What is the Net Price Calculator? Why do Boards Need to Know about It?

By    //    Volume 19,  Number 3   //    July/August 2011

Every year, almost all boards have an action item on their agenda to approve their institution’s tuition and fees for the next year. Yet few of them are involved in discussions about the values and policies embedded in what they are being asked to approve or how the institution decides what to charge different students. That could very well change beginning in October, when the federal government will require higher-education institutions to create a “net price calculator” and post it on their Web sites. The purpose of the calculator is to help students and their families gain a better sense of what they will actually have to pay for a year at a specific college or university. Constructing the calculator could also appropriately engage trustees in their institution’s strategies for pricing and financial aid.

I recall an unusual joint committee meeting years ago between a board’s finance committee and the enrollmentmanagement committee where the tuition for the next year was to be decided. The vice presidents of finance and enrollment management informed this group of board members that they could bring in the same net tuition revenue with a 10 percent tuition increase, a 10 percent tuition decrease, or no change in tuition. That conversation highlighted the issue that the combination of published price and financial-aid policies might lead to different compositions of students in the freshman class but not different net-revenue outcomes. The values implicit in achieving that same net revenue were quite different and merited lively discussion among committee members.

Such discussions, however, rarely occur at board meetings. And the tuition that trustees approve is a relatively meaningless number because most students do not pay it. Institutions have complex strategies for awarding financial aid that few people really understand. Boards tend to focus on the results: They look at some key indicators, which usually include the number of students enrolled, the average SAT score or high-school GPA of the class, and perhaps the average tuition discount rate (the average amount below the published price that students pay due to financial aid).

The calculator has the potential to enlighten students as well as institutions and their board members. It could increase both access and choice among students, as it will allow them to understand that the price they will pay may be far less than the published price—and, that in fact, there is little if any correlation between the published price and what they will be charged. Right now, most students pay less than the institution’s published tuition and fees—more than 80 percent of the students at private colleges and universities, and many students at public institutions, receive institutional grants. But individual students have no systematic way of estimating what the net price of the college that they are considering attending will be, as the award that a student receives will differ significantly even among similarly priced institutions with similar discount rates. With the advent of the calculator, many low-income students may be able to see in concrete terms that it could actually cost them less to attend a high-priced college or university than their local community college.

The share of students who receive federal Pell Grants, which go to people in financial need, has remained relatively flat over the past five years at many of America’s wealthiest institutions, according to an analysis of data from the Education Department by the Chronicle of Higher Education (March 28). The calculators will allow these students to directly compare, early in the application process, the most-selective, highest-priced colleges and universities, which provide very generous financial-aid packages. Thus, the calculators could finally help improve access to those colleges and universities for low-income students, who often don’t apply for financial reasons, despite the outreach efforts that such institutions have been making. Jeffrey Brenzel, dean of undergraduate admissions at Yale University, which has offered significant need-based aid for decades, said in the Chronicle article, “Even after 40 years, that message is still hard to deliver, because the assumption the schools are out of reach is so deeply entrenched.”

For their part, if institutions want to provide a fairly accurate estimate for students, creating the calculator will force them to reveal a lot about how they make their financial-aid awards. The requirement to publicly mount such a calculator provides an excellent opportunity for the board and administration to jointly evaluate their institution’s financial-aid policies and ensure they are consistent with its mission and values. As part of this, the institution should give its board members additional information about financial aid and allow them to understand how its policies are translating into producing the quality and quantity of students that it wants and needs.

Reexamining Financial-Aid Policies

Historically, trustees have usually only been given the average discount rate and not provided with any information about the composition of the aid at their institution. Yet the average discount rate at two colleges might be the same but for very different reasons. At one, it may be the result of almost all students at the institution receiving some financial aid; at the other, only 60 percent of the students might receive aid, but each one might get a larger amount than at the first institution. At one institution, most of the aid may be based on the student’s ability to pay; at another, it may be based primarily upon the student’s academic merit; at a third institution, athletic ability may play a significant role in the discount rate. And in all cases, some students might get a lot more aid than others.

