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Trusteeship Magazine

Strategic Finance: The 4% Solution

By Duane Kilty
January/February
2018

To enjoy long-term financial health, a higher education institution should experience a 4 percent operating margin. That means enrollments are growing, or at least are stable, costs are being controlled, and debt is kept within its threshold limits.

Trustees and campus leaders need to think carefully about the future of higher education and the changes the institution should make to be competitive.

A six-step planning model—reevaluate, reimagine, reduce, reinvest, resolve, and results—can be helpful to create systemic change to strengthen the financial and strategic health of the institution.

The challenges facing higher education today are well documented. The cost of delivering high-quality programs continues to rise, and the expectations of students have never been higher. Reliance on tuition to cover costs is increasingly unsustainable: Demographics for traditional-age prospects are unfavorable in many parts of the country, making it difficult to recruit students. Income from private giving has not kept pace, nor has the spending from endowment funds. And state support for public institutions has declined in most areas of the country. Discount rates are increasing as prospective students shop for more affordable options. The pressure to change is significant and not likely to end anytime soon.

Governing board members bear responsibility for oversight of the financial and strategic health of the colleges and universities they serve. To enjoy long-term financial health, an institution should experience a 4 percent operating margin, according to Strategic Financial Analysis for Higher Education by Prager & Co. LLC. That means enrollments are growing or at least are stable, costs are being controlled to ensure they don’t rise faster than revenues, and debt is kept within threshold limits. It also means that institutions must offer academic programs that match student interests and teach the skills that are necessary in the workplace, as long as they are consistent with institutional mission and educational purpose.

Some schools are strong and robust with an optimistic forecast. Many others are struggling and need to make significant changes to compete successfully in the marketplace. Even if things are going well today, the demands of the public and the challenges facing higher education are likely to ensure change will be needed in the future.

To be prepared, trustees and campus leaders need to think carefully about the future of higher education and the changes the institution should make to be competitive. The process should be comprehensive and robust. The ultimate objective is to create and implement a strategic plan that will help the institution become stronger.

From my perspective, campus leaders will need to take risks because the required changes will be significant. Alterations are likely to include innovative programs, delivery modalities, and new business models. At the same time, leaders will need the discipline to execute strategic plans with high levels of accountability. Throughout the change process, trustees and the administration must maintain a steadfast commitment to the institution’s mission. The question is, will institutions be proactive or will they react after the institution is in decline?

Because annual operating health is a prerequisite for overall financial and strategic health, I approach strategic finance from a planning perspective. If the annual operating budget is producing a 4 percent margin and enrollments are growing, the balance sheet will become stronger with good management. In my experiences as a longtime CFO, campus leader, and consultant, a six-step planning framework can be helpful to create systemic change and strengthen the financial and strategic health of an institution. The approach, which draws from my experiences as a longtime chief financial officer, a campus leader, and a consultant, is designed to create systemic change to strengthen the financial and strategic health of an institution.

Through long experience with 11 institutions, I have proposed a six-step financial planning model that works well in practice.

SIX-STEP PLANNING FRAMEWORK

The six-step framework for strategic finance planning is:

  1. Reevaluate
  2. Reimagine
  3. Reduce
  4. Reinvest
  5. Resolve
  6. Results

STEP 1: REEVALUATE

The purpose of the analysis in Step 1 is to get everyone to agree on the starting line. There are six sub-steps. Step 1A, Environmental Analysis, comprises a SWOT (strengths, weaknesses, opportunities, and threats) analysis. The gross price, net price, retention, and enrollment funnel study occurs in Step 1B, Market Position. Step 1C, Financial Analysis, reviews financial health and follows the AGB publication The Board’s Role in Financial Oversight by Natalie Krawitz. Mission, vision, and values are reviewed and changed, if necessary, in Step 1D, Mission/Vision/Values.

The creation of profit-and-loss statements in Step 1E, Program Margins, reveals the operating margin each program generates. This exercise provides good data for decision making. Plus, it shows how much each program contributes or draws from the bottom line.

The aim is to use the data from the analysis to improve programs and identify ones for elimination. Decisions must be rooted in the culture and history of the school. Sometimes weak programs should be kept for pedagogical or mission-related reasons. At other times they are essential to the identity of the institution.

In Step 1F, baseline budgets are prepared to reflect the current plan for the next five years. The enrollment, pricing, staffing, compensation, and other assumptions should be explicit. The discussion of the baseline budget and financial statements should include any real or perceived unfunded budget needs. These issues are elephants in the room later in the process and should be addressed at the front end.

For Step 1, governing boards should ensure:

  • Trustees reviewed mission, vision, and values.
  • The academic committee and student life committee processed the data generated in the various sub-steps.
  • The finance committee reviewed the baseline budget for realism.
  • Everyone is comfortable with the data and process.

