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Week 8: Budget Systems Money matters, as we have seen. Universities implement their values by how they spend their money. While many academics do not like to talk about money, preferring instead to talk about values, the basic structure of university life requires money to express values. Academics speak often about values in the abstract. Much academic writing focuses on such issues, and many eloquent colleagues as well as critics write persuasively about the values that ought to prevail in academic life. Such commentary makes for stimulating and often inspiring reading, but when the warmth passes, and it is time to do something to implement the values, almost everything is about money. Some of the conversation is disguised. Universities appoint study commissions that meet and think and talk about what the faculty, students, administrators, and others should do about curriculum reform, about student retention, about research promotion, or about undergraduate student life. This talk appears to be free, but it is not. If faculty spend three hours a week for fifteen weeks on a task force, they spend time they might have used to develop a new course or apply for a grant or write a paper. Work of this kind is only free if someone outside the university pays for the faculty hours spent in this activity. Perhaps talk is cheap, but it certainly is not free. More important than the talk and its direct cost in lost work, however, is the budget. With few exceptions, universities spend most of their income. When they manage to create a surplus, it normally ends up paying for deferred maintenance or other pressing needs held hostage by low priority for funding in prior years. This circumstance of full expenditure has a profound impact on the relationship of money and values. Every university has a backlog of exceptionally valuable programs and ideas that it would like to implement but that do not yet have a high enough priority for funding. Improvement of student life, introduction of technology, development of new academic fields, creation of interdisciplinary programs, engagement in community activities, development of research facilities, the list is endless. For every new $100,000 available to a university from whatever source, the faculty, students, staff, alumni, friends, and supporters of the institution will have at least $1,000,000 worth of outstanding projects and probably at least another $1,000,000 of good but not quite as stellar activities. Note that none of these are worthless projects, easy to dismiss. University people have no lack of imagination, creativity, and wisdom, and their good ideas overwhelm the funding capacity of the institution. Every university decision about money is a decision about relative values. If we buy student activities and not research development, we have made a choice among competing values. If we choose to renovate old academic buildings rather than upgrade the football stadium, we make a value-based choice. If we choose to subscribe to electronic journals for the library rather than increase faculty salaries, we make a choice based on our values. Each year, the university's budget serves as a snapshot of the values the institution chooses to support that year and has supported in previous years. Some will say, "Oh, no, you have it wrong. The university can't just choose to do something different with its money. It is constrained by this rule, that regulation, this contract, that state requirement." This is true to some extent but misses the point. The values that the university's budget expresses do not necessarily reflect those of one individual, one group, but rather the values that the institution has acquired from all sources over the the years. The snapshot of a single year's budget demonstrates those values, without assigning blame or credit to anyone in particular. It is simply an objective, straightforward demonstration of the things that the university chooses and has chosen to spend money on. For better or worse, those are the things that the university, its many constituencies, and its funding sources value enough to buy, as contrasted with the other things that the university might have chosen to buy but did not. The proof of this proposition is easily demonstrated. Whenever any group wants to change the university's behavior, it almost always does so by buying a different behavior through the budget. State legislatures are among the most aggressive in this activity, although the federal government from time to time also intervenes. If the legislature thinks there should be smaller classes (they value smaller classes over larger ones) it will pass a law that changes the distribution of the budget to support small classes or if the institution is fortunate, it provides a supplemental appropriation to pay for the extra costs of the smaller classes. If a donor wants to see ethics taught at the university, she can provide an endowment in support of teaching ethics; if a corporation's CEO wants to see new business techniques researched at the university, she can provide a grant that pays for the research; the list is endless. These examples demonstrate that people know they can affect the university's values by changing the budget. Yet, the introduction of new activities funded with new money does not usually pose a major challenge to the university's values, even though it does affect them. When someone offers to buy something, say a new program, with new money, the university does not evaluate whether the proposal is the highest and best use of new money. Instead, it simply asks whether the new value is compatible with the university's mission and current values, and if it is, it takes the money and implements the new program. Internal change in the allocation of money, however, gives a much clearer view of the university's fundamental values. No university budget is ever constructed from zero (even