Home > Update > March 2008

The Wisconsin Naming Gift in Context:
Trends in the Economics of Higher Education

By Dean Michael Knetter

The Wisconsin Naming Gift provides a significant boost to our capabilities at the Wisconsin School of Business. Combined with funds from increased annual giving and undergraduate tuition that coincided with the gift, it enables us to make substantial investments in people and programs. We are already having a very successful recruiting year and are preparing to open the new addition to Grainger Hall this summer. Our future seems very bright. One might be tempted to even celebrate a little bit.

Nevertheless, trends in the economics of higher education remain very sobering for public universities. So, even though much of this issue of UPDATE is focused on the great strides that we will be able to make thanks to alumni support, we would be remiss if we did not provide some broader context for why this kind of gift was necessary for the school and why we believe it can point the way forward for the university as a whole.

What better way to ruin a party than with this recent quote from a BusinessWeek article on the disparity in resources between public and private universities.

“…the increasingly plush Ivy Plus model casts into sharp relief the travails of America’s public institutions of higher learning, which educate 75% of the country’s college students. While the Ivies, which account for less than 1% of the total, lift their spending into the stratosphere, many public colleges and universities are struggling to cope with rising enrollments in an era when most states are devoting a dwindling share of their budgets to higher ed.”

In the article, Harvard’s new president, Catharine Drew Gilpin Faust, is quoted as saying that public universities would be wise to really emphasize social sciences and humanities and have science endeavors that are less ambitious than those of Harvard and its peers. Apparently, Harvard and its private brethren are now so flush with resources, we might as well concede the best faculty members outside of a few areas where they are still willing to share. Is she kidding? No. And although all the current evidence is running in Faust’s favor, she doesn’t have to be correct over the long haul. In fact, let’s hope her high-profile comments stimulate the kind of national conversation that can lead to the solution of an important problem facing public universities and the nation.

Basic Trends in Higher Education Finance

The BusinessWeek article was an exposé on recent trends in higher education finance that have shifted decidedly in the favor of elite private universities. In particular, the underlying sources of salaries of faculty and staff have grown far more rapidly for elite privates than flagship publics.

Before we walk through the details, it is important to define a few terms. The salaries of faculty and staff that carry out the basic education and research mission of a university are funded from the base operating budget.

Total expenditures at a university will be much larger than this base budget because they include many other “restricted funds.” Research grants are restricted funds earmarked for specific research activities undertaken by the faculty and staff.

Private gifts at a public university are also typically restricted to support specific program expenses, buildings, scholarships or faculty chairs that provide incremental research support for faculty members. At private universities, there is a much greater tradition of unrestricted giving. Alumni expect to contribute toward the base budget, in addition to funding the many specific items that gifts fund at a public university.

The divergence in the unrestricted resources that underlie base budgets of private and public universities is the impetus for Harvard President Faust’s opinion. The base budget of a public university comes predominantly from legislative appropriations (which in turn, are funded by taxes) and tuition. The base budget of a private university comes predominantly from unrestricted gifts and tuition.

Interestingly, tuition constitutes a comparable share of the base budget in private and public universities. Publics have a lower price and higher enrollments, whereas privates rely on higher price and lower enrollments. (One advantage of the privates in this area is that they do have greater control over tuition revenue and price. This provides more powerful incentives for them to focus on value creation through educational programs and greater flexibility to respond to changing market conditions. Public universities are regulated by governing bodies and tuition is subject to myriad political and economic forces.)

The major difference in the fate of public and private universities, however, is accounted for by the growth in unrestricted annual gifts and unrestricted endowments over the last 15 years relative to the growth in state funding for public higher education. The growth rate in wealth and the return on invested endowments over this period has simply dwarfed the growth in state funding for public higher education.

As a result, base budgets have grown far faster at private universities than at public universities. This has their leaders brimming with confidence. It should also have sensible people who appreciate the role public universities play in creating a ladder of opportunity in society very worried. Concentrating a greater share of the resources dedicated to higher education on a smaller fraction of students will, in my view, have harmful long-term impacts on the economy and society.

At Wisconsin, we are justifiably proud of the research reputation of our faculty and our standing in receiving major research grants. Last year, we had the second-highest amount of sponsored research activity of all U.S. universities. We are also proud of the level of support we receive from our alumni, which is also at or near the top of all public universities.

