UV Letters

Feb 8, 2013 BACK

The Price isn’t Right

UV Letter - Volume III, #3

“How should families think about college affordability?...
At many colleges, almost no one pays the sticker price.”
  - Chronicle of Higher Education

It has been over a year since the Occupy Wall Street movement flowed onto college campuses. Occupy Colleges focused our attention on the college affordability crisis and its corollary, the student loan debt crisis. In this time, the sense of crisis has only deepened. 11.4% of all student loans are more than 90 days past due. Average loan balance per borrower is now nearly $24,000. 26 million consumers have two or more open student loans on their credit report. Total student loan debt has surpassed $1 trillion – well ahead of credit card debt. Nearly 50% of employed U.S. college graduates are in jobs that the Bureau of Labor Statistics says require less than a four-year degree. Today, 15% of taxi drivers have a bachelor’s degree.

Higher education’s response so far has been less than satisfactory. A year ago, 123 schools charged annual tuition, fees, room and board totaling more than $50,000. Today 151 do, and Sarah Lawrence College was the first to break the $60,000 level. Tuition hikes also continue at more affordable institutions. In the Chronicle of Higher Education’s database, more than half of all colleges and universities raised tuition in 2012-13; 40 colleges raised tuition by 10% or more.

A year ago, the Obama Administration pivoted to make affordability its top higher education priority. The result was a July 24 letter from Secretary Duncan to all Title IV-eligible institutions that focused on making it “easier for parents and students to finance their college education and to understand their financial obligations.” The Department of Education asked colleges to adopt a new “Shopping Sheet” that “unravels the mystery of higher education pricing” by clearly listing the sticker price, grants, the net price, and loan options. (This followed a 2011 directive that required all colleges to post net price calculators on their Web sites.) As of November 2012, the Department announced that more than 500 colleges had adopted the Shopping Sheet.

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The responses of our universities and our Department of Education have something important in common. College Presidents are fond of repeating that net price paid by students is not increasing at nearly the rate of increase in sticker price, and may in fact be declining. Secretary Duncan and his team naturally want every American family to understand a core tenet of the U.S. higher education system described well by Peter Sacks, author of Generation X Goes to College: “The published prices of higher education are virtually meaningless. The far more important number is net price, which is the cost of attendance (tuition sticker price plus expenses) less federal, state and, especially, institutional grants.”

Raising sticker prices but not net prices means that our colleges and universities are increasing their use of institutional grants. These grants, often characterized as scholarships of some form, are the primary price discrimination tool wielded by colleges and universities.

Price discrimination is a methodology by which producers attempt to extract as much surplus from consumers as possible. By charging each consumer the maximum amount he or she is willing to pay, producers are able to maximize revenues and profits. Price discrimination explains why airlines have sophisticated models that price tickets based on hundreds of variables.

The good thing about price discrimination for colleges and universities is that those who can afford to pay $50,000 or $60,000 per year may be asked to do so (although it turns out this is only 1/3 of all students). But two very negative results of price discrimination give reason to stop and question this core tenet of our higher education system.

First, price discrimination is not fair. A large amount of grant aid is distributed on a merit basis (rather than financial need) in order to attract more capable students. Estimates range from 50% at private colleges to about 2/3 at public institutions. In addition, colleges use different formulae to award need- based grants. Some colleges consider home equity; others do not. But all colleges award grants based on the family’s finances from the previous year – also not always representative of a family’s true financial situation. Finally, as the Chronicle noted last week, “families can spend four years preparing and have four weeks to decide with all the information” once colleges respond with grant awards.

Second, the ridiculous sticker prices sustained by price discrimination likely reduce college accessibility for lower income and minority groups, regardless of what grants or discounts might be available. In the 2004 study “Cost, Quality and Enrollment Demand at Liberal Arts Colleges” in the Economics of Education Review, Economists at Berkeley and Reed demonstrated that price discrimination in higher education reduces quantity demanded: “Increasing both tuition and average grant levels by one dollar leads to a reduction in enrollment yield. Students appear to look beyond a ‘net cost’ number and consider tuition and aid separately. Perhaps this reflects uncertainty about continuation of aid in future years, whereas ‘tuition is forever’.”

Other economists have linked high sticker prices and price discrimination in higher education to confusion among low-income, non-English-speaking and first-generation students – confusion that discourages students from applying to college in the first instance. In a 2005 report by the Lumina Foundation, Jerry Sheehan Davis concluded: “One of the unintended consequences of tuition discounting is that financial access to four-year colleges for lower income, financially needy students may generally be diminished… Tuition discounting works for some colleges… but the actions by large numbers of individual colleges, when combined across all institutions, have produced some worrisome outcomes for students and for colleges in general.”

The unfairness and inaccessibility become apparent in thinking about how airlines would act if they price discriminated in the same way as our colleges and universities. A typical travel experience would go something like this: You are planning a trip; you send ticket requests to several different airlines that all charge a fee you know you would never pay; then a short period of time before you need to travel, the airlines respond with the discounts they’re willing to give you, all based on different factors; you decide if you’re going to fly, and if so, on which carrier. Such a model would ground American air travel.

As the Chronicle noted last week, “A big push from the federal government to provide better consumer information has not created better-informed consumers.” By focusing on net price and making grants transparent, the Obama Administration is kneeling at the altar of price discrimination and effectively accepting the unfairness and inaccessibility that flow from the current model. A more effective public policy would help wean colleges and universities off price discrimination. The goal shouldn’t be to “unravel the mystery of higher education pricing,” but rather to eliminate the mystery altogether.

