Is discounting dangerous? Caught in an 'arms race,' higher education needs to find a way out of the tuition discounting spiral.

Internally, it's an ongoing topic of discussion; publicly, administrators avoid the subject like the plague. Either way, tuition discounting has been a fact of institutional life for some 30 years. In the late 1990s, however, warnings were raised that the practice might not be working as intended. Now, new studies by the National Center for Education Statistics (nces.ed.gov) and the Lumina Foundation for Education (www.luminafoundation.org) have demonstrated that those fears have, in fact, become reality. In a nation faced with a sour economy and ever-heated competition among IHEs to attract the best students, tuition discounting could cause greater harm than the good for which it was intended, say the studies' authors.

According to the Lumina Foundation's "Unintended Consequences of Tuition Discounting," released in Nay, poorly managed tuition discounting strategies can impact colleges and universities in several ways:

* Discounting may unintentionally reduce student accessibility and affordability

* Institutions that pay for discounting by shifting funds from instructional and student services may impede their own efforts to improve student retention and attainment

* Some colleges may be courting fiscal danger because of the discounting practices

"The evidence we have is significant enough to show that for higher education in general, especially private colleges, tuition discounting isn't working," Jerry Davis, vice president for Research at the Lumina Foundation and author of the report. "When you take the collective experience, as our report says, you do run into unexpected consequences."

Works for Some

That's not to say that some colleges can and do continue to grow and thrive under their tuition discounting policies. Tuition discounting works for some colleges, says Martha Lamkin, president of the Lumina Foundation. But to be truly effective, tuition discounting should simultaneously attract students and increase revenue for institutions. Expanding access for lower-income students will succeed only when a school ensures that enough financial aid is available specifically for that purpose.

"Most of the tuition discounting that is currently thought of as leading to disaster is the simple tuition discount that is totally unfunded," explains Ron Allan, assistant to the dean for Research and Data Services at Georgetown University (DC). Allan has authored several studies on tuition discounting. Ironically, "I suspect tuition discounting works welt for those schools that have a good market position to begin with, and probably don't need to use it," Allan says. He adds that not much has changed since his 1999 study entitled, "A Taxonomy of Tuition Discounting" (www.georgetown.edu/users/allanr) except, perhaps, for a newfound willingness to talk about it.

"Because college finances are difficult to explain--and because college administrators sometimes don't want the public to know where their money comes from or for what purposes it is expended--higher education has been less than forthcoming about such concepts as tuition discounting," he says. "In some states, there were actually laws against giving tuition discounts," he points out, "and since they were given anyway, it really had to be covered up, so people were unwilling to talk about it in public."

Now, the Governmental Accounting Standards Board (www.gasb.org) rules (which established standards of state and local governmental accounting and financial reporting, and which were implemented in fiscal year 2001 for public colleges) are being absorbed by their financial departments and institutions. "The fact that there are accounting rules gives them some cover," he says. "The public schools are now marginally less reluctant to talk about it."

Still, willingness to talk about tuition discounting is far removed from doing anything about it, and reform may be some time in coming, suggests Allegheny College (PA) President Richard Cook. "There's no doubt that we are in a marketplace, and there are pressures in that marketplace. We are forced to respond to those pressures whether we like it or not. Individual institutions have limited ability to shape their financial aid policies in significant ways," Cook says. "That, to me, says there needs to be a national conversation about what our financial aid policies are doing, and a recognition that individual institutions are acting in ways that they must, to survive and grow--but that those ways might be changed and be made to be more rational if we began a national conversation about it."

Back to the Roots 

Until the late 1970s, financial aid was awarded on the basis of need, and colleges competed on a variety of levels besides price--scholarships, academic strength, location, and even athletic programs were a part of the mix. By the end of the decade and into the early 1980s, enrollments dropped at colleges across the country as the number of high school graduates declined. It was then that price competition heated up.

"The initial leaders in using tuition discounting got a market edge on the others," explains Davis. "But then, virtually all colleges and universities got into the tuition discounting game." With so many schools offering discounts, says Davis, the playing field became level once again. In order to gain or hold a market position, colleges offered merit aid and even greater discounts, creating a cycle that some analysts have likened to an all-out arms race.

The problem intensified when many colleges and universities began using more of their tuition revenue to pay for scholarships and discounts, says Davis. "As a result, they found they had fewer net tuition revenue dollars for instruction, academic services, student support services, and the other things that go to running a college as a business organization."

Students and their families who had the ability to pay for higher education didn't necessarily have the willingness to pay for it, and many colleges and universities dug deeper for discounts to continue attracting these students. Combined with the enrollment arms race, it meant that schools had to further deepen the discount (to a current average of about 39 percent nationally), leaving fewer resources to spread around.

