Tip and Ring: A Parable of College Tuition

The latest economic parable explaining why tuition at American colleges and universities has risen twice as fast as health care costs is aimed at supporting an insupportable value proposition: a university education is cheap at twice the price.  In my last post I talked about the danger to higher education in “clinging to myths”, as MIT’s John Curry put it.  Justifying the high cost of a college education rests on one of those myths.

Here is the basis of the economic argument: since college costs are driven by labor intensive processes that require high degrees of skill and are resistant to technological efficiencies, we should look to the value received in other specialized service markets like health care and banking where quality demands 1-1 contact with a highly trained service provider. The conclusion is that higher ed prices have fared no worse than prices in those other markets. Some of the comments to my last post also repeated this argument.

The problem with this line of thought is that virtually none of the assumptions underlying it are true.  Never mind that wholesale “mission creep” has systematically siphoned off value that should be delivered to students in the classroom in favor of dozens of other priorities. The basic underpinnings of the things-aren’t-so-bad argument are simply fabricated.

Running a university is like running a business.  There are denyers who dispute that claim, but the fact of the matter is that in higher education income has to balance expenses.  If expenses rise, then a university president has to search for new sources of income.  State subsidies are drying up. Endowment income has been shrinking. Research income does not help, and licensing income is, well, let’s just say it’s an unlikely source. The only source of new income is tuition, and the parable concludes by saying,  “Labor costs are high, so let’s get students to subsidize the increase.”

There are not that many different ways to bring costs down in any business: (1) you can deskill your workforce, (2) you can find a more efficient physical plant, or (3) you can use materials better.  There is no reason that a higher quality university education cannot be delivered to more people by applying one or more of these principles.

Let’s take on the we-must-use-high-cost-labor assumption. Even if you are not a believer in online education, only a stunningly short-sighted point of view  fails to recognize that ed tech is on a different innovation curve than classroom instruction. Compare the improvement in the educational blogging experience over the last six months with the rate of change in the classroom, where it can be argued that the last real technological innovation–one that became ubiquitous because of its obvious value–was the introduction of the chalk board in 1801.

I understand the thesis: university teaching cannot be deskilled because it is by definition undeskillable.  Higher education is artisinal by its very nature.  It has to be delivered by professors to individual students–or, at least, to small groups of individuals–in person. I agree with that:  given the premise of an artisinal workforce, deskilling makes little sense.  If we do nothing at all to change what and how we teach then what we have today is probably pretty close to the best that we can expect from the system.  But I reject the premise out of hand. Which brings me to a very different way of looking at the economics of higher education: the parable of  tip and ring.

Tip and ring is the technology that telephone operators used to manually switch telephone connections a hundred years ago. The tip and the ring of the plugs that operators used kept the twisted pair of copper wires in a telephone cable separated so that they could be inserted into the large patch panels of a central exchange switch.

Early studies of telephone operator efficiency by Western Electric indicated that a skilled worker at peak performance could switch up to 250 calls at one time. Everyone did the math.  Given projected population growth and even the most conservative estimates for network growth, the current method of switching was going to be very expensive.  Underlying labor costs would limit the extent to which Americans would have direct access to telephone communications. An investment banker in 1887, summarized the various Bell System technical memos on the subject very succinctly:

The possibilities of a private home telephone system throughout the country is out of the question. Almost the entire working population of the United States would be needed to switch cable.

Network engineers were aware of the current economic curve and a few brave souls piped up: “Well, what if we do things differently? What if we replace the human telephone operators with automated workings? Wouldn’t we be able to multiply the number of switching operations per minute by many fold?”  By 1918, rumors of the promise of deskilling in voice telephony reached the office of Theodore N. Vail, president of American Telephone & Telegraph:

Automated working is not adapted to our needs, any more than radiography will will ever supplant telegraphy by wires.

Human operators were eventually helped out by some technology, but it wasn’t until the first crossbar switch was installed in Brooklyn, New York, in 1938 that automation began in earnest.  It took a hundred years for the U.S. telephone systems to reach 700 million installed lines. In the next ten years, the number of lines doubled, while technology put voice call quality on its current growth curve. By 1986, fiber optic technology enabled Sprint to revolutionize the long distance telephone business with its “So clear you can hear a pin drop” marketing campaign. None of this would have happened if Theodore Vail had  his way and the telephone business had remained dependent on a highly skilled manual workforce to switch voice calls.

