Address to the University of Michigan Senate Assembly:
The Economic Outlook in Higher Education

Teresa A. Sullivan
April 13, 2009

(Slide 1)

I’d like to thank the Senate for inviting me to speak a second time this year. I appreciate the opportunity for continuing conversation.

I want to focus my remarks today on the economic situation in higher education and how it affects the University of Michigan. Although I’d like to speak about more cheerful topics, I suspect that economic issues are very much on your minds as they are for those of us who work in the Fleming Building.

(Slide 2)

As you likely know from news reports or conversations with your colleagues across the country, many colleges and universities are facing serious financial difficulties. Private institutions, particularly those that rely on endowment income for operating costs, face significant drops in revenue, as much as a 25% to 30 % decrease. This means they have less money for faculty hiring, assisting students, and other costs associated with academic programs. Many public institutions are facing decreasing state appropriations and this results in hiring freezes, travel restrictions, and other sudden measures such as the across the board spending freeze at the University of North Carolina. Some institutions are planning to make up for lower appropriations by raising tuition significantly, as much as 15% at the University of Florida and 14% a year for two years at the University of Washington.

The Chronicle of Higher Education recently outlined thirteen reasons for the economic difficulties facing many colleges and universities. I think it is useful to examine some of them as an aid to understanding the situation of many of our peers. I want to point out that here at Michigan, we have avoided these problems and I will elaborate on this as I speak.

(Slide 3)

Risky investments have proven to be a source of difficulty for many institutions. They put a significant portion of their investments in hedge funds and private equity holdings. When these declined, they lost income and the value of their holdings dropped as well. Our investment policy is more conservative. We have a diversified portfolio. Our chief investment officer, Erik Lundberg, is thoughtful and highly skilled. Under his leadership, we have been disciplined, sticking to our conservative approach. The wisdom of this is now evident.

Some colleges and universities have, in the past decade, taken on debt to build new facilities or finance program expansions. When credit markets contracted, it became expensive to carry this debt. In some institutions, operating cash was invested in the market as well. When the market dropped, schools had to borrow to meet operating costs, often at rates of 8% or so. Many have seen their credit ratings drop as a result. At Michigan, we have limited debt and are less reliant on endowment income. As a result, we maintain a triple A credit rating.

Nationwide, there has been a building boom on campuses. A walk across our campus will provide you with evidence of this. A couple of things make our situation different from many others. Much of the construction you see here is being done by auxiliary units, the health system and athletics. They cover their own costs. For other building projects, our policy is that we don’t begin until we know we have the funds to build and use the new facilities. You may know that two years ago we began a space utilization project that is helping us to identify ways in which we can use existing buildings more effectively. In addition, our review process for all capital projects helps us prioritize our capital investments.

In some states, the public universities have difficult relationships with the legislature and/or the governor. Here in Michigan, the state government is generous in its recognition of the role higher education plays in the redevelopment of the state economy. The research universities have forged an effective partnership through the University Research Corridor and there is state-wide cooperation among the public universities through the Presidents Council of State Universities.

Student demographics are changing across the country. Undergraduates are often older than in the past. They are also more likely to attend community colleges and transfer to four-year institutions. If a college does not have a strong identity, it may have a hard time recruiting students, especially as the mix of students changes. We are a selective institution with a clear identity. We continue to have a large number of strong applicants. Like all other institutions, we are wondering how the admissions process will unfold this year. We expect that students will be making their decisions later than in the past, due to financial concerns. We recognize that there may be more “melt” than usual over the summer and that many institutions may go more deeply into their wait lists than has been the case in recent years.

Some institutions have faced had the unfortunate experience of poor oversight by their governing boards. Bernard Madoff’s role on the board at Yeshiva University is the most striking example of the conflicts of interest and other problems that are found on some boards. Our Board of Regents takes its responsibilities very seriously, recognizing that they are stewards of an important resource that must retain its quality for the benefit of future generations.

(Slide 4)

While we do not share the problems of some of our peers, like them, we do face rising costs. The increase in costs here at Michigan is driven our core activities in teaching, research, and training, all of which are labor intensive. Some of the increase is driven by greater activity on our part and that is both expected and appropriate. Another cost driver is investment in facilities and technology. These investments are essential to our research and teaching, but they don’t add to the bottom line. We do seek efficiencies, such as the sharing of equipment among research groups whenever feasible, and we do have research groups from industry purchasing time on some of our specialized research equipment. We continue to compete internationally for faculty and students. The positive side of the recession is that there are fewer outside offers to faculty this year than in the recent past. Finally, on the cost side, is the increase of activity over the past decade. Our enrollment is up about 5% and research volume has increased 17%. At the same time, we’ve held staff growth to just 1%. This indicates that people are working very hard and that we are making effective use of technology.

(Slide 5)

As you can see on the slide, the area of greatest growth in our general fund expenditures in the past five years has been financial aid. We think that is good, it reflects our commitment to making a Michigan education affordable to qualified students regardless of their financial circumstances. The next largest area of cost growth is in utilities. We are working to contain these costs but the market remains volatile and we expect that costs will continue to rise.

