Why discount rate suddenly matters

For the longest time, I used to tell people that discount rate didn’t matter. I always had a sense of it, but one day during a trustees finance committee meeting in the mid-90s, one trustee was complaining about discount and said the increase was unsustainable.

At the time, tuition was something like $20,000, and our discount rate was something like 30%, meaning our net revenue per student was something like $14,000 per student. A finance professor responded to the trustee, saying he thought we should actually raise the discount rate to 80%, and raise our tuition to $100,000.

The trustee, who was a banker, instantly saw the error of his ways. That scenario would mean we’d net $20,000 per student, and, assuming you’d have the same number of students (you wouldn’t, of course), you’d be substantially better off. Even if you lost enrollment (you would) you could still be better off because your total revenue could increase, even as your costs decreased. (This was mostly an intellectual exercise…I would not recommend increasing your average cost by 43%). Discount rate was irrelevant; it was a function of a numerator and a denominator. While it may make sense to benchmark your own tuition discount rates in a trend analysis, it’s not a worthwhile to compare yourself to other institutions charging different tuition rates.

This also holds true for rising tuition discount rates. Or at least it did.

Warning: There will be a little more math here.

First, I’d recommend that you go through these slides from a presentation I’ve been giving for a while. The takeaway–if you want to skip the slides and the math–is that if you raise tuition faster than inflation, you will almost certainly either increase your discount rate, or you will lose enrollment (because you’ve raised your price, supply/demand, yada yada, yada.) This can be a problem, but it’s probably not the problem most people think it is.

Those were the good old days. Now, when you see articles like this one in Higher Ed Dive, and you see a graphic like this in Inside Higher Ed……

….you realize you may have a problem, because colleges are keeping tuition increases much closer to the rate of inflation these days. That means that net revenue–the really important measure, because you run a university on cash, not accounting ratios–is shrinking. And that’s a big problem.

I did a visualization to show discount and net revenue per first-year student here. Even with a tiny data issue that causes numbers to be off a bit, you can see that discount and net revenue are different things. And you can see that some institutions with high discount rates are likely to do just fine.

What do you think? Tweet at me or post a reply.

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