Why Deep Tuition Discounts May Not Spell Financial Doom

They can be a useful tool as long as tuition revenue is solid

Larry Ligget for The Chronicle

At DePauw U., in Indiana, the tuition-discount rate is high: 59 percent. That's "not where you want to be," says Christopher Wells, a vice president.
May 02, 2010

Many colleges have taken a whack at their sticker prices with heavy tuition "discounts"—knocking off big dollar amounts with institutional grants to get students in the door.

DePauw University, for example, discounted 59 percent of the total tuition it charged last fall's incoming class. So while the small liberal-arts university, located in Greencastle, Ind., charges about $33,000 in tuition and fees, it doles out enough aid to cover all but 41 percent of that amount.

The university's discount rate far exceeds the average among private colleges, which hit a record of 41.8 percent in 2008, according to a report by the National Association of College and University Business Officers. These growing financial-aid expenses, particularly for merit aid, have led to hand-wringing in higher education and the news media. The arms-race approach to attracting students may not be sustainable, some experts say.

But does heavy discounting mean trouble for an institution's financial health? When a college discounts more than half of its tuition, is it in a fiscal death spiral?

The answer, many experts say, is not necessarily.

A high discount rate is like one flashing light on an oil tanker's control panel—it's worth keeping an eye on, but is only part of the complex alchemy of pricing in higher education.

"Just quoting a rate won't tell you enough," says Lucie Lapovsky, a consultant and the former president of Mercy College, who was until recently a primary author of the annual Nacubo report. That's because discounting can cut both ways. "Sometimes it's a revenue generator, and sometimes it's not."

A more valuable financial indicator is net tuition revenue—total gross tuition minus grant aid. To get a better idea of how a college is faring, experts say, look at how much tuition money it's adding to the operating budget, whether that amount is increasing, and how it compares with the cost of educating students.

"There's no magic to the number" of a discount rate, says Richard A. Hesel, principal and co-founder of the Art & Science Group, a college-marketing company. "It's all about net tuition revenue."

Heavy discounting can pay off as a short-term tactic if it's part of a strategic enrollment plan and accompanied by good marketing. Another key, if more students enroll, is whether the college can handle growth without having to build new facilities and hire more professors.

In October, Moody's Investors Service, which rates colleges' debt, issued a report that questioned DePauw's fiscal stability. The university has faced deep operating deficits, mostly because of investment losses and declines in giving. The report also pointed to the university's high discount rate, which climbed from 52 percent the previous year.

But Moody's said one crucial number was moving in the right direction for DePauw: a 28-percent increase in net tuition per student over the last five years. As long as more tuition money is flowing toward the university's budget, high discounting might not be a problem. And DePauw has the capacity to handle this year's large incoming class, university officials say, and can discount less in coming years.

DePauw's 59-percent rate is "not where you want to be," acknowledges Christopher J. Wells, the university's vice president for communications and strategic initiatives, who was also the recent interim head of its admissions and financial-aid offices.

He expects that the university will decrease that rate and that future classes will pay a bigger share of the sticker price. "We've got some indication that we're leaving money on the table."

A Crowded Field

Discounting in higher education began in the 1970s, as college admissions officers copied the pricing systems used by airlines and other businesses. The approach of charging as much as people would pay was novel in the academy.

As the Nacubo report says, discounting "acknowledges that students' decisions to enroll can be influenced as much by their willingness to pay the costs of attendance as by their ability to do so."

Discounting took off in the 1990s and is now the norm for both private and public colleges. However, private institutions award 64 percent of all annual grant aid in the four-year sector, according to Nacubo, despite educating about 30 percent of undergraduates.

The practice can serve worthy goals in addition to filling seats. Most notably, discounting can be used to increase diversity or to draw students with special skills, like musicians. However, some research suggests that, on an industrywide basis, discounting may actually freeze out more lower-income students, who are more sensitive to sticker shock and not as likely to receive merit aid.