So, yes: if higher education remains dependent on the tip and ring process of using an unnecessarily labor intensive system, costs will continue to rise. There are many–perhaps a majority–in higher ed circles who would repeat Vail’s dictum: “Automated working is not adapted to our needs.” To be more precise, they say, “Higher Education remains essentially an artisinal industry.” There are others, however, who believe that fundamental change will not only bring costs down, it will bring the 1986 promise of pin drop quality to the 21st century university. And don’t get me started about how wrong Vail was about mobile telephony.

Picking Daisies for American Universities

 

One of the commercials broadcast during the NBC Monday Night  Movie on the evening of September 7, 1964 was a one-minute campaign ad for President Lyndon Johnson.  It began innocently enough with a child picking daisies and ended in the horrifying nuclear catastrophe that would be the inevitable result of electing Johnson’s Republican opponent, Barry Goldwater.  Johnson’s voice intoned: “These are the stakes!”

The Daisy Ad was broadcast only once, but it was in the view of many historians the decisive factor in Johnson’s landslide victory. Goldwater was at the time a sitting two-term United State senator and the rock-solid leader of American conservatives.  He was a fierce opponent of Roosevelt-era programs,which he considered financially irresponsible, but he was by all accounts anything but excitable.  Nevertheless, the Daisy Ad defined Barry Goldwater as the man who would recklessly plunge the nation into nuclear war. It was a dramatic illustration of the ruination awaiting public figures who allow their opponents to define them.

The number of “These are the stakes!” portents of disaster for American Universities is on the rise. Everything from tenure to the economic benefits of a university degree seems to be under assault.  Richard Vetter, Director of the Center for College Affordability and Productivity (CCAP),says that an economic nuclear wasteland is the price of ignoring the recklessness of American higher education:

The pell-mell investment in sheepskins is beginning to look an awful lot like something our economy has seen in real estate: a debt-fueled asset bubble. It might end just as badly.

How do American universities respond? Meekly. As reported in the Chronicle of Higher Education, university leadership has been slow to recognize the direction and force of prevailing winds.  A common mistake in business and politics is to focus on the feel-good stuff that is ultimately valueless, and universities are making the same mistake.  The Chronicle reports that former MIT vice president John Curry told a gathering of heads of public universities to stop clinging to “worn out myths about campus strengths.” Curry told the group, “We like our stories more than the truth.” That leaves a vacuum for others to tell their versions of the truth.  It was devastating to Goldwater and it will be devastating to higher education.

The CCAP has in recent months published a series of highly critical studies of cost and value in American higher education.  I have mentioned some of them here. CCAP themes have gone viral in communities that are to all appearances unfriendly to the overall goals of higher education, among them the conservative think tank The Heritage Foundation.

It is no secret that conservative groups are increasingly cool to the idea of an academic meritocracy, preferring to view the inevitable hub-and-spoke network of influencers within the academic community as unfair to arguments and causes that would draw relatively few advocates on their own merits–a “liberal tilt” they call it. Now CCAP’s Matthew Denhart has published a study for the Heritage Foundation that argues for less federal involvement in higher education.

You see where this is going. Taking themes that are deeply troubling to the future of universities, like the overreaching of accreditation agencies, and constructing a “Picking Daisies” story about the politicization of higher education, the silence of university leadership becomes the Goldwater response to the doomsday ad. Here’s an example of the disconnect. On my campus, as on many others, there is still serious debate about the use of online education.  We cling to the worn out myths about the value of classroom attendance when overall enrollments are growing at a paltry 2%. The most recent Sloan Survey of Online Education reports that during that same period online enrollments surged by 21%.  I did not drop a decimate point. That’s a factor of ten difference. It sounds to me a little like debating the desirability of damp weather as a tsunami is approaching.

Among the Sloan findings: class differences caused by increasing selectivity and rising costs in traditional public universities are driving a new generation of students toward online learning in unprecedented numbers. The unresponsiveness of public institutions to obvious trends like these clears the way for anyone who wants to define higher ed. What are traditional universities doing in the meanwhile?  We argue about the effectiveness of increasingly baroque systems of ranking our own hubris-driven reputations, we fight tooth-and-nail against a level playing field for traditional and for-profit universities, we are able to argue with a straight face that college costs that have rise at twice the rate of health care costs are not really out of control.