(Slide 6)

At the same time that costs increase, state support to the university has decreased. Since 2002, we’ve seen a decline in state appropriations. If state funding had kept pace with inflation as indicated by the Detroit Consumer Price Index, we would have $100 million more in the general fund than we do today.

(Slide 7)

Despite the very difficult financial situation in the world, the University is thriving. We are making robust investments in financial aid, thanks, in good measure, to generous support from donors. We’ve been successful in recruiting and retaining faculty members, in part because we maintain market competitive salaries and market-leading benefits offerings. When we have lost faculty members to outside offers, we’ve been able to replace them with very good newcomers. We’ve launched several important academic initiatives in areas such as environmental sustainability, energy, and global health as well as the interdisciplinary junior faculty initiative that will bring us 100 new colleagues doing path-breaking research they will share with our students. We’ve expanded facilities with support from private philanthropy. Last fall we concluded the hugely successful Michigan Difference campaign which raised $3.2 billion dollars.

(Slide 8)

Our success in maintaining and enhancing our teaching, research, and service activities has attracted some attention. Others are eager to learn how we’ve done this. Our white paper on cost containment is posted on the web and is getting hundreds of hits from around the country. How have we managed? The keys are diversification of revenue streams and containment.

(Slide 9)

Our success is diversifying revenue streams is tied to the success of the Michigan Difference campaign and other gifts and endowment income that provide a crucial margin for our operations. As I mentioned earlier, we have successful auxiliary operations that contribute to our success here as well. The athletics department provides $2 million annually in scholarship funds. This is not money for athletic scholarships, but for the general scholarship funds that provide support to many students.

One of the silver linings to be found in the long period of economic uncertainty in Michigan is that we have a good deal of experience in cost containment. This is an ongoing activity and has enabled us to trim $135 million from our operating budget in the past six years.

(Slide 10)

We work to maintain vibrant academic programs through the reallocation of resources. Each year the deans are asked to reallocate 1% to 2% of their budgets from lower priority to higher priority programs and activities. This helps to insure that we are offering programs that are important and strong.

In conjunction with the Flint and Dearborn campuses and with other universities, we are working to leverage our size and scale to achieve cost savings. We are also continuing to focus on reducing energy use and thus costs. Our benefits strategy emphasizes helping employees lead healthier lives so that urgent and chronic medical costs decrease. Using technology to good effect, we are developing paperless processes in areas such as graduate admissions to reduce costs. Finally, the strength of our investment and development offices and the high level of productivity among our staff are enabling us to thrive.

(Slide 11)

As you know, we are making changes that will help us to contain costs further. The university’s contribution to health care benefits will be reduced from 30% to 20%, still a very competitive position. There will be a one-year waiting period before new employees are eligible for the retirement savings plan. This will save about $6 million annually. We are looking at areas such as telephone service where we could realize savings. About 20% of the conventional phones on campus are used less than once a month. It may be that we could reduce the number of phone lines we have. We are merging the central IT services and considering limiting purchasing options. For example, we can realize a savings from vendors if we restrict ourselves to 14 colors of post-it notes, rather than offering 28 color choices. Finally, we are studying best practices for the utilization of gift funds.

(Slide 12)

We know that the coming year will hold challenges for us. The Research Seminar in Quantitative Economics predicts a sharp decline in state revenues through fiscal year 2010. This could well mean reduced funding for higher education. In addition, there may be a negative supplemental or “give back” required in the current fiscal year. We continue to keep a sharp focus on affordability, especially for undergraduates, because we know that many families are facing difficult choices. The external funding picture is mixed. Federal research agencies like NIH and NSF have increased resources, but foundations are making fewer and often smaller grants and gifts. We expect increased financial need among our students. Inflation is likely to remain low in the near term but could increase more rapidly beginning in 18 months or so.

(Slide 13)

The University is in good financial shape. We are well positioned to sustain our excellence despite the economic crisis. We are in this position because of many years of careful planning, sound policies, and a disciplined approach to spending. Our conservative endowment spending rule, prudent investment strategy, ongoing cost containment, careful budgeting practices, and investment in revenue diversification reinforce each other, enabling us to fulfill our mission of providing excellent research, teaching, and public service.

Our efforts in all these areas will continue. The prudence panel charged with recommending new cost containment measures is reviewing hundreds of suggestions that have come in from across campus. I encourage you to offer your own suggestions to them.

My message today is positive. The university is in a strong position. But the situation is fluid. We don’t know what level of support the state will be able to provide in the coming year –and we know that Lansing faces hard choices. This makes our own planning difficult. We are in regular discussion with Board of Regents about the budget. Our plan is present a budget to them in June. Students need to know what their tuition costs will be so that they can plan appropriately. While we are unlikely to know about the appropriation in June, we believe we need to assist students in their planning and thus the university will live with some uncertainty until the state makes its decisions on funding. I thank you again for the opportunity to talk with you today and would be happy to answer questions.

Click here for entire slide show.