As it is with most things, generalizations about discount rates don't apply to über-wealthy colleges. About 30 institutions have coffers deep enough to meet all student need, and many do not offer merit aid.

But for the thousands of colleges that joust for students outside of that rarefied air, discounting is crucial to enrollment management. Admissions offices use merit aid and combinations of need-based and merit aid to draw students and to adjust their institutions' academic profiles.

DePauw has more money than most, with an endowment of $425-million, although nowhere near enough to match the aid budgets of Ivy League universities. The bucolic campus, with 2,400 students, located about 45 miles west of Indianapolis, is in a region where discount rates are often sky-high.

Indiana and Ohio are loaded with strong public universities, which have developed honors colleges that draw students who would have attended private colleges in the past. Liberal-arts colleges are also plentiful in the Midwest, and they compete for a shrinking number of academically prepared high-school graduates, many from families whose wages have taken a beating in recent years. As a result, it's no surprise that discount rates at DePauw and several of its competitors, including Denison University and the College of Wooster, have topped 50 percent.

In flusher times, families were willing to pay for perceived value, says Robert J. Massa, Lafayette College's vice president for communications and acting dean of admissions and financial aid. Now he says they ask, "What am I getting for my extra dollar?"

Partially as a result of discounting, DePauw's net tuition is relatively low. The university collects about $14,000 per student, according to Moody's, compared with an average of $19,000 for similar small, private colleges. And like many private institutions, DePauw must cope with a big gap between tuition revenue and the cost of educating each student, which is about $36,000.

But the university is unlike most in that its tuition revenue is increasing. Net tuition actually fell 2.5 percent nationwide between 2007 to 2008, according to the Nacubo survey, as discount rates outpaced tuition and fee increases.

New Markets

DePauw blew past its enrollment target last fall, welcoming 717 freshmen to its campus instead of a projected 635. The glut of students followed a drop in enrollment in 2008, and was driven by aid, leading to the high discount rate.

Mr. Wells says administrators heard "doom and gloom" about the admissions picture when they were crafting the financial-aid approach for last year's class. The result was aid packages that were too large in some cases.

"We've probably been unnecessarily sweetening the pot," he says.

Equilibrium is hard to find in a recession, says Thomas C. Longin, a veteran consultant and expert on college finance. Universities were "learning to cope with what was really a crisis situation."

The big question, Mr. Longin says, is, Can they right the ship and bring down discount rates? And how quickly? If it's a fine-tuning of a few years, "I don't worry about them as much."

Mr. Wells says DePauw expects to reduce its discount rate by at least five percentage points with the next class, and to stay below 55 percent over the next few years. That will bring the four-year rate down below 55 percent, because students generally pay a higher portion of the bill after their first year.

For DePauw, having a discount rate of less than 55 percent means "millions of dollars a year" in new tuition revenue, Mr. Wells says.

But this year's highly discounted class will obviously affect the university's financial-aid budget for years. "That elephant's got to move through the snake," he says.

Key factors in DePauw's favor are good retention rates and the fact that the university was able to deal with the big class. Some doubles in dormitories were converted into triples, but no major expenses like temporary housing were needed.

In addition to cutthroat competition with other universities, Mr. Wells attributes DePauw's high discount rate in part to successful fund raising and scholarships. (About 30 percent of DePauw's institutional aid is strictly need-based, with a significant chunk of the rest blending need and merit aid.)

The university has increased its share of minority students to 16 percent from 12 percent a decade ago. DePauw also gives grants for music performance to students in its acclaimed School of Music, cultivates lower-income students with two cohorts of Posse Foundation students at high schools in Chicago and New York City, and also began recruiting internationally five years ago.

"Breaking into markets like that can be expensive," says Mr. Wells, and "also pushes up discount rates."

Sarah R. Wallace, a university trustee and a banker, says she would like to see DePauw discount less. But in the meantime, she says, focused aid will remain part of DePauw's admissions approach.

"We will do what we can, but we are not going to sacrifice our strategic priorities."