The general public does not care about any of this.  It’s no wonder that they have tuned out pleas for more funding and are willing to turn their backs on a great engine of wealth creation in favor of just about any story that makes sense to them. Richard Vetter’s story is that traditional higher education is the Goldwater who threatens the innocent daisy-picking American public.  It doesn’t make much sense, but it’s better than the story that we tell.

The Internal Start Up: Heading for the Exit

It’s not only the clash of investment cultures that tends to doom internal start ups. At least that’s what I told the Bellcore and SAIC CEOs at the post-mortem for the internal division that we had tried to run as a venture-backed business.

It’s also what I said to Bob — who you will recall — wanted to incubate an internal venture inside his Fortune 10 company that would match in excitement and star power the coolest gang of Sand Hill Road funded misfits. He would have to be willing to sacrifice a boatload of management principles that had served him well in his career. I didn’t think he would do that.

Like a generous parent, Bob was in a position to give the new kids everything they needed for success: mentoring, time to succeed, and ample resources. What he did not have was a clear idea of which exit to take. Bob’s idea of a venture failed the value test.  A new venture succeeds when the right leadership team focuses on a market need with staged funding.  The idea was doomed as soon as Bob said,“Look, I’m in charge of new technology and platforms and I’m going to be the venture capitalist funding a new product, so that when it succeeds we’ll be able to fold it back into our current business.”

The moment someone in a large company forms a thought like this, the options for maximizing the value of the investment are narrowed to one.  The only exit is one in  which access to internal resources can be used to shoehorn a fit into existing businesses. I had seen the danger of this kind of investment strategy at other companies, and the results were not encouraging. This thinking had infected our Bellcore start-up, but I have been in the executive suites of a dozen West Coast technology companies when the discussion turned to how the value of an internal start up was going to be captured by an existing business line.  It always turned out the same:  because there were no choices to a successful exit, backers literally threw money at the new company. They were thinking way down the line about how to succeed.

There are other options, but they do not necessarily align well with Bob’s goal of internal commercialization:

1. Sell the technology: it’s always possible that the upside does not justify continued investment.  But if you’ve made a large up front commitment–as opposed to small increments that are tied to market tests– it is hard to execute this option and capture value.
2. Licensing: the main reason for choosing  licensing as an exit is that there are differing value expectations in the marketplace.  The technology may be used in many different applications by many different players, for example.  You can maintain a central IP position and benefit from this diversity.
3. Resell your R&D effort: if the technology is a critical product component, there may be other vendors who would like to benefit from your near-term “deliverables.” An R&D contract gives up a little IP in the short run, but you not only recover your development costs, you also continue to expand what you know about the technology and its applications. This is such an interesting–and seldom used–exit strategy that it deserves a post all by itself.  Watch for it!
4. Sell the right to market or form a joint venture to market and sell: this is a range of exit possibilities that allow you to keep the option of bringing the technology in-house at some later point.  Of course, the attractive thing about such partnerships is that they generate revenue while spreading the risk around several players.
5. Spin-out/IPO: the obvious counterpoint to the internal start up is to kick the baby bird out of the nest to see if he can fly on his own. I don’t know why our Bellcore start up was not conceived from day one as a spin out.  Bellcore, after all, had a history of spinning out companies to commercialize research technologies.  Some of those companies (Telelogue for voice menus, Elity for CM analytics, and a host of companies for communication network traffic monitoring and tools) were quickly picked up by angel and venture investors who went on to ride the businesses to their own successful exits.

Why Bob was determined to retain ownership in an incubated business says as much about internal corporate culture and priorities as Bob’s own approach to innovation. What seems to be missing when managers fixate on internal startups is the recognition that there are other worlds involved in the success of a new business, and they often  have very different rules.The internal start up is an opportunity for worlds to interact rather than collide. Here is the value chain that Bob had to work with:

• Creative engineering: internal R&D interacts with a larger, external innovation community.  It  is very good at coming up with gap-filling concepts that need to be externally validated
• Venture funding: is useful for establising performance metrics based on value and focusing funding to meet performance goals based on those metrics
• Corporate resources: the company itself is in the driver’s seat.  It sets out the strategy for value capture and makes the option calls that start chains of transactions that are key to success. And by the way, the creative engineers call it home.

