announcements are not noticeable because they generally have no direct impact on our own lives or institutions.
Mergers, as a strategic alternative, have been not been well received by institutions that seek to find their path forward. The loss of identity, mission, governance, and employee redundancies, prevents a board from seeking merger alternatives until it is too late in their life-cycle. As a result, there are very few strategic mergers and instead an overabundance of “late-in-life” mergers, such as the one between Pine Manor College and Boston College.
The health care industry has seen family medical practices affiliate with major health-care systems. In higher-education, a trend is forming in which we will see institutions affiliate with either a single entity or a collection of colleges that make up a “private system.”
For institutions, affiliations are becoming a more attractive alternative compared to mergers as they preserve the legal entity, identity, mission, governance, president, and the senior executive team.
Qualifications and Value Proposition for Affiliations
Affiliating with a private system is not as simple as it sounds. There are qualifications, and “late-in-life” institutions generally do not qualify. Joining a private system is not a bail-out. Private system affiliation organizations are hesitant to take on institutions that do not have a strong vision of their future. Affiliated institutions must have the willingness and resolve to transform their business model and think about long-term prosperity versus survivability.
Among the benefits of affiliation with a private system is access to a deeper level of human resources and technology to execute their business plans. Economies of scale allow a private system to afford best-in-class resources and technology. The depth of human resources includes gaining access to best-in-class digital marketing student acquisition functions, admissions support team, instructional designers, retention services, global enrollment support, compliance, HR, financial and legal support services, and academic strategy support. This, coupled with a strong technology infrastructure, enables affiliated institutions to be more capable of executing their growth plans versus what they could achieve as a single entity.
Today there are three private system affiliation organizations in the market: the TCS Education System, the Core Education Foundation, and the National University System. These private systems provide valuable supporting services such as marketing, admissions, technology, compliance, financial aid, and new product development. Each private system has their own unique qualifications for affiliation. What they all have in common is a deep level of organizational capabilities and best in class functions to enable affiliates to achieve a greater capacity to be their best self in all functional areas of the organization.
Becoming Affiliation-Ready
For some institutions, becoming affiliation-ready will make the difference between finding the right partner and becoming a “late-in-life” merger casualty. For board and senior leadership, time is the enemy. Too many institutions are gaining clarity of their situation very late in their life cycle. Unfortunately, for late-in-life institutions the alternatives are not pleasant or plentiful. There are too many warning signs to ignore. Leadership needs to be proactive and use value time to become knowledgeable of the alternatives available for long-term prosperity.
Institutions who have received recent government Paycheck Protection Program funds can be lured into a false sense of security by believing “we are okay for now.” Those institutions should use this valuable time to consider becoming “affiliation ready.”
There are multiple pathways to prosperity. A merger is not the only pathway. There are single institution affiliations, private systems, and cooperative agreements that can be pursued.
For those institutions seeking to become affiliation-ready for long-term prosperity, there are three important milestones:
Prosperity gap calculation and board education; (can be calculated with a few weeks)
Revenue growth and diversification plan for success—development of strategic growth building blocks; (can be developed over a few months) and
Developing a “decision matrix” to identify the best alternative pathways.
Prosperity in a Sea of Change
Transforming the higher education business model will not be achieved through small incremental movements. Institutions continue to fall further behind in their ability to successfully compete in the marketplace. New business models of the future will require diversified revenue sources along with strong technology capabilities and institutions will need to become far more innovative. Boards should have on an ad-hoc committee focused on “long-term strategic partnerships and transformation.” This will allow an institution to become educated on alternative strategic pathways while educating the full board though a series of meetings.
The unique nature of governance in American higher education has served the nation well in the past, and while the challenges facing the sector today are unprecedented in their scope and complexity, trustees today must lead in this era of significant change and a broken business model. If there ever was a time when board service was solely honorific, that day has passed. Today’s boards are critical leadership partners and advocates for their institutions and they cannot afford to take a laissez-faire approach to their long-term future.
While institution closures will continue to accelerate, there remains great opportunity for long-term prosperity. Affiliations and mergers are likely to continue to be a long-term trend and the pathway forward will look different compared to historical journeys. For those who have the institutional “will and resolve” to think differently about their future and align with the positive market trends, they will have the greatest chance for long-term prosperity.
Rick Beyer is a senior fellow and practice area leader for mergers and affiliations at AGB Consulting. A former college president, board governance chair, successful technology CEO and senior operating executive of a $1-billion public company, he has consistently been at the forefront of industry-leading initiatives and has a successful history of leading organizations through change and growth.
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