"This is only a recent phenomenon," says Davis. "Up until the late '90s, this wasn't the case, but now lower-income students are actually getting a smaller share of the dollars and it is hurting their access."

Allegheny's Cook agrees: "There is a national phenomenon of increasing the merit-based portion of aid for students, that's been developing now for several years. The amount of aid that is available for institutions to give is growing but limited, and there is concern at many colleges and universities that the neediest students are receiving proportionally less aid."

Consequences

The recent work by the Lumina Foundation, Allan, and NCES points to some real dangers for higher education if tuition discounting is left unchecked.

Reduced financial access for lower-income students. According to NCES surveys, the average dollar amount of institutional grant awards rose faster for higher-income undergraduates than for lower-income students, at public and private four-year schools. In 1995, the average private school grant aid for high-income students was only 39 percent as large as the aid for lowest income students ($1,359 versus $3,446). Just four years later, however, aid to higher-income students jumped to 82 percent of the average aid given to lowest-income students. Similarly, by 1999, aid to lower-income public college students remained almost unchanged from 1995 figures ($838 compared with $836), while higher-income student aid jumped from $239 in 1995 to $619 in 1999.

This, says Davis, is a recent phenomenon. "As a researcher, I've been following this situation for about 15 years. When institutions substitute state grant money and other money for their own money and give it to upper-income students, there's a concern that lower-income students would at some point begin to lose," he says. "I was encouraged over the years--until this recent study--that that hadn't happened. But now the thing that I feared would happen has."

Part of the problem is that federal subsidies have not stayed in step with rising tuition costs. Over the years, as colleges started giving more money to affluent students they still had sufficient funds left to give to needier students. Then, as it did with so many other sectors, the slumping national economy landed squarely on higher ed. Most schools were forced to raise tuition. Fiscal constraints meant fewer federal dollars to subsidize aid at public schools, while at private schools, endowments suffered.

"As a proportion of costs, the federal subsidies are not growing as fast," says Allegheny's Cook. "That is, even though Pell grants may have grown by $500, tuition has risen even higher, so that amount may not have the same impact on total cost."

The Lumina study also suggests that one reason aid may have increased to middle-and upper-income students is that the formula for calculating ability to pay is indexed to inflation and changes in tax rates: "Students from middle- and upper-income families with identical incomes in 1995 and 1999 would have Lower Expected Family Contributions (EFCs) in 1999 and, therefore, higher financial need. Cost of living and tax rates increased between 1995 and 1999, so even if the family earned the same amount in both years, it would have fewer resources available to pay college expenses in 1999."

But, because the lowest-income students' EFCs would be zero in any year, their financial need would rise by only the increase in their education expenses, says the report.

Discounting does not always increase student quality. For all the claims that tuition discounting and merit aid are useful toots in helping schools compete to attract the best students, the research suggests otherwise. In fact, tuition discounting and merit aid doesn't seem to make a difference in scores or the types of students that enroll.

"What surprised me most [in the research] was that schools were not achieving their intended end," says Lamkin. "For those schools that had the deepest discounts, the net [tuition] revenue did not go up--in fact it went down--and the SATs only improved marginally." Indeed, between 1995 and 1999, even with widespread discounting and merit aid, median SAT Verbal test scores decreased at 45 percent of private institutions and 44 percent of public institutions.

Discounting doesn't always increase institutional revenue. Conventional wisdom holds that increasing enrollment through discounting should, in turn, increase net tuition revenue and thus institutional revenue. And, in well-managed programs, this is true. However, as the Lumina Foundation study and others show, if financial aid expenditures grow faster than tuition, then net tuition grows more slowly, and can even decline. The "arms race" analogy is particularly apropos here, because just as the Cold War arms race severely crippled the Soviet economy, so too can the emphasis on tuition discounting without additional revenue sources, deprive a school of funds for instruction and facilities.

In his 2000 study "Discounting Toward Disaster," Kenneth Redd of the USA Group Foundation (precursor to the Lumina Foundation) showed how four-year private schools raised spending on institutional grants by $3,375 per FTE undergraduate, but tuition and fee revenue grew by just $3,069. "Due to the large losses in revenue, these institutions had smaller increases in the funds they devoted to academic instruction and other educational services to students, and had declines in spending on maintenance of campus buildings and other facilities." Moreover, wrote Redd, the schools in the study saw their retention and graduation rates decline, because their efforts were focused more on increasing first-year enrollments than on helping see students make it to graduation.