This all started because Bob was worrying that normal, internal product R&D would not lead to  “breakthrough product ideas that do not align well with their core business.”  It is a common problem, but there are three fatal errors that doom most attempts to solve it. Here’s how to avoid those errors.

First, don’t set the new venture up for failure by limiting the end game to only those ideas that align well with the core business.  That was what got you in trouble in the first place, and can be avoided by considering up front the full range of exit options.

Second, don’t pretend that you are a venture fund.  The fundamental belief systems are different, and it is simply not possible for a large corporation–one that has to worry about quarterly results and long-term growth–to capture value in the same way that a VC does.

Finally, recognize the role that interacting worlds will play in the success of your venture.  External innovation networks, market-validating communities and the relatively heavier weight corporate resources and processes have a tendency to collide, when what is really needed is a strategy for working together.

Investor vs. Investor

Internal start-ups have all of the usual new business challenges.  They need products, customers, and a profitable way of getting customers to pay for the products.  But above all, they need cash, because even the best strategy will crash and burn if money runs out too soon.

[Production note: at this point investors should enter, corporate investors stage left, venture capitalists stage right]. They speak the same language and are genuinely interested in incubating  great new businesses, but don’t let that fool you.  They are from different worlds.

I  promised to talk about some of the things that doomed the Bellcore internal start-up which I briefly led.  There is no way of  knowing whether a VC-funded company would have fared any better. In fact, one of the companies that we might have merged with was a venture-funded operation that lasted only a few months longer than we did.  Nevertheless, we did learn a lesson or two about corporate sponsorship of start-ups:

Corporate sponsors of new ventures and VCs have different belief systems.  They are fundamentally incompatible, and without early, explicit steps to stop it, corporate attitudes, practices, and beliefs will overwhelm the fragile culture of the start-up.

Let me set the stage a bit.  In 1999, Bellcore (now Telcordia Technologies) was a small company (revenue creeping up on two billion dollars) that was trying to ride the internet wave, but it had inherited a corporate style from its previous owners that was, well, hierarchical.  Big deals dominated the business mix, and internal investment decisions were obsessively analytical.

Bellcore’s new owner was SAIC, a big company serving a hierarchical marketplace that was paradoxically entrepreneurial. Bob Beyster, SAIC’s founder, had insisted on a flat corporate structure in which managers were encouraged to develop independent business.  When my little start-up failed, I  made my wrap-up presentation to the CEOs of both companies.  One of them tended to believe that Bellcore’s internal investment machinery was the right way to grow a new business.  Here’s how it went.

1. We spent a lot of  money on extensive analytics to gauge market potential.  It was how the investment decisions for Bellcore’s big operations support systems were made and every new round of funding was based on a rosy prediction of a complex market study. In reality, market behavior was unpredictable.  We should have evolved our concepts in the market.
2. Except for the few top  technologists that I could steal from my own research staff, corporate investors would not permit top talent to be redirected from existing projects — where the  big customers were —  to this risky venture with uncertain prospects. Once both scale and success were clear, we could recruit internally, but until then, we had to rely on good-natured volunteers to help us out.  The only thing we could do was hire externally, but there was little upside to attract the kind of business team that we needed.  A VC sponsor would have known that new ventures do not succeed without a highly talented team.
3. Speaking of success: the corporate sponsors were only interested if the likelihood of success was high, so we spent a lot of time on the success factors that would be convincing to them.  An angel investor or a VC would have known that, since the likelihood of success of a given venture is quite low, it is better to fail earlier rather than later.
4. Corporate culture was a culture of ownership, so many business planning meeting focused on patents and intellectual property rights that would build walls around the business.  It was an unfortunate mindset.  This was a time of open standards and sharing, but shared ownership was not part of the equation for our start-up.
5. Internal sponsors wanted to see scale.  Niche markets were simply not interesting. The business had to embrace all of telecommunications, so part of the operating strategy was to place many product bets simultaneously, a disastrous choice given the meager resources for product development and the lack of real experience on the part of our business development team.  A VC would have told us that a narrow, easily explainable, product focus was key to success.
6. The corporate sponsors were all senior Bellcore executives, and they were focused on building the core businesses.  They believed that value creation had to be demonstrated by earnings. A VC would have told them that the market recognizes value well before earnings are even possible — it’s the single most obvious characteristic of early-stage investors to constantly seek those kinds of  market signals.