STEP 2: REIMAGINE

Now that everyone involved has a common understanding of the starting line, attention is turned to communicating the academic mission, developing new programs, and thinking carefully about the future. It is important to reimagine what is ahead before diving into the hard work of potential budget reductions and other important changes.

The aim of Step 2A, Distinctives, is to communicate the school’s academic mission. To ensure students consistently experiencethe academic mission, the elements should be mapped to the curriculum and co-curriculum. That is the only way to be sure the institution fulfills its commitment to students.

Step 2B, New Programs, puts a process and decision-making model in place to develop and launch new programs. When done well, this model serves as the innovation engine that drives the institution into the future.

Trustees should partner with the administration in Step 2C, Strategic Thinking, and create an understanding of the future of higher education. The list would include changes in student demographics, educational delivery channels, the business model, and student expectations. In addition, the changes required for the institution to remain competitive are identified. Even though the future is uncertain, a working understanding serves as the roadmap for the strategic plan. Having a clear direction aids decision making and improves productivity.

For Step 2, governing boards should ensure:

  • The curriculum and co-curriculum have a clear and consistent articulation of the academic mission.
  • The administration can scan the environment and launch new programs that interest students and meet the needs of employers.
  • The administration understands the future landscape of higher education, along with the institution’s standing.

STEP 3: REDUCE

With two steps completed, the starting and ending points of the process are in place. For schools that must reduce their budgets, now is the time to do the hard work.

This step has three sub-steps. The aim of Step 3A is to clarify existing priorities. Faculty and staff have long memories. Every promise made by the administration is expected to be funded someday. Outstanding issues can impede strategic planning and should be resolved before continuing.

Creating a “stop doing” list in Step 3B is a good business practice. By freeing up funds, institutions can invest in the future.

For some institutions, Step 3C, Budget Reductions, is the only way to fund new ideas. For others, it is a good business practice. Schools that have budget deficits need to cut enough to balance the budget and allow funds for reinvestment. Cost cutting, without reinvesting, is likely to turn into a death spiral. Reducing to reinvest in new ideas creates hope for the future.

Schools that are doing well and do not need to cut costs to free up funds for reinvestment should consider doing so anyway. Good times don’t last forever. Leaders need to stay alert and not let any waste slip into the system.

For Step 3, governing boards should ensure:

  • Clarification of existing priorities and elimination of those that are not important.
  • Identification by the administration of programs, people, systems, and processes that will be discontinued.
  • A viable plan to close the gap between available resources and the cost to fund the new strategic plan.

STEP 4: REINVEST

After three steps, half of the process is complete and funds for reinvestment have been identified. The focus of Step 4 is to develop a strategic plan that will guide the institution into the future. Step 4A completes strategic goals, which should commit to a clear direction. Because people fear change and want certainty over the outcome, it is much easier for leaders to make minor adjustments than to alter the direction of the institution. Great leaders transform the fear of the unknown into confidence.

The outcome of Step 4B, Modeling the Future, is a forecast that shows cost reductions and changes. Plus, it identifies the cost of each element of the strategic plan. The table on page 28 shows the multi-year impact of each decision organized by category so leaders understand the impact.

Step 4C entails writing the strategic plan. It should be easy to read and formatted like other important documents. Each goal should include strategies, target dates, measures, and the person responsible.

For Step 4, governing boards should ensure:

  • They have reviewed and approved the strategic plan.
  • The administration has committed to a clear direction.
  • Financial projections are realistic and achieve the overarching financial goals of the institution.
  • They are comfortable with the amount of risk the administration is taking, and that new programs align with the mission.

STEP 5: RESOLVE

Completing Step 4 puts the strategic plan in place. Now it is time to do the hard work of implementation. The purpose of Step 5A is to create operational plans that will help accomplish the strategic goals. Each major unit of the institution should create its own plan aligned with the strategic plan. Employee plans should align with the unit and the strategic goals.

Step 5B, Executing the Plan, has two activities. First, the administration and operational leaders should meet. This happens at least four times per year. Key faculty are included, and every element of the plan is reviewed. Roadblocks are removed and any confusion about what is most important is clarified.

When discussions are frank, these meetings work well and help to get things done. Leaders must create an open environment for people to speak honestly. If not, they won’t share their ideas.

Second, administrative and operational leaders need to instill new habits that will change the culture and incentivize the right behavior. I recommend that every employee send his or her goals for the next week to their supervisor. The email should review the accomplishments from the week before. The reason for missed goals should be explained and discussed in person. Like the strategy execution meetings, the purpose is to remove roadblocks and solve problems. I call this process “implementation emails.” Everyone should be included, especially the senior administration.

For Step 5, governing boards should ensure:

  • The institution has, or is developing, a culture of execution.
  • Strategy execution meetings are being held regularly.
  • Operating plans are properly interconnected.
  • Implementation emails, or something similar, are used to foster a culture of execution.