Unfortunately, we may be victims of our own success. Our outstanding performance in generating research grants and restricted gifts has obscured an emerging crisis in our base budget. A healthy base budget is essential to recruit and retain the world-class faculty that sustain excellence in our core educational programs and generate these impressive grants. Our success in obtaining restricted funds may well create confusion or complacency among alumni. (I often hear from people puzzled by the juxtaposition of our alleged budget woes with the building boom on campus.)

The Public University Reaction

This situation did not develop overnight, and public universities around the country have been taking steps to adjust.

They are all trying to shore up state support for their missions. Unfortunately, many of the great public institutions in this country are located in the upper Midwest and these states have struggled in the face of global competition that has eroded employment and earnings in their manufacturing-based economies. Wisconsin fits that mold. Our public finances seem unlikely to keep up with returns on invested endowment.

Many public institutions have put increased emphasis on private giving to support the university. Although private giving to public universities is certainly growing, most of that giving continues to be earmarked toward specific projects and not base budget. Wisconsin is again a good example.
Finally, many of our public peers have sought and won greater control over tuition prices and tuition revenue within their states. Michigan led the pack, but others such as Indiana and Illinois have followed suit, finding ways to ensure that tuition prices and revenue can support the strategic direction and quality objectives of the university. Wisconsin has not budged on this front.

Keeping tuition prices low has been a higher priority in Wisconsin (see chart on page 18). This decision has an enormous effect on our budget. For example, Indiana’s slightly more aggressive increase of in-state tuition of $3,935 (compared to Wisconsin’s increase of $3,219) and out-of-state tuition increase of $9,358 (compared to Wisconsin’s $6,821) over the past six years translates to a nearly $30 million revenue advantage for Indiana’s budget.

There is, of course, a tension that arises with relying on tuition for a greater share of the university’s operating budget. The hallmark of a great public university is that it provides an education at lower cost, offering greater access, at a competitive quality to elite private institutions. Raising tuition may jeopardize access. Yet, lack of resources will erode quality. After carefully considering all these factors, it appears as though Wisconsin has lost ground relative to its public (and private) peers. Faculty migration patterns provide the best evidence. We have seen media reports, locally and nationally, that many schools that previously had little success luring Wisconsin faculty away are finding it much easier today.

While ebbs and flows will happen, our situation seems to be clearly linked to systematic features of the U.S. and regional economy that limit state support, combined with the governance and financial model underpinning UW-Madison, in which we have virtually no control over tuition revenue generation. If we are going to maintain or enhance our position as a leader in higher education and research, we must confront these basic facts and ask some tough questions about mission, values, governance and finance.

The Importance of the Wisconsin Naming Gift

Many of these forces that are impinging on the university became apparent at the business school much sooner. For one thing, private universities are much larger players in professional business education than they are in many other academic fields. As a result, their ability to generate resources through tuition and private giving influenced the market for business faculty sooner and to a greater degree than has happened in most other academic units. Faculty costs began rising rapidly and the national ranking of our full-time MBA program declined rather sharply.

Against that backdrop, we articulated a new strategic plan five years ago that has provided the basis for our development and decision making ever since. This planning and subsequent resource allocation was undertaken with an eye toward ensuring, to the best of our ability, academic excellence and long-term financial sustainability for the school. Academic excellence requires attracting and retaining the best faculty members possible. Financial stability requires wise use of resources and more rapid growth in unrestricted funds. It was clear that traditional sources of unrestricted funds—tax-funded state appropriations and tuition revenue from traditional degree programs—would not grow rapidly enough to keep pace with market salaries.

The only opportunities for growth in unrestricted funds over which we had some control were: expanding net revenue from our part-time professional programs and non-credit executive education, seeking a special tuition differential for the undergraduate business degree (we already had one for the MBA), and making the case that alumni should make unrestricted gifts to the school. Still, before asking alumni and students to pitch in, we felt it was important to show that we could make the adjustments needed to help ourselves in professional education.

Our strategy placed top priority on enhancing the fundamental quality and national prestige of our full-time MBA program by building on our traditional strengths in focused specializations, such as applied security analysis and real estate. Thanks in part to major gifts to create new specializations in brand management and corporate finance, we have made substantial advances in student quality, student satisfaction, placement outcomes and national rankings.

Prioritizing and improving the quality of the full-time MBA did not generate new resources itself, since we do not control the tuition revenue generated by full-time degree programs. But it strengthened our brand and honed our core curriculum, which in turn increased quality and value in our part-time professional programs where we do control revenue. Enrollments in our part-time Evening MBA and Executive MBA programs have grown substantially in recent years, increasing our base of unrestricted funds.