There were ways through this thicket.  That is one of the lessons for corporate leaders who want to launch internal start-ups: avoid colliding worlds by choosing the right corporate role.  Corporate sponsors need to be responsive to the needs of the new venture, but proactive support is just one more opportunity to infect the start-up an alien culture.  An internal start-up needs to be managed, but managing for value makes much more sense than managing to artificial revenue and earnings targets. And freaking out over the possibility of failure is also not helpful.  New business creation is a portfolio game, and any corporation that does not take a portfolio approach is betting against high odds.

An overlay to the story of every internal start-up is corporate machinery.  The milestones that mark the calendar for corporate sponsors are timed to fit the needs of much larger — and more visible — core businesses.  No billion dollar company can afford make its processes dependent on external business and market events.  But that is exactly what a start-up needs to do.  So, even if the new venture survives the Investor vs. Investor duel, it needs protection from the calendar, the  topic for my next post.

The Internal Start-up

I had a conversation the other day with a senior executive — let’s call him Bob —  of a Fortune 10 company about their “internal start-up” culture. It seems that they are looking for breakthrough product ideas that do not align well with their core business.  The solution seems obvious: let’s create the same kind of  exciting, market-driven environment that you would find in a start-up!

Everything sounded fine for a few minutes.  They thought that the most creative people in the organization needed to have elbow room that would be difficult to achieve in the risk-averse culture of a hundred billion dollar company.  So how did they plan to achieve that?

• Freedom to break some rules:  the start-up can use its own  product roadmaps and sales strategies
• Freedom from process-driven corporate calendars and budgets: the leadership of the start-up is not bound by the revenue and earnings goals of their parent
• Freedom to take risks: they have permission to fail

It didn’t take long for the discussion to go seriously off track.  When I started in with questions about how they were going to actually pull this off, Bob said: “Look, I’m in charge of new technology and platforms and I’m going to be the venture capitalist funding a new product, so that when it succeeds we’ll be able to fold it back into our current business.” I had seen this movie before.  It’s called When Worlds Collide. When I suggested that Bob lives on a different world and would make a terrible venture capitalist, things got a little heated. As I recall it, Bob said, “In your ear!” A surefire way to put a fine point on your argument.

Bob lives on a planet where the scale of his business creates a climate for successful development of new products that can be sold to familiar customers using existing channels and tried-and-true processes.  Above all, in Bob’s world, it is possible to make big bets. The examples are impressive. Everything from HP’s inkjet printing to the Boeing 777. Unfortunately for Bob and his start-up, none of those things matter.  The start-up lives in a world of new markets, which means new customers, new channels and new processes.

Even though Bob has all the talent he needs for market success,  the likelihood of failure is high. The Newton and the Factory of the Future did not fail because  because Apple and GE could not innovate.  They failed in large measure because corporations foster a system of beliefs that is fundamentally incompatible with  taking capabilities to new markets. When I asked Bob  how the start-up employees were going to be recruiteed and rewarded, whether they had a safety net for returning to the company in case of failure, and how many simultaneous bets he was willing to place, the answers were not encouraging.

I immediately did a deep dive into my archives, hoping to find traces of a long-forgotten venture that I helped steer into the ground.  In the late 1990s Bellcore was poised to enter the online services business, hoping to attract newer, smaller customers than the seven  Regional Bell Operating Companies who accounted for most of the company’s revenue.  This was a time when Bellcore’s Applied Research group was generating a blizzard of patents in e-commerce and software, technology that I have talked about before. We were as smart and nimble as any West Coast start-up, and best of all we had the cash to fund a new venture, the talent to staff it, and the power of an existing sales team to go after those new customers. I was asked to lead the new company.  We would be funded just like a VC-backed start-up…

When the dust settled and I reported lessons learned to the Bellcore’s CEO Richard Smith and later to Bob Beyster, CEO of SAIC,  Bellcore’s parent company, the first thing I said was that there had been no structural reason for failure.  A team from McKinsey had already given us the range of possibilities. We could have set up an independent business unit or spun 0ut a company in which we retained minority ownership.  Setting up a new incubator would have required more time than we thought we had, and, in any event,  Applied Research was already in the incubation business. We had chosen to bypass corporate reporting structure and create a company-within-a-company with direct oversight by a CEO who was committed to our success.  It was exactly the Hughes DirecTV model.

