For some time, the business model that supports traditional colleges and universities has been breaking. The ability to continue to implement sustaining innovations—more research faculty, more extravagant facilities, more administrative positions—that add cost by using increased revenue from a mixture of tuition, government funding, endowment returns, and donations is in peril for many institutions.

As a result, we’ve written about how there are a number of traditional higher education institutions that will likely merge or even cease to exist in the coming years. Many have suggested that this could not happen—despite the fact that a state like Georgia is already consolidating its public institutions of higher learning; that the situation is not so dire; or that it is something for which there will be a fix at some point.

Although this may prove true, the emergence of disruptive innovations powered by online learning—institutions like UniversityNow and Southern New Hampshire’s College for America—that are making higher education fundamentally affordable and potentially more focused on the learning outcomes that employers and students need—portends something different. Even as the great middle of traditional colleges and universities in the United States are perhaps most vulnerable, a telling in-depth article in the Yale Daily News last spring reveals that the elite schools are hurting, too. And if they are hurting—with their significant endowments and generous alumni who have a vested interest in maintaining the brand of their respective institutions—we should not underestimate the change that is coming for the broader world of higher education.

The article relates how even five years after the onset of the recession, revenue sources have not bounced back at Yale: “More and more students require financial aid, endowment investment returns are still down, government funding is declining and tuition and fundraising increases are limited by the weak economy.”

Yale’s revenue does not cover its expenses today. If it cannot eliminate a projected $40 million annual budget deficit, Yale’s reserve funds will run dry, the article reports. And although Yale will be ultimately fine, it will likely have to cut back on its expenditures. By doing so, Yale will cease to keep up with the cost of remaining competitive in a world of sustaining innovations and could fall away from its mission of providing equal or better educational and research opportunities for generations to come.

Built into Yale’s model are unavoidable rising expenses. The costs of its food ingredients continue to escalate. Its labor expenses for the university’s technical, clerical, and dining hall workers are set to rise 3 percent each year through 2016; excluding benefits, these labor expenses cost Yale $689 million in FY2012, a quarter of Yale’s operating budget. What this tells us is that to sustain an operation such as Yale’s is expensive; to sustain and improve—through the implementation of sustaining innovations—is even more so.

On top of this, as at many institutions, Yale’s students who enjoy the luxuries of the college dining halls cost Yale money. According to the article, roughly 57 percent of Yale’s undergraduates received some form of financial aid in 2011-12, but even the 43 percent who paid the full tuition rate of $52,700 (!) only covered a fraction of the amount that Yale spends per student. That might not be a problem, but Yale’s increased financial aid commitment—to admit students regardless of ability to pay and cover every student’s full financial need—has resulted in financial aid costs that have quadrupled over the past decade to $120 million in 2012.

Although eliminating its need-blind financial aid policies could perhaps solve Yale’s budget woes, Yale administrators say that that option is not on the table.

The bigger point for traditional institutions of higher education beyond Yale is that with the repeated annual tuition increases over the past few decades, the middle class is increasingly being priced out of much of higher education. Yale has been able to manage this by extending financial aid to cover those students whose families earn below $60,000 annually and by substantially reducing the contributions for other income brackets, but most institutions cannot do this. And Yale educates only roughly 5,400 undergraduates at any one time, a blip in the greater college landscape of 21.8 million students per year enrolled in America’s colleges and universities.

What this points to is that in the long run, the nation will not make higher education affordable by allowing people to afford what is an expensive education. The way to make higher education affordable will be by offering options that are fundamentally lower cost—and therefore can be priced less as well.

The limits of the former strategy become clear when one understands Yale’s financial model more deeply. As the article relates, “To meet rising costs, Yale’s financial model assumes that revenue will grow each year. But many of the University’s traditional sources of revenue — endowment income, tuition, government funding and alumni gifts — cannot keep up with the rising costs of all components of the Yale experience.”

A prime example? Despite posting a 4.7 percent return, the Yale endowment decreased in value last year because Yale spent more out of the endowment to cover operating expenses than the endowment returned.

This points to why unrestricted gifts to Yale’s Alumni Fund matter so much—as these gifts, unlike funds for the endowment or for capital projects—can be used for deficit relief. But even Yale can’t raise enough through this vehicle to cover its losses, and the story outside of Yale—where at many institutions the practice of alumni giving is weak—is undoubtedly bleaker.

Higher education experts across the nation call on the government to make up the difference. But the U.S. government itself is running up against its own pile of red ink and committed obligations that will increase in the coming years and are squeezing the funds available for higher education.

Although people continue to wring their hands and hope for a change—along any one of these dimensions—the reality is this is why the nation so sorely needs innovators in higher education who create new, fundamentally affordable models that don’t rely on federal funds so that they are not prone to the reality that is the gridlocked political process and the tide of red ink facing the American government. Hoping for change may be a nice thing to do, but it does not constitute a strategy.

Although Yale may be fine in the years ahead, unless they make drastic changes by either disrupting themselves or focusing so deeply on an important Job to be Done instead of trying to be all things to all people, many institutions will not.


  • Michael B. Horn
    Michael B. Horn

    Michael B. Horn is Co-Founder, Distinguished Fellow, and Chairman at the Christensen Institute.