In the summer of 2010, a number of powerful politicians launched an attack on for-profit higher education, painting with a very broad brush to portray the whole sector as villainous. Is that accurate? Or is it political posturing? Or some of each?
Daniel Bennett, Adam Lucchesi, and Richard Vedder have written a timely, useful, and balanced report on for-profit higher education. If you have heard the indictments against the for-profit sector, you should read their assessment, too.
The authors begin by noting that share of students attending for-profit institutions of higher education has grown substantially in the past quarter century. In 1986 for-profit schools enrolled 300,000 students, by 2008 it was 1.8 million. Their market share of higher education enrollment had risen from 2.4 percent to 9.2 percent. The last decade has seen even more impressive growth, with for-profits capturing 23 percent of the total growth in enrollment for the period 1998-2008.
The implication is obvious—the for-profit schools could not have enjoyed such sustained growth if they weren’t delivering an educational product that a large number of students found satisfactory.
An important part of the authors’ analysis is the difference in incentives between for-profit institutions and public and non-profit ones. Public and non-profit colleges and universities rely on third party revenues for much of their funding. Tuition makes up only 17 percent of the revenue for public colleges and universities, and 36 percent for private non-profit institutions.
In contrast, for-profit institutions rely on student tuition for 85 percent of their revenue. This means that for-profit institutions need to be very sensitive to the consumer—the student.
This leads to a different mission for for-profit institutions than for most public and non-profit colleges and universities. While public colleges and universities and non-profits often treat undergraduate education as a step-child, for-profits are strictly focused on teaching undergraduates. Their customers are concerned with what they are taught and how well they are taught, rather than with what research is being done by faculty members or how well the football team is doing. The profit motive thus minimizes the diversion of resources into unnecessary overhead (recently labeled “administrative bloat”) and numerous non-educational ventures.
As with any industry, for-profit institutions gain from innovation in education, and from lowering costs or improving service. If the University of Phoenix, for example, does not provide an education that its customers find worth the tuition cost, then it will eventually go bankrupt, whereas if it can provide a quality education for low cost, then it will earn profits and be able to expand as it attracts new customers.
The authors point out that this is indeed the case. The Apollo Group established the University of Phoenix in 1976. Today is has 400,000 students at 74 campuses and learning centers. The 2007 profit was $598 million and it had a market cap of over $11 billion in 2009. These figures are impossible to reconcile with an institution that is not providing a service that its customers find value greater than the price they must pay for it.
The report also demonstrates that for-profits differ substantially from the traditional higher education institutions in their cost structure. They spend half as much per student as public institutions and one-fourth as much as non-profit colleges and universities. The authors point out that the way expenses are reported makes it difficult to make direct comparisons between for-profits and the non-profits and state universities. However, it is clear that a good portion of the cost differential lies in the fact that for-profits spend significantly less on research, entertainment and facilities.
As state governments become strapped for funds, higher education budgets have been declining and will probably continue to. The success of for-profits in providing education at lower cost may be emulated by the public sector as it faces continuing revenue constraints. Instead of making politically-motivated attacks on the for-profit sector, legislators would do well to learn how those schools manage to avoid so much of the cost that non-profit colleges run up.
Bennett, Lucchesi, and Vedder also provide a useful history of federal aid to higher education and the expansion of regulation of the industry that coincided with it. As one would expect, once the federal government became a funding source for higher education, it also became increasingly involved in regulating it, which had previously been a province of the states. There was some loosening of such regulations in the 1990s, which led to growth of the for-profit sector; that growth has, in turn, led to increasing scrutiny by federal regulators and politicians.
Increasing intrusion by various federal agencies has created “an uncertain and complex regulatory environment “ for the for-profits, the authors write. Although they don’t mention it, this will likely lead to consolidation in the industry as the fixed regulatory costs have to be spread out over the number of pupils that an institution has. That will give a cost advantage to the larger colleges and universities.
Another interesting point brought up by the authors is the effect of the disparate tax treatment of for-profits and non-profits. When non-profits need to raise capital, the donors receive a tax deduction. When for-profits raise capital by selling equity, the purchasers of stock will be subject to the capital gains tax on any gain in value. The tax structure therefore results in for-profit institutions being taxed when they are successful in reducing costs and increasing enrollment, while non-profits tend to receive more subsidies as they expand enrollment.
One area in which the authors might have expanded their analysis is the ways federal financial aid for students affects the behavior of for-profit institutions. Does it affect their course offerings? Does it affect the students who choose to enroll in them? Does it lure people who are more interested in capturing federal money than providing education into the industry?
In their conclusion, the authors hit upon what seems to be the nub of the problem so many people have with for-profit higher education: profit! “Some observers,” they write, “contend that profit has absolutely no place in the sacred endeavor of education.” Non-profit schools are supposedly pure, while for-profit ones are at least tainted.
People who think that way are ignoring the vital role of incentives. The profit motive creates a strong incentive to satisfy customers (in this case, students) at the lowest cost. The lack of the profit motive means less attention to the needs of students and less effort at making education affordable for them. That’s probably the most crucial point of all.