There are three reasons that internal start-ups like ours tend to fail.  Bob was not in the mood to listen because he is banking on success, but the topic comes up in every large enterprise, so I thought it might be a good time to repeat the conclusions here:

1. Failure is common: Building new business is a portfolio game in which 90% of the returns come from 15% of the investments.  It is fundamentally unlike product development. A “big bet” strategy only succeeds when there is high degree of confidence in your ability to sort out winners and losers.  In a new market, that just never happens.
2. Market-driven milestones drive success in new ventures.  An internal start-up — even one with strong support at the top — cannot divorce itself from processes that are timed to fit corporate needs.
3. Corporate sponsors of new ventures and VCs have different belief systems.  They are fundamentally incompatible, and without early, explicit steps to stop it, corporate attitudes, practices, and beliefs will overwhelm the fragile culture of the start-up.

I want to spend the next several days elaborating on these ideas.  I hope Bob is reading.

Damaged Pipelines and the Future of Innovation

One of the strongest arguments for shoring up the nation’s public universities, increasing graduate offerings, and expanding the role of expansive research plans in determining institutional priorities is the effect that investments like these have on America’s ability to innovate. It’s an argument that rings true, but as facts accumulate, it is beginning to look like public universities are not doing much to secure the future of innovation in the United States.

The nation’s supply of scientists and engineers is fed by a pipeline that extends from the undergraduate programs of colleges and universities to the graduate programs that educate the next generation of PhDs.  The massive investment in research at public universities should have had some impact on the health of this pipeline, but it has not.

A couple of weeks ago, I cited a depressing  CCAP ranking of universities that placed many of the country’s most highly respected research universities near the bottom of value-oriented rankings.  Now there is a new survey from UCLA’s Higher Education Research Institute that adds more details to this portrait of failed priorities.

On a per capita basis the schools whose undergraduate programs are responsible for the most PhDs in the STEM (Science, Technology, Engineering, Math) disciplines are the ones that are also highly regarded by students and alumni for the value they deliver.  There are only three public institutions in the top fifty: UC Berkeley (39), William and Mary (45), and a surprisingly strong 15th place showing for tiny New Mexico Tech.  Who is at the top? Caltech is number 1.  Private research universities like MIT, Princeton, and Chicago are also in the top ten. But so are schools with virtually no research funding.  Harvey Mudd is ranked number 2.  Reed, Swarthmore, and Carleton — all liberal arts colleges — are among the top ten as well. Many in the top fifty are small, but there are a couple of  large institutions like Berkeley (35,000) and Cornell (21,000).  About half enroll between 10,000 and 15,000 students.  All are highly selective, but so are the most of the public universities that are members of the AAU.

In a recent post, I asked “Why universities do research?”  This data makes the question even more pointed. The largest consumers of federal research dollars should be directing their energies to insuring the health of the STEM research pipeline.  All of the schools in the top fifty manage to do it — some with little or no help from the federal government.  So it makes perfect sense to ask what is going on at the other institutions.  I have my own ideas — and I talk about them in my book — but I am also interested in hearing your thoughts.  Is this another indication of a damaged pipeline?

Bankrupt!

In Where’s the money….? I described for you the Department of Education’s assessment of the financial health of the nation’s private universities:

The U.S. Department of Education issues a regular report on the financial health of  degree-granting colleges and universities.  It is a sort of test of financial strength.  When I started tracking the course of these institutions for my book, there were about a hundred non-profit colleges  that failed the test.  By 2008, that number had risen to 127.  The Chronicle of Higher Education has just reported that 150 non-profits now fail the Education Department’s test.

Now we have picture of the toll that the financial meltdown and runaway expenses are exacting on America’s public institutions as well. Moody’s Investor Services has just issued its report on the liquidity of public universities: “U.S. Public University Medians for Fiscal Year 2009 Show Tuition Pricing Power Amidst Rising Challenges.”  The report is available only to Moody subscribers, but Goldie Blumenstyk, writing in today’s Chronicle of Higher Education, summarizes the key findings as follows:

The median level of debt for 200-plus public institutions rated by Moody’s—$176.9-million as of the end of the 2009 fiscal year—has grown by 31 percent over four years. That’s notably greater than the rate of revenue growth (25 percent), total financial resource growth (15 percent), and enrollment growth (13 percent) during that same period…For the first time, colleges’ debt per student ($13,665) exceeded their financial resources per student ($12,893).