This is particularly important as our higher education institutions look to take flight in international markets with online and blended programs. Price discrimination will not be an effective tool for interesting international students in online or blended programs from U.S. universities. If the sticker price seems absurd, students unfamiliar with our unique discounting culture will turn elsewhere. And as online programs produce a more coherent global market in higher education, more U.S. institutions will be compelled to join their international brethren by becoming EDLP (everyday low price) providers, rather than discriminators.

There are a few promising signs in this regard. Belmont Abbey, a Catholic college located on the outskirts of Charlotte, is one of six colleges to have announced a reduction in sticker price over the past two years. William Thierfelder, the President of Belmont Abbey, which cut tuition by 33%, told CNN “it seemed a little bit like madness… We were raising tuition each year, only to give it back on the financial aid side to help students be able to afford it.” He went on to add that most students are so discouraged by the sticker price that they don’t even consider applying to a school they think is beyond their family’s means. Another one of the six is University of Charleston, which reduced tuition by 22%. Edwin Welch, Charleston’s President, said he “realized parents and families were now considering the overall price, not just the discount… Advertised price is driving middle-class students away.” Welch pointed to the example of Sewanee, University of the South, which announced a reduction in sticker price last year ago and saw an increase in enrollment.

One final note concerning for-profit universities: One would think these market-driven institutions would be most responsive and likely to move away from high sticker prices and discounting. In fact, the opposite has happened. For-profit companies like University of Phoenix, Career Education, Corinthian, DeVry, Capella and Strayer have kept their high sticker prices, but are now offering substantial scholarships to entice students.

The other higher education policy priority of this Administration and the accreditors it regulates has been to make our for-profit universities more like traditional universities. Congratulations are in order, we suppose.

University Ventures (UV) is the premier investment firm focused exclusively on the global higher education sector. UV pursues a differentiated strategy of ‘innovation from within’. By partnering with top-tier universities and colleges, and then strategically directing private capital to develop programs of exceptional quality that address major economic and social needs, UV expects to set new standards for student outcomes and advance the development of the next generation of colleges and universities on a global scale.

Comments

Oliver Sabot 2013-02-09 10:10
UV Team, Thanks for an articulate and insightful piece as always. You rightly condemn the status quo of university pricing in the US and I agree that much more fundamental change is needed than simply attempting to increase consumer awareness of net prices. But I am not yet convinced that a... Read more blanket move to EDLP is the right answer. First, differential pricing is theoretically the optimal way to maximize access to a fixed product (an education of the same quality in this case). The greater income reaped from those with higher ability to pay effectively cross-subsidizes those with less means. If the overall sticker price is lower, institutions will most likely forgo some income they would have yield from the top tiers and thus they - particularly the less endowed institutions - will effectively raise the price to the poorest (i.e., through less aid). This is theory of course and you outline a number of ways this fails in practice. But it seems worth carefully exploring alternative solutions to make this optimal structure work before abandoning it altogether and potentially adversely impacting some students with the greatest need. Second, an alternative to differential pricing for the same product would be differential product offerings. For example, universities could advertise a sticker price for a core experience (ideally primarily focused on educational outcomes and without some of the higher cost extracurriculars) and then optional add-ons for higher prices. This would enable the institution to significantly drop the sticker price while still generating additional income from wealthier students. Almuni giving is effectively a form of this now, but there is no reason why it could not also be done during enrollment. There are a range of practical challenges to this, notably the cultural associations with college in the US mean that the extracurriculars that some of the services that would most naturally be excluded from a basic offering are what students of all incomes are seeking and so demand for the school may fall and/or poorer students may end up paying more nonetheless. But it certainly seems worth experimentation. Lastly, all of these pricing strategies can only help mitigate and not solve the root obstacles to broader and more equitable access to quality higher education: high cost structures and lack of focus on educational outcomes. Even if flat pricing is broadly adopted, prices will be unacceptably high at many institutions and continue to grow as long as the current high overhead business models are used. Pricing strategies will be a factor as US universities seek to expand abroad, but undoubtedly the greatest impediment to their success abroad will be their cost structure. New models that offer similar or better educational outcomes for far lower costs will increasingly emerge and the dominant brands of US institutions will only last them so long as the ROI of those models becomes clear. We are exploring these price and cost issues in detail for a range of developing countries (discussed on our blog at www.mindoverminerals.com). We of course don't have any clear answers, but are looking forward to experimenting and to discussing with you and other thought leaders in the space. Best, Oliver
Kevin Corcoran 2013-02-08 08:10
This article raises many good points.
Antonis Polemitis 2013-02-08 05:22
For most universities, price discrimination is almost certainly the correct economic strategy, public policy issues aside. (1) If you are right and there are huge benefits to going to EDLP, then market should easily take care of this issue and the EDLP leaders should out-perform their... Read more competitors. We will see to what degree this happens. (2) Having said that, it is tough to overestimate the power of price discrimination that universities have. What business wouldn't kill to have market acceptance of the principle that customers have to hand over detailed financial statements before a price is quoted? It is almost a textbook economics case on how to maximize rents. (3) The closest analogy is car purchases, not airline tickets. Yet, despite some attempts at no-haggle/EDLP over the last 20 years, most dealers are on a start high and haggle model still (aka price discrimination). Can you imagine what would happen to car dealer profitability if, before quoting you a price, they had the ability to check all your financials too?! (4) International online is neither here nor there, IMHO. That product is so different than on-campus in the United States that it could easily be priced differently without causing channel conflict. The real problem for international online is for the state institutions who won't be able to do this because then they have to explain to their state legislators why they are giving away their education 'cheaper' than random 'foreigners' than to in-state residents (5) None of this is to say that lower-priced programs won't emerge. They must emerge. But if you are selling the high priced program, I bet the economics play in favor of price discrimination for a long time.

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