To better understand their institution’s financial-aid and tuition policies, what questions should board members ask? I recommend the following:

1. What is the discount rate by family income or some measure of ability to pay? A graph like the top one on the right should be provided to boards. (See Graph #1)

2. What is the discount rate vis a vis students’ academic ability, leadership qualities, musical or artistic talent, and other characteristic that are relevant to the institution? These characteristics are often combined into a “reader rating” that indicates those students who are most desirable to the institution (rated A) and those who are less attractive to the institution (rated D). (See Graph #2.)

3. What is the distribution of the class by discount rate—for example, what percent of the class receives no financial aid, what percent has a discount rate between 1 percent and 25 percent, and so on? (See Graph #3.)

Why should the requirement of mounting the net price calculator motivate a board to ask such questions? Because students and others will begin comparing the calculators of different colleges and universities, and those calculators will reveal very publicly how each institution is awarding its aid and which students it most wants to attract. Such information has been private for most institutions in the past. In many ways, it is like a company that has suddenly decided to publish the salaries of all of its employees and put information that was once considered quite confidential out in the public domain. Boards spend a lot more time analyzing various areas of institutional expenditure; this is one of the largest and deserves more attention than it has received in the past.

The responses provided to these three questions can provide a board with a great deal of information about the priorities of their institution in terms of providing aid and the characteristics of the students that the institution hopes to attract. They can help a board make much better decisions about tuition and financial aid.

The hypothetical institution portrayed through these graphs, for example, might want to explore its pricing policy. The data in the third graph show that most students receive a discount between 30 percent and 49 percent, and only 5 percent of the students are paying 70 percent or more of the published price. Would the institution be better served with a lower published price that more accurately reflects what students are paying?

The answers to such questions will also tell boards how much or how little the institution is differentiating its awards based on family income. You will see in the first graph that the average discount received by upper-middle-income and lower-middle-income students at this hypothetical college is the same at 40 percent. Meanwhile, upper-income students receive an average discount of 60 percent. The data in the second graph also reveal that those with an A reader rating pay almost no tuition, while those with a B rating have a 50-percent discount rate, and those with a C rating and D rating have a 30-percent discount rate. Is the board comfortable with those results? These are questions that should be explored and the trade-offs well understood.

Key Questions to Ask About the Calculator

Once they are comfortable with the institution’s financial-aid strategies, boards and top administrators must ask themselves some fundamental questions about how their institution should present itself to potential students and how transparent it should be when estimating the actual cost of attendance. Robust discussions in a committee or even with the entire board around those questions will help trustees better understand their institution’s approach. Board-level guidance can also benefit the administration in designing the calculator.

The key questions to ask include:

1. How accurate do we want to try to be? What if we underestimate the award or overestimate it? What is the tradeoff between accuracy and complexity?

2. How much should we reveal about the student characteristics that our college considers when calculating financialaid awards? Are we embarrassed by some of those characteristics?

3. Is there a chance that we will gain public attention in the news and community if we reveal our financial-aid strategies? What headline risks do we face?

4. Will we tell the student how much he or she will receive in aid or how much he or she will owe? Should we provide information on loans or just grants? Do we want to include warnings about debt levels?

To start with the first group of questions, it’s best to provide students with the most accurate estimate possible. If you underestimate the financial aid that might be awarded, it could discourage students from applying. If you overestimate it, the student will feel misled when the actual award is made, creating a breach of trust between him or her and the institution early in the relationship. At the same time, board members should be aware that the more accurate the calculator, the more the institution will have to reveal about its financial-aid strategies and tactics and the greater the amount of information that will be required from the student.

As for the student characteristics that the college considers, most institutions use one or more measures of academic ability, such as SAT or ACT scores, high-school GPA or class rank, or some combination of these variables. Not only institutions that provide merit awards, but also those that give need-based aid use these variables, as they often want to give more grant aid to students who appear to have greater academic ability.