Demonstrating our ability to set and achieve goals with respect to the full-time MBA also inspired confidence in key constituents. Alumni became more willing to invest in the school. Equally important, our own students showed a willingness to invest in the school’s future.

An ad hoc committee made many recommendations to improve our already outstanding undergraduate program. The committee recommendations provided the impetus for a differential tuition plan. Our student leaders endorsed a plan to increase tuition for the business major by $1,000 per year. While 75 percent of the proceeds went directly into our pool of unrestricted funds, which will be used to hire more faculty and staff to support undergraduate business programs, 25 percent was set aside for financial aid to preserve affordability for all students. This is important because preserving affordability, as noted earlier, is critical to our public mission. (Our most recent application cycles imply that the differential tuition has done nothing to dampen demand for the programs.)

Our MBA students have also voted with their pocketbooks. Beginning in 2005, MBA students have run a commencement campaign to encourage graduates to give back as they leave the program. Participation was light in the beginning, only 6 percent the first year, but reached a remarkable 99 percent with the graduating class of 2007.

When undergraduate and MBA students make direct contributions to their school, it sends a strong signal to all alumni that we are engaged in dialogue with students and are accountable to their interests. I know firsthand that the commitments made by our students played an important role in convincing our Wisconsin Naming Partners that the time was right to make a major investment in the school.

The remarkable $85 million commitment of the Wisconsin Naming Partners was not the end of something, but the beginning of the next big thing: creating a culture at a public business school in which alumni make unrestricted gifts to support our base budget.

In order to help us expand that culture to more alumni, one partner provided a $1 million fund to match unrestricted gifts to the annual fund in the final two months of last year. I am pleased to report that we exhausted the matching fund and exceeded our prior best total of annual giving by nearly 70 percent. (More on the matching campaign in "A Day Like No Other") Our next challenge is to expand our base of support and participation rates in the annual fund even further.

Together, we have done something rather remarkable in a short period of time. We have articulated and executed a new strategy and at the same time built a new partnership between students and alumni committed to building and sustaining excellence at the business school. This has allowed us to make progress in an otherwise challenging environment for a public university.

Implications for the University

The university just concluded a very successful capital campaign and we have continued to secure record amounts of research funding. Still, these achievements have not provided enough of the base budget funds that the campus desperately needs. The shortfall in base budget is growing, and the university is struggling to retain its best faculty.

The gap in resources is large enough in our estimation that it cannot be solved by any one source of funding. The only viable solution for the campus is to chart a strategic direction that is more entrepreneurial and financially sustainable. In short, in the way many of you have helped do at the business school, we need to build a partnership between students, faculty, staff, administrators and alumni to take greater financial responsibility for the future of the university as a whole.

There is no reason to think that this cannot be done. The University of Wisconsin will continue to be as great as we want it to be.

The education we provide has never been more valuable. The premium earned by college degree holders in the labor market has grown substantially in recent decades. It is only fair to ask our students to pay a greater share of the costs of that degree. Their lifetime incomes on average will swamp the average earnings of current Wisconsin taxpayers.

Wisconsin is blessed with a large and talented alumni base. In fact, I would argue alumni goodwill may represent the single greatest asset on the university’s balance sheet. The premium earned by alumni who attended the university at very low cost in prior decades has exceeded any reasonable expectation they might have had when they enrolled. I am confident those alumni appreciate the value of their degrees and will help us keep this ladder of opportunity available for future generations.

The research we do has never had greater value to the commercial world. I would argue that no institution has more potential to move the state of Wisconsin into a stronger position in the knowledge economy than our university. University-based tech transfer has provided the foundation for knowledge economy hotspots, such as Silicon Valley, in many regions.

The Economist magazine recently ranked Wisconsin as the 18th most important university in the world. And the demand for what universities do has never been greater than it is today. If we can unlock the potential for value creation that resides within our faculty, the university can thrive and grow.

I am optimistic that with a renewed commitment to the important mission of a great public university and more effective communication of our value proposition to students, alumni, the state and to others around the world (perhaps even some Harvard graduates), who share in the aspirations of a great public university, we can secure the changes in regulation and increased unrestricted funds we need to grow and thrive.

There are too many good people willing to help, too many things on which all of our stakeholders agree and too much at stake to let this opportunity slip away.

Michael Knetter has led the Wisconsin School of Business since 2002. Previously, he was professor of international economics and associate dean at the Tuck School of Business, Dartmouth College. He previously served as senior staff economist on the President’s Council of Economic Advisors and is currently a trustee of Neuberger Berman Funds and Northwestern Mutual Series Fund.