As a consequence, operating margins are at or near all-time lows for public institutions and are negative for many.

Tuition is rising at many public universities, but the cost to students is not being converted to increased educational value.  In many cases, tuition increases simply service expanding debt obligations. While the liquidity of top-ranked public research universities is worse than their private top-ranked counterparts, the public medians have the ability to convert a larger share of their assets to cash in the near term.  What Moody’s doesn’t say is where the liquid cash comes from.

The lack of transparency in public funding of higher education matters.  A public university has a public budget, and we all know that in most states funds slosh back and forth between spending categories without regard to the rules of arithmetic that most of us have to live under.

One large eastern state delayed paying university employees until the start of the next fiscal year.  Another one routinely delays most raises until the start of the next calendar year.  Still another allows cash to flow freely between major athletic programs and major academic obligations in the hope that a great athletic season might generate enough private donation to repay internal mortgages. Cost-sharing contributions are shifted, research cost recovery is murky, and personnel obligations are sometimes backloaded for months and years.

Even in good times, generating cash for operations in a public university is an exercise in juggling future payments.  With zero operating margins, administrators are the unlucky Monopoly™ player who has just landed on Park Place and realizes that the only way to pay the rent on the three hotels is to mortgage all of his properties. He spends the rest of the game hoping that he can keep his meager wages. Hope is not a strategy.

That is why the ability to raise tuition is so powerful.  But, as Moody’s new report makes clear, tuition increases are like passing GO.  New tuition dollars fill budget gaps. They do not change a university’s finances. It is only a matter of time before students figure that out and go for the e-pill.

Holding the Middle by Nibbling the Edges

One of the consequences of the e-pill scenario that I painted in my Ephemeralization post is the increased threat to colleges and universities in the “middle.”

Most American colleges and universities lie in the middle between the seventy or so top institutions that are wealthy enough to set their own agendas — even in tough financial times — and the proprietary, for-profit universities whose growth seems to be unperturbed by the financial meltdown of the last couple of years.

For many universities in the middle, online instruction threatens to hollow out their value. This is especially true for those institutions whose courses have been charted to follow the elites. When I raised the possibility of new kinds of technology enabled courses, the reactions were predicable:  lots of reasons that the online experience was vastly inferior to in-person instruction.  If that’s the value that the middle is holding on to, then the rapid embrace of online courses by top institutions is a real threat as larger numbers of the best students enroll in elite online courses and  price-sensitive students continue to choose the customer-friendly, jobs-oriented online programs at proprietary colleges.

Now in today’s The Choice blog at the New York Times, Rachel Gross asks:

“What if you could graduate from an elite university without ever stepping foot on campus — if instead, you had merely to open your laptop?”

The implications are staggering:  no more artificial size limits for entering freshman classes; elite curricula repackaged; focus on market share. Can an elite institution enroll fifty thousand students?  In 2000, executives at Hewlett-Packard asked whether HP could profitably produce and sell a forty-nine dollar printer.  They are really the same question.

In both cases, the answer is yes, but only if you can figure out a way to grab and hold increased market share with increased quality and service. As HP found out, you cannot turn your value proposition upside down by nibbling around the edges.  You have to be prepared to dramatically change your business model.

If Rachel Gross is right, then top-ranked institutions are already making this leap.  No more arguing over the drawbacks of online instruction or snarky comments about the low-brow nature of the  for-profits.  That means some at the top have already figured out new business models. If so, they are not talking about it. Whether it is a razor-and-razor blade platform, a cost-cutting approach to commoditized courseware, or a hybridized delivery model, every advance at the top threatens the stability in the middle.  I don’t think many will survive by nibbling around the edges.

dy, dynac, and Carly Fiorina

I recently heard from Chuck House, co-author with Ray Price of The HP Phenomenon (THPP) about my post The dy Logo.  I had used Chuck’s book as a jumping-off point for a discussion of how difficult it can be to integrate “outsider” cultures, even when the outside ideas have obvious value —  like correctly orienting the logo on a consumer product. It was a riff on WWC that I enjoyed writing.