if the process carries the name Zero-Based-Budgeting). Instead, all university budgets result from incremental adjustments implemented over time. Probably at least ninety-five-percent of a major university's budget supports the same activities this year as it did last year. Over many years, however, the five percent that does change shifts the institution's priorities. Over time, the money that no longer pays for the teaching of Latin and Greek goes to pay for the teaching of computer science and environmental studies. This change represents a change in values: computer science and environmental studies become more valuable to the university today than the study of Latin or Greek that were valuable yesterday. Every time the money buys something new or ceases to buy something old, the university's values have changed; and over time, the values can change a lot. Because of the importance of budgets, the university world is filled with systems for managing the budget. These often follow fads that have currency in the corporate world, and universities tend to adopt these fads about the time their effectiveness has faded from the corporate environment. Zero-Based-Budgeting, for example, had some currency a generation ago. This fad said that every year the institution should build its budget anew, questioning each expenditure in light of the organization's current values and opportunities. In practice, this system produced a labor intensive budget processes that resulted in marginal adjustments to the next year's budget. Like other fads, this one contained its germ of truth. Institutions do need to understand their business from the ground up, they do need to review the accepted priorities periodically, but they do not need to pretend that everything every year is new. Another system goes by the name Responsibility Centered Management (or RCM for short). RCM is another quasi-corporate import. It rests on the assumption that every unit in the university generates both income and costs. If the university makes each unit responsible for earning its own income and controlling its own costs, the university at large will be most efficient. The budget system defines the Responsibility Centers (a department, a college, an administrative service unit) and then creates the financial and bureaucratic infrastructure to assign income and costs to the centers. If a center spends more than it earns, it must reduce its expenditures or increase its income. If it earns more than it spends, it can reinvest the surplus in its operations. This system has a beautiful simplicity and the appearance of tough, no-nonsense management. It appeals because it appears to put the authority for success into the hands of the local responsibility center managers. An additional advantage of this method is that it tends to remove the conversation about values from the upper administration to the responsibility centers and perhaps lets the invisible hand of economic determinism and the market adjust the budget and, in the process, determine values. A number of institutions embraced RCM and implemented all or parts of the system. RCM, however, has had a difficult history for a number of reasons. The most important, is that RCM makes some assumptions about the relationships between income and expenditures that are not entirely true in most universities and particularly public universities. RCM imagines that a unit's income is controlled in a significant way by the unit. In most colleges and universities in America, and especially in public institutions, student-driven income is only partially related to the cost of the programs that produce it. Students taking expensive courses in physics or music performance are charged the same tuition as students taking inexpensive courses in western civilization or art appreciation. While some universities do charge a premium for engineering and some other lab sciences or allied health programs, the majority of undergraduates are charged a flat rate for attendance. As a result, a system that allocates income in terms of what students pay (when they pay the same average price) but charges units for the cost of the services provided (when those services have widely varying costs) cannot function as planned. Units with inexpensive instruction make subsidy profits; units with expensive instruction incur artificial losses. Universities could, and do if they implement versions of RCM, make technical adjustments to the earned income streams of various units depending on some understanding about relative costs, paying the physics department more for the courses it teaches than it pays the English department. The process of determining these differential costs, however, creates a complicated relationship. High cost programs receive an income increase relative to the cost of their program, not relative to their efficiency. Efficient programs under these income adjustment systems, may suffer because they are efficient and inexpensive; expensive programs may also benefit because they are inefficient. The process of making such adjustments in a university can become a political conversation and in that case many of the benefits of the impartial market adjustment fade. Another difficulty of RCM lies in the system for allocating centralized costs. If each unit is a responsibility center and pays all its costs and receives all its income, the university must assign the costs of physical plant, parking, landscaping, heat, light, general administration, and other similar overhead costs. One way to deal with these is simply to charge a standard overhead cost to all units (much as is done with grants and contracts). This solution, of course, falls into the same problem as the allocation of income. Some units require much more overhead than others. Laboratory sciences, for example, use many more common resources and much more expensive space than do history departments. If instead of a centrally allocated overhead