Tuition Discount Rates Are Rising

Good news for students may be bad news for private colleges and universities.

The National Association of College and University Business Officers (NACUBO) released its biennial tuition-discounting survey in April. The results indicate that increasing discounts may be the canary in the coal mine for serious financial difficulties looming for private colleges.

The headline from the NACUBO press release is that discount rates for private higher-education institutions are up from 46.4 percent to 56.2 percent in the last 10 years. (The numbers in question apply to first-time undergraduates.) NACUBO defines the tuition discount rate as “the total institutional grant aid awarded to undergraduates” by colleges and universities, as “a percentage of the gross tuition and fee revenue the institution would collect if all students paid the full tuition and fee sticker price.”

In addition to the higher discount rate, the number of students receiving some kind of “grant” rose from 88 percent 10 years ago to 91 percent this year, and the amount of the average grant rose from 53.1 percent to 62.1 percent.

Lower tuition is good for students and families, of course, but enticing students with cheaper fees can be extraordinarily damaging to colleges’ bottom lines. As NACUBO puts it,

Private colleges often advertise high sticker prices compared to public institutions. To enroll students who are unable or unwilling to pay those high prices, colleges employ tuition discounting strategies that subsidize a fraction of the sticker price through financial aid grants. As the competition for students gets more intense, private colleges will be pushed to increase their tuition discount rates in order to enroll the same number of students.

NACUBO tells us what these increasing discount rates have meant for institutions: “After accounting for inflation, net tuition and fee revenue decreased by 5.4 percent per first-time undergraduate and by 5.9 percent among all undergraduates.” Net revenue is what institutions have left to cover their costs, and it is going down.

Higher discounts may not necessarily be bad—if, for example, endowment income has grown to cover it. But “56.5 percent of grant aid funding came from undedicated sources of revenue, including unbudgeted general funds, unplanned contributions, and foregone revenue. An additional 28.6 percent came from institutional reserves.” In other words, private colleges are drawing students with money that might otherwise have gone to cover operational expenses.

Colleges to prospective students: “We’ll charge you what we think you can afford.”Higher discounting could help institutions grow enrollment, but that isn’t happening either. Instead, higher discounting is the result of “extreme” competition between institutions, and “more and larger discounts are not universally resulting in enrollment growth,” according to NACUBO.

The numbers bear that out. Undergraduate enrollment at private, nonprofit, four-year colleges has declined every year since at least 2017.

Let’s take a deeper look at college and university discounting practices and see why they haven’t worked to solve enrollment or financial problems. In many ways, colleges and universities operate like businesses. Although a lot of press has been devoted to the sky-high costs of higher education, most students, like buyers of airline seats or new cars, don’t pay sticker price. Tuition pricing is complicated. Competition, subsidies (via government-sponsored loans and grants), varying value propositions, perceived quality, price discrimination, and discounting are all factors that result in the net price that a student actually pays. You could say that the college financial-aid process amounts to “tell us everything about your finances and we’ll charge you what we think you can afford”—up to, of course, a declared sticker-price maximum.

Price discrimination is the practice of selling the same good or product for different prices. Generally speaking, airlines sell seats cheaply to leisure travelers who book far in advance and sell the same seats at much higher prices to business travelers booking at the last minute. Similarly, colleges sell seats at higher prices to wealthier or less academically accomplished students and offer them more cheaply to high test-scorers and financially needy students.

The idea that a seat in a college class is “sold” is anathema to most college faculty and administrators, but the fact is that admission slots are sold in ways that would be familiar to both car dealers (who discount sticker prices) and airlines (who price discriminate). When you are sitting in your seat on an airline and look at the person next to you, he or she almost certainly didn’t pay the same price that you did. Colleges’ admissions pricing works the same way.

College-admission slots are “sold” in ways that would be familiar to both car dealers and airlines.Discounts serve to lower net revenue, a result that has especially stressed mid-tier privates. In-state public tuition is, in most cases, significantly lower than that of comparable privates and is rarely discounted. Since, like most products, the basic, public-college experience provides 95 percent of the utility of luxury models for a fraction of the price, there is heavy pressure on the privates to lower their net price to the cost of in-state public rivals, especially for desirable students. At the same time, there is also a lot of institutional pressure to maintain “selectivity” and enroll the best students (as measured by GPA, standardized test score, or, increasingly, immutable physical characteristics like race). But those students are the most “expensive,” and institutions compete for them like airlines compete for budget travelers—by offering discounts.

As any economist knows, prices clear markets, so having to heavily discount your sticker price is a sign that supply exceeds demand. Trustees and administrators of higher-ed intuitions should have concerns similar to those of Tesla’s shareholders, whose stock value plummeted 14 percent on the news that the company maintained market share by discounting its sales price. Companies with rising costs that are forced to heavily discount because of competition and other market conditions will find themselves in financial difficulties. GM’s collapse into government-sponsored bankruptcy in 2009 had roots in the Motor City’s practice of overproducing cars and using heavy discounts to stoke sales.

Just like airlines with a fixed number of seats, colleges are incentivized to discount their tuition to fill otherwise empty slots rather than letting them go empty. Colleges often employ staff and consultants to determine the optimal price point for each student. This effort, begun in earnest in the early 2000s, has probably reached the point of diminishing returns, and further discounting won’t yield higher net tuition or better students. Also, the value proposition for a college education, which dramatically increased enrollments starting in about 1970, has probably hit the diminishing returns part of the curve, as well. College was worth the tuition charged in 1970 and the debt incurred because it dramatically increased your lifetime earnings. But, since then, the prices have soared and the outcomes stagnated.

The trends in college and university discounting show that the business model of many less-selective private institutions is under severe stress. Escalating costs (too many administrators and faculty in low-enrollment programs), as well as revenue pressure from general enrollment declines and discounting, may lead to a crisis in financial viability for many institutions.

The business model of many less-selective private institutions is under severe stress.Finally, increases in price elasticity mean that students are becoming more sensitive to increases in price. Rising discounts could mean that colleges become less able to attract full payers to offset the higher discounts given to “better” students. It could be that college tuition prices are entering an area of elasticity after years of price increases far above the general level of inflation. Factors affecting price elasticity—including demographics and the declining college value proposition—are headed in the wrong direction for many colleges and universities.

There is worse news, too. Sticker prices have been rising more slowly than the general rate of inflation for the past four years. Since sticker-price growth has been flat, net revenue is declining as discounts rise. NACUBO again: “Rising tuition discount rates can depress net tuition revenue per student if a college does not raise its sticker price in lockstep or line up other sources of funding to pay for financial aid grants.” Of course, declining net revenue is only a problem if costs are flat or increasing, which they are.

As illustrated in this recent Wall Street Journal article, more and more students and parents are realizing that financial-aid offers are negotiable. That is driving discounts higher. Tools like this one help drive discounts to even greater heights by helping students realize that tuition might be negotiable.

It is important to note that the NACUBO study is about averages, and many institutions are doing fine. Those with strong brands, large endowments, and the ability to be very selective in their admissions are discounting less and have even seen net revenue growth. But there is a large swath of the higher-education universe that must dramatically change their business models, or they won’t survive. Perhaps it’s time to learn another good business discipline—cutting costs.

Chris Corrigan was Chief Financial Officer at Andrew College (1998-2005), Emory College (2005-2008), and Armstrong State University (2015-2017).