Chuck’s note was a wonderful read in itself.  He took good-natured issue with some of my characterizations, reinforced other points that we agreed on, and reminded me of a few things that I should have remembered (and were in his book).  I don’t have Chuck’s permission to publish his email in its entirety, so I won’t.  Nevertheless I wanted to share with you a couple of his observations.

First of all, Chuck pointed out that the “dy” logo was actually used at HP in the 1950’s.  From page 64 of THPP:

A spin-out corporation…Dynac allowed a number of HP employees a higher equity stake in their success while giving HP a chance to invest in areas adjacent to its main activities. Dynac’s logo was the HP logo inverted. Later, when it was found that the Dynac name was trademarked, it was renamed Dymec, keeping the same logo.

There are many wonderful things about this story, but I was most fascinated that — even in the 1950’s — corporate leadership would have invented such a thoroughly modern approach to identifying and seeding market adjacencies. Some things were lost over the next couple of decades.  At least, there is no indication that Steve Wozniak’s management was inclined to create a spin-out to  give “HP a chance to invest in areas adjacent to its main activities.”  In any event, most of the HP engineers who argued for keeping the “dy” logo were not even born when Dynac used it, so it is unlikely that their resistance to flipping the shield was a nostalgic bow to a prior golden age.

Chuck went out of his way to reaffirm the comments in his book about Carly Fiorina’s positive  impact on HP.  Despite the obvious oustider-insider clashes, he says that, ” I don’t buy that Carly introduced WWC to HP, or even that she was all that good at it herself…,” but he does think that “…she was the best CEO we’d ever had in a WWC regard by quite a long ways (except Hewlett when he would actually do it…).”

To temper my comments about the narrowness of  THPP’s sources, House described for me the considerable pain and expense that he and Price endured in preparing the research.  Ninety percent of the people interviewed about events in the last fifteen years were what Chuck calls “current participants.” It’s hard to characterize that as the reminiscences of old colleagues. Point taken.

It was interesting to me that Carly opened the HP archives to House and Price.  That access was eventually revoked.  In fact, by 2001, access to the archives had become a sensitive issue with Carly, and she asked me to undertake a review of both the libraries and the archive.  I was not very excited about doing it, and other events quickly had a higher priority.

For Chuck’s unvarnished “side-by-side” view of recent HP CEOs — along with a pretty striking analysis of value given versus value received — I will simply point you to his recent blog on the topic.

“Ephemeralization” Follow-Up: Is the marginal benefit of college more than the cost?

Matthew Denhart and Christopher Matgouranis write on the August 19 blog of the Center for College Affordability and Productivity (CCAP):

The only way to judge the how worthwhile an investment, is to know the marginal benefits that result from it compared to its initial cost.

Based on these criteria, it is clear that the public is largely in the dark as to the value of a college degree. As we discuss in an article for Forbes.com today, colleges and universities rarely collect and publish information about the outcomes of their graduates. Perhaps this is an area where the U.S. Department of Education should step in and require alumni information be gathered and presented to the public in a clear and coherent manner. This would go lengths at providing the transparency and accountability in higher education that would benefit students and taxpayers at large.

The full text of their article can be found at Forbes.com.

In case you were wondering whether factoring value into reputational rankings of colleges and universities would change things, the answer is yes.  CCAP publishes an annual ranking of undergraduate colleges based on value.  The top of the list may not be a big surprise.  Williams College is the top ranked institution.  Princeton is second.  MIT and Stanford are in the top ten.  But so is Claremont McKenna College (9). Some Ivies don’t make the top fifty (Cornell is ranked number 70).  Georgia Tech ends up way down the list (242), a few positions ahead of Ohio State, but well out in front of the University of Arizona (339) and the University of Minnesota  (418).

Not surprisingly, the CCAP/Forbes rankings have generated heated — some might say enthusiastic — responses that either decry the irresponsibility of Forbes editors for publishing an obviously flawed ranking or agree  “it’s about time..” that Middlebury (26), Bowdoin (40), and the U.S. Naval Academy (29) get the recognition they deserve.  Research institutions — particularly those with high per-student expenditures — populate the bottom of the list in alarming numbers.  On  the other hand, student and alumni approval improves a school’s rank.

One reading of the CCAP article is that ephemeralization is overdue since American higher education seems incapable of doing more with more. I’ll let you take a look at the rankings and come to your own conclusions.