cost, units pay directly for their own overhead for such common assets as building and plant, this creates a significant incentive to sub-optimize. Rather than pay for scheduled maintenance, the unit may choose to defer maintenance to increase current revenue, leaving to the next group of academic leaders the problem of paying for the deferred maintenance. Another challenge is the result of the core concept of RCM: the university will hold the units responsible for their financial behavior. This means that if the college of arts and sciences runs a deficit of $2 million dollars, the university must insist that the college reduce its budget or increase its revenue by $2 million dollars. In practice, most universities have found this form of accountability difficult to implement both for structural and political reasons. In the arts and sciences case, if the cost overrun is the result of salary increments for which no revenue appeared, the structure of academic compensation is such in most institutions that no salary reduction among the faculty in that unit is possible. Neither is it easy to effect a reduction in personnel in the unit with the cost overrun. Significant numbers of professors are tenured, others that are not tenured may well be major revenue earners as a result of teaching large classes or earning significant grant or contract revenue, and any dismissals would require massive due process procedures. As a result, the institution often subsidizes the deficit, the administrator responsible for the deficit returns to the faculty, and a new dean will not take over the operation unless the administration agrees to cover the deficit to start off with a clean slate. This cycle, obviously undermines the point of the exercise, for if the unit does not bear the cost of failing to meet its fiscal obligations, then RCM loses a the key benefit of enforcing fiscal responsibility and accountability. Equally difficult is the case of the college that succeeds dramatically under this system, either by virtue of a low cost structure or efficient and imaginative management. This unit will generate a large surplus. It may spend that surplus on enhanced salaries, improved amenities for the faculty and students of the that unit, and other benefits that come with profitability. However, the guild systems of the university almost always intervene to limit the permissible upside growth, again undermining the financial neutrality of the RCM model. Perhaps even more problematic, the RCM model does not offer good incentives for quality, but instead seeks primarily to maximize the positive result of the income-expense equation, leaving to chance the reinvestment of surplus in quality. This lack of an explicit reference to quality (and the fact that there may be no easily referenced real market against which the units can measure the quality of their products) greatly reduces the effectiveness of RCM as a tool for university improvement. University success requires money, but it requires money invested in improved quality as well as improved productivity, and it must know whether its investments actually do result in quality improvement. In most universities, a final challenge of RCM comes from the complexity and sophistication of the data required to allocate costs and income accurately to the units. Because neither all costs nor all income exist in a marketplace where the units can buy and sell effectively, but rather represent negotiated and managed costs and expenses derived from the university's internal decisions, what began as a technically neutral market-like system to enforce fiscal responsibility and create incentives can become a politically driven argument about the algorithms for determining the cost and income allocation system. RCM like other budget methods has its important truths. It recognizes that university efficiency and productivity is rarely a top down phenomena but instead works best when it is driven by the units that do the work. RCM's responsibility centers focus on the people who generate the income and incur the costs. These people know best how to improve. It is also an excellent model for focusing attention on a careful analysis of income and expenses, a topic much neglected in academic administration. Drawing on the experiences of universities following RCM, as well as the lessons of other budget models used in the past, universities today often have hybrid models that implement the best features of various systems. The most effective versions focus on value budgeting that identifies the critical elements in the budget process that will support the improvement of productivity and quality.
A value budget focuses on quality and productivity in the university's two primary products: teaching and research. The separation of these two elements of the university's work and the assignment of all costs (other than overhead) to these functions serves as one of the key elements in the success of the model, although not without significant controversy. Equally important, however, is the development of a model for benchmarking quality and measuring quality improvement. Because quality evaluation is a much less well developed field than financial measurement, this part of the model takes much longer to propagate across the institution's various units than financial elements. Finally, the value budget exists in combination with a set of institutional requirements that establish a baseline of performance for all units (in a public university case, this baseline may focus on enrollment management because the institution's state funding rests on an enrollment funding model). The university must create measurements and indicators of productivity and quality that will inform a budget that can drive improvement in both of these university values. In reviewing the materials in this week's readings, we need to consider questions such as the following:
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