Institutions also differentiate the amount that they award students on factors such as gender, race, and ethnicity because students with different characteristics may choose to enroll in the institution at different rates. An institution may have to discount more heavily to students with certain characteristics to attract them. Other characteristics that may influence how an institution awards financial aid include a student’s major, legacy status, leadership activities, instate or out-of-state status (especially at public institutions), and extracurricular activities.

The question for boards and institutions is: Do they want to acknowledge that publicly? If they do, then these characteristics need to be among the inputs for the calculator, and the calculated award will differ based on them. If an institution actually makes such distinctions in its strategy for awarding financial aid and does not include the relevant variables in the calculator, the students with the characteristics that receive more-generous awards will not get this information soon enough in the collegesearch process and may not be favorably inclined to apply to the institution.

Board members do not want to be surprised, so they need to be sure that they understand and are comfortable with how their institution sets its policies and communicates them through the calculator.

A Chance to Gather Information

The calculators will also give colleges and universities the opportunity to learn much more about the students who are expressing an interest in them. There has been a good bit of discussion as to whether institutions should ask students to identify themselves before completing the calculator. The rationale is two-fold: It will allow institutions to follow up with, and target their communications to, specific students, and it will give institutions data to explain if the final award differs from the estimate.

At the same time, there have been significant issues relating to confidentiality of students if they provide identifying information when they complete the calculator. There have also been concerns that requiring too much information from students will reduce the number of those who will complete the calculator. I suggest that colleges allow students to complete the calculator anonymously, as this will probably increase the response rate yet still give the institution information about the types of students who are interested in it.

Colleges and universities also need to be aware that students may “play with” the calculators to see how they can influence their awards. While that may give institutions false information, they may want to consider allowing students to do “what-if” scenarios.

For example, a student may want to see what the impact of having a higher SAT score is on her financial-aid award. This change may be achievable if the student is completing the calculator at the end of her junior year or beginning of her senior year when she still has time to retake the test. Students using the calculators before senior year will also have the opportunity to add extracurricular activities to their portfolio if they see that the institution that they are interested in attending values such activities. Colleges and universities need to understand that students who try different variables in their calculators will learn a great deal about what is important to an institution and what characteristics it will lower its net price for.

How to Present the Results

In addition to determining how to calculate an award, institutions must decide how to present the results. Federal regulations require all institutions to show the net price to the student to attend the institution after grant aid—which includes not only institutional aid but also federal and state aid. Beyond that, institutions have a lot of latitude in terms of the information that they provide on work study and loans.

Several institutions already have put calculators on their Web sites, and their presentations differ markedly. The differences in presentation may obfuscate comparisons among institutions and implicitly provide each institution’s philosophy on levels of indebtedness. This is clearly a good place for boards to weigh in.

For instance, some of the presentations do not differentiate in any clear way between loans and grants; they just come to a bottom line of zero labeled “additional funds to attend.” On some calculators that I “played with,” my family and I were awarded loans exceeding $30,000 for the first year of college alone, while other institutions showed that my family and I needed to come up with $30,000 to meet the costs. In addition, many presentations do not differentiate the types of loan funds that they are including and the differences in costs of these various loans.

Institutions can obviously find different ways to give students and their families information about the availability of loan funds. But each should provide adequate information about the total level of debt a student and his family are likely to incur over four years. As many colleges and universities have policies about the level of indebtedness that they think is appropriate for attendance at their institution, this is a good place to put that information.

Ultimately, institutions will want to be sure that they do not disadvantage themselves relative to other institutions in how the net price is calculated and how they present the information to students. They will want to benchmark the results that their net price calculators give for their incoming class with the actual financial aid awards that the students receive. They should also benchmark the awards given several “model” students with those that these students would receive from peer institutions.

With the requirement of the net price calculator, institutions will now have much greater information on what their peers and competitors are doing relative to the net price that students will be paying. They should use this information to better understand the competitive landscape. It is only a matter of time before there is a Kayak.com for net price calculators where students put in their information and get a set of institutions that meets their net price parameters. More important, as the net price calculator will require institutions to reveal what is in the “black box” of their financial-aid tactics, it is incumbent on boards, as guardians of institutional mission, to make sure that those tactics are consistent with their institution’s goals and values.