Saturday, June 19, 2010

The Next Bankruptcy....Colleges and Universities?

College enrollment has steadily increased every decade since WW II. What happens if the trend reverses? Or what happens if people decide that four years of partying isn't worth $100,000 in student loans?

General Motors appears to be on course to make it out of bankruptcy. What caused it to go bankrupt? It was not hard to see it coming, even 30 years ago, when I worked there.

Stuck with a high, fixed overhead, both for plant, labor, and management, the company was in no position to move with the market. Its products became calcified and safe and attracted smaller and smaller market share - often by selling on price, at the expense of profits.

Eventually, the declining market share, increased costs, and decreased revenue curves all met in 2009, resulting in bankruptcy. No one wanted poorly made, lackluster products anymore, no matter how low the price. And the prices offered were so low, they lost money on each unit sold.

But the question remains, what other, similar, institutions are at risk of bankruptcy in years to come?

The thought hit me the other day - Colleges and Universities.

Like GM, colleges and universities are stuck with high overheads in terms of labor, plant, and management. Most have sprawling campuses of buildings that are half-used and half-empty, but still must be maintained, heated, and air conditioned (an alumni donor wants his name on a building, not a parking lot or the general fund, so colleges and universities get more and more buildings over time).

If you doubt me on this point, visit any large college or university. They occupy dozens, if not hundreds of buildings in various styles and sizes (often built cheaply, or horribly old, and thus expensive to maintain and heat). And most are poorly utilized - empty for most of the day, or occupied in an inefficient manner.

The labor to maintain this campus is usually union labor, and the workforce at even a medium sized college or university is pretty staggering. All that lawn doesn't mow itself.

Add in the cost of professors - particularly tenured ones, and you have an overhead that is pretty steep. And management for such institutions is often bloated, with more departments and department heads with criss-crossing authorities and responsibilities.

Needless to say, most private sector institutions would go belly-up in no time with such a management, labor, and physical plant structure.

Colleges and Universities have been staying afloat for the last couple of decades by increasing tuition by 2-3 times the rate of inflation - which in any market is not sustainable. Remember the housing bust?

In other words, like a government contractor, they have been taking their costs and passing them on to the students. In such an environment, there is no incentive to cost-cut or save money or to even evaluate whether the product being sold is worth what is being charged. So long as students show up - and pay - there is no incentive to operate efficiently.

Until now, most students just paid the price of tuition and didn't think too much about it. Funny-money in the form of Student Loans (you never have to pay those back, right? Think again) made college "affordable" for many.  And with the increasing price of homes, many parents could take out home-equity loans to pay for tuition. Whoops. Guess we can't do that anymore.

We are already hearing, in some quarters, that perhaps the "value" of a college education for many is over-rated. Spending $40,000 to $100,000 for an education (or much, much more) that ends up being useless, really seems like a waste of money.   The same money, placed in a retirement account, would be worth millions for the student when they retired from their low-skill minimum-wage job that they end up taking anyway, when their PhD in advanced naval-gazing takes them nowhere.

Throw in demographics. So long as the number of student applicants increases over time, colleges and universities can raise tuition all they want. But suppose the current generation is smaller than the previous? It is already happening in many parts of the country.  In our county, they are combining high schools and grade schools, as there are not enough students to fill both. This does not bode well for application rates in 2012 and beyond! Less High Schoolers means less applicants for college down the road.

And since the "funny money" is getting harder to come by, students may be more closely scrutinizing costs in the future and choosing schools base on price as well as quality.  And perhaps many may decide that $100,000 in student loans isn't worth the payback. You might be better off as a plumber, electrician, or A/C repairman (where there are actually jobs and people are hiring).

As I have noted before, it only takes small changes in the supply/demand curve to cause huge changes in prices.  For example, if there are 100 homes for sale and only 99 buyers, well, expect housing prices to drop 5-10% at least, as one desperate seller lowers his price to chase after a buyer.

Similarly, a small drop in applications at colleges could cause huge shifts in pricing, as colleges compete for applicants on price as well as quality.  Colleges need "butts in the seats" just to cover costs, and a small drop in the number of applicants could start a price war.