"Unfortunately, there are signs in some of the financial markets that a number of schools may be putting themselves in harm's way by using this practice," notes Lamkin. "Several of the national ratings services such as Moody's Investment Service and Standard & Poor's Ratings Services have, in fact, issued bulletins to that effect," she says. "In at least one case, tuition discounting has been listed as a contributing factor to the jeopardy the school is in."

Bryant College (RI) President Ron Machtley is quite aware of the delicate balance between spending funds to supplement tuition, and sustaining the institution. "When you are providing financial dollars from your institution to assist your students, you've got to try to keep that amount of money as a relationship to the total revenue coming in," he says. "At Bryant, we think that balance is in the 30 percent range. There are, however, some schools that are providing 40 percent or higher of their funds in aid, and that is a dangerous spiral. They have fewer revenue dollars to use for their programs, even if they have a large endowment."

Machtley believes that the free market will reward schools that are responsible with financial aid and will penalize schools that are not. "Ultimately, those schools that are not doing the appropriate thing will not have a student body that is sustainable, and their budgets will not be sustainable," he says. "Schools that are focused on 'buying' the best students by giving them more financial aid often ignore an equally important aspect, and that is to develop a student body that is diverse and which is not just coming from affluence."

Solutions

Faced with the problem of varying discounts and their effect on revenue, the logical question might be, why not lower tuition all around? Of course, most aid at private colleges comes directly from the school rather than state or federal sources (as at public institutions), but the question is a good one: Since most students receive some form of discounting, why not just lower the sticker price of the school and give everyone a break?

While the idea sounds plausible, it carries several limitations that could make it fail along the way. Chief among them is a school's risk of losing market position, as well as students.

"If you lower your tuition for everyone in that way, and your demand curve for students who want to go to your school doesn't change, then you lose the revenue associated with the full-pay students," says Georgetown's Allan. "I'd think most schools that might consider reducing tuition across the board aren't in the position to do that without losing revenue."

A few schools have, in fact, taken this approach in recent years, he says, most notably Muskingum College (OH). "Muskingum conducted substantial market research before they took this step," says Allan. "They discovered that if they lowered their tuition it would probably tilt their demand curve in the appropriate direction, so the loss in revenue would be more than compensated for by the increase demand by students to go to Muskingum. So far, it appears to have worked."

Davis agrees: "Muskingum is a classic example of returning from a tuition-discounting pattern to flat tuition. They are the poster child for this particular approach because it was successful for them," he says. "They were able to achieve their enrollment and financial goals, but at the same time, they're the first to admit this isn't for everyone." Allan says a better approach would be for an institution to devote its efforts to raising additional gift money specifically for student financial aid.

"Most of the discounting that the Lumina report warns is leading to disaster is the simple tuition discount that is totally unfunded. But in the university world, if you say 'let's raise money for financial aid,' the reply is, 'That's fine, but what good does it do for the university?'" Allan says. "Until about four years ago, the financial aid crowd was stuck for an answer; it was clearly an altruistic thing to do but perhaps not terribly helpful."

However, Allan says, if an institution with a 4 percent payout rate raises, say, $25 for financial aid and puts it in the endowment fund, that will increase gifts and endowments by one dollar, which in turn decreases the simple tuition discounting by one dollar forever. "And if you do enough of that--as Princeton has done in spades, and as Stanford has done--then your financial aid starts to be funded. Not only can you afford the tuition discounts, but because you are in a stronger financial position, you don't need the tuition discounting so much."

A Much Needed Conversation

In the end, will colleges and universities be able to call an end to the tuition arms race? Or will they continue discounting toward disaster?

"I don't think they can [end] it by themselves," says Davis. "I don't think an individual college can say it isn't going to do this anymore. It will have to act in concert with other colleges, and they will need to get some of the antitrust legislation changed in Washington, so that they can return to administering financial aid on the basis of need."

Says Allegheny's Cook: "It's important to emphasize that we at individual colleges are virtually helpless to act on our own to reverse the situation. If we were to establish a financial aid policy that we felt was entirety rational and really emphasized the original intent of financial aid, which is to meet financial need, colleges like us--and that is the vast majority--would be at a severe disadvantage when it came to attracting students."

But, Lamkin says, that shouldn't stop IHEs from having a much-needed conversation about the direction of financial aid. "Our goal in publishing this research was to support a conversation among a whole range of parties--certainly the institutions themselves, but also the policymakers and other foundations," she says.

Cook agrees that legislative changes would be necessary, "but those changes aren't necessary to have these general policy discussions. We really should be discussing where the financial aid system is leading us. It is absolutely essential that we do that," he says. "And I think that can be done openly and toward the best interest of national higher education."