STEP 6: RESULTS

After five steps of the process, everything is in place except for the scorecard. Step 6A, Strategic Targets, sets financial goals for the various measures the administration and trustees use in their governance roles. These targets guide decision making. Action is required for any measure below its desired level. The solution is likely to involve addressing operational issues.

A great practice is to create a strategic finance fact book and include every measure being tracked. The measures should include historical trends and projections for the future. My goal as a chief financial officer was to include the answer to every question the finance committee ever asked because if members inquired once, they were likely to check again. New questions were added to the fact book with historical trends and projections.

The aim of Step 6B is to create a dashboard report, which includes measures essential to the institution’s financial health, along with definitions, trend data, comparisons with other institutions, and strategic targets. Trustees help create the report. It contains only a few key indicators whereas the strategic financial targets are comprehensive. Once in place, it serves as the financial GPS. A good dashboard report helps trustees quickly assess how well things are going.

For Step 6, governing boards should ensure:

  • Regular review of the strategic plan.
  • Regular review of the strategic financial plan.
  • The administration understands why measures are doing better or worse than the target.
  • Questions receive appropriate answers that are not defensive.
  • Finance committee involvement in dashboard report development.
  • Every trustee understands the dashboard report.

Implementing the six-step planning framework can cause staff problems to surface. Some mid- and upper-level leaders won’t be able to make hard decisions and produce at the level necessary. As a result, they could choose, or be asked, to leave their positions. In my experience, this has not been disruptive, but beneficial. A stronger person assumes the role, and the institution moves forward.

No one knows what the higher education landscape will be in a decade, but if the past 10 years are instructive, it will markedly change. As schools implement the framework, they will:

  • Find ways to lower the price and maintain quality.
  • Develop new business models that are more sustainable than the current one.
  • Develop expertise in scanning the market and implementing innovative programs that meet market needs.
  • Improve processes to be more productive.
  • Experiment with and implement creative new delivery modalities.

Trusteeship asked Conrad Clemens, MD, chair of the Goshen College board of directors, to comment on his experience with Duane Kilty’s strategic finance process and offer advice for board members undergoing a similar analysis. Dr. Clemens is associate dean for graduate medical education at the University of Arizona College of Medicine.

1. Why did your board get involved with strategic finance? What had it been doing previously?

Like other small, private liberal-arts institutions, Goshen College has been buffeted by the swirling winds of change in higher education. As Duane mentions in his article, the increased scrutiny regarding the value of a liberal-arts degree in light of rising tuition costs, coupled with alternative educational models (i.e., online programs, community colleges), has posed a challenge for maintaining enrollment levels. Because Goshen College traditionally has been a tuition-driven institution, this deeply affected our bottom line. Although Goshen has a fairly robust endowment, the need to balance a budget with fewer tuition dollars fell increasingly and ominously on draws from the unrestricted endowment.

Goshen’s board and leadership had an unrealistic hope that this unstable higher education landscape was only temporary. As the endowment draws became larger and more frequent, we realized our usual annual budgeting process was not strategic but only nibbled around the edges. We periodically made painful, reactionary cuts, hoping we “wouldn’t have to do that again.” We needed a strategic plan that was agile and reality-based.

2. What, in particular, is happening at small, private institutions that makes this work critical?

The smaller the institution, the less cushion there is to withstand changes in the higher education landscape. Most of these institutions are driven by enrollment. Any downtick can lead to a downward spiral with less income and, as a result, fewer programs or faculty for students. The competition for students is fierce, resulting in attempts to woo them with larger and larger discount rates as well as a reactionary temptation to add programs. Compounding this challenge is the desire for students to have immediately translatable job skills upon graduation. Smaller private institutions tend to have smaller, close-knit faculties. While making strategic cuts is difficult anywhere, these close relationships, coupled with intense pressure to keep programs considered “sacred cows,” require a board and institutional leaders who are strategic, clear-headed, and strong.

3. What advice would you give other boards undertaking a similar analysis?

I have three pieces of advice that stem from this process. First, accept the fact that the “swirling headwinds” in higher education are not temporary. For many, the hope was to simply hunker down and outlast them. The challenges that we are facing in higher education are the new normal. And they may become more difficult. Institutions that refuse to accept this fact do so at their own peril and risk becoming obsolete.

Second, institutions need a strategic plan that is agile. Given the unpredictability of higher education, setting an immutable five-year plan is unwise. Agility is critical.

Finally, since these changes can be deeply disruptive for small institutions, open, trusting, and frequent communication between board and institutional leadership is a must. Both must be fully on board with the plan. This communication provides mutual support during difficult (and emotional) times. It provides the ability to review the strategy frequently and decide when to continue the course and when to tweak a program or make a major change. A categorical statement that the board supports the leadership’s strategic plan is very powerful and must be substantiated.

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