Throw in some other factors, such as pre-paid tuition programs.   A friend of mine invested in this, which provides guaranteed tuition at an in-State school at a fixed price. The bought in when their child was 10. Eight years later, tuition costs have gone up nearly 50%, but my friend is paying almost half. How do the colleges make up the difference when all these "pre-paid" plans come due?

It is an interesting thought. Colleges and Universities have been living in a dream world of no competition and no motivation to manage costs - largely since World War II.   Incoming classes each year are getting bigger and bigger and most folks have looked at a college education as a "guaranteed ticket" to increased income.

But as college costs escalate at 2-3 times the rate of inflation (which is not sustainable), there will eventually reach a tipping point where the cost of a college education just isn't "worth it" economically. And at that point, more and more young people will re-think the idea of college. This will only add fuel to the fire, as with lower enrollment, colleges will be forced to raise tuition further to make ends meet.

Like with GM, college management will be reluctant to cut its own ranks or its own perks - and not have the courage to attack its bloated cost structures - selling off unused assets or re-negotiating bloated union contracts.

The analogy is apt. Colleges and Universities are structured much like GM was, and are unable to quickly move to re-invent themselves for new markets. All it will take is a change in demographics and a small drop in demand to trigger a landslide of bankruptcies. Alumni will be hit up for more donations, of course, but as more baby boomers contemplate retirement on their diminished (or non-existent) assets. they will not be a position to donate as their parents did.

Could it happen? Is it already happening? Google "enrollment down" and read the results. High schools across the country are showing lower enrollments, as are community colleges. It could hit 4-year colleges and universities next. Or check out Census Data.   Our population is growing older and while birth rates are holding steady, there are not as many young people as before. The rate of increase of population growth is flattening out.

Or check out this US Census Age distribution chart from 2005. Note the "pyramid chart" (Page 2) is no longer a pyramid, but looks more like a minaret. From age 15 down to age 5, the population shrinks. That chart was made in 2005, so these kids are now ages 15-20 - in college or about to apply. Is this a large enough dip to cause problems for colleges? Again, a small drop in demand can mean BIG swings in pricing.  As schools chase after a smaller and small audience, they will have to offer perks - scholarships or other incentives - to keep their enrollment up.

I am already hearing noises about problems at some small Colleges and Prep Schools. Donations from alumni are down (our generation is in no position to endow much!) and their existing investments have taken a hit in the market. And some are seeing lower enrollment and fewer applicants. All-black or all-female colleges are re-thinking their policies to try to expand enrollment, with many girl's schools going co-ed and historically black colleges admitting white students.

As students (and their parents) scrutinize the cost of an education, they become more aggressive consumers. And if demand drops, they may be in a "buyers market" that was unheard of, only a few years ago.

Many colleges and universities are taking steps to cut costs now. Tenure is largely a thing of the past at many institutions. Why pay someone top dollar, when you can bring in a "temp" (adjunct professor) for less?  Plus, you can fire them when they make embarrassing comments about "little Eichmanns".

And many schools are courting older students as well - so-called returning students. As the population ages, you have to go after an older audience.

And perhaps negating this effect are international students. Many schools are accepting more and more students from overseas to fill out their ranks. US Colleges and Universities are viewed as some of the best in the world, and a US education is valued even more overseas than here. Of course, after 9/11 some students had trouble getting visas, but presumably that has been worked out by now.

But even overseas "customers" can only pay so much, and there are only so many overseas people who are wealthy enough to send their children to a US School. And there is competition from Europe in this regard as well. So whether foreign enrollment can take up the slack is anyone's guess.

It is possible that some smaller institutions could go under or be merged with other schools. Obviously, large "name" schools like Harvard and Yale have little to worry about. But many boutique schools might have a harder time of it, in terms of attracting students and making money at the same time.

Perhaps I am an alarmist. But it is interesting food for thought. Whenever an organization operates in the manner of GM - or many colleges - any disturbance to the equilibrium of the environment can be disastrous, as they cannot adapt to changing conditions.

Adapt or die.