Before making a switch to education over 20 years ago, OESIS Network President Sanje Ratnavale had a 15-year career in finance including positions as CFO of a public company and Director at a Venture Capital Fund; he has been CFO of a K-12 independent non-profit school in L.A. for seven years managing an $80 million asset base and a $30 million budget. His passion, however, remains for teaching and learning.
Two years ago in our COVID Survey April 2020 Report of 154 Schools (page 19) at the dawn of the pandemic, we stressed that it was time that independent schools take a cue from McDonald’s and stop the “all-day breakfast” mentality. What did we mean and did anyone take our advice?
“It is not just schools that are learning this hard lesson in product management through this crisis, but others that have allowed brand management to fall prey to ever-increasing customer demands on choice. McDonald’s recently reversed course by eliminating all-day breakfast after five years, a service they had resisted for years, but customers had demanded: all-day breakfast made customers delay breakfast purchases impacting breakfast sales in the mornings and it took away from higher-margin lunch purchases.”
It is clear from the recent OESIS Head of School Survey March 2022 of 84 School HOS that another threat to survival has reared its head. Inflation. One that now brings the extensive choice mentality of schools into direct conflict with unseen realities around recruitment. The chart below shows that 81% of Heads are “fairly or very concerned” about inflation impacting recruitment and retention of faculty (I am assuming both housing and consumables).
Inflation may not seem like a new phenomenon for schools since for decades now schools have increased tuition with abandon at way above the rate of inflation. At best we viewed this as a benign disease — a malady considered by many as natural to education, like an infectious laugh; but dark clouds are manifesting, unlike any seen before.
Named after its proponent, Baumol’s cost “disease” has assumed that education and healthcare costs could keep rising harmlessly in perpetuity. In a nutshell, Baumol argued that rising costs in “stagnant” or labor-intensive sectors (without the typical potential for productivity gains) like the arts and education are offset by dramatically reducing costs in high growth “progressive” sectors like technology. Musicians are not going to get more productive, they produce music, but TVs and phones get cheaper through greater productivity. Baumol posits that it is basically an offset, so there is nothing to fear because the rising profitability through productivity in one sector affords the rising inflation in the other. Here is a quote from an ISM Independent School Management, Inc article (2014) very much cheerleading this approach and exhorting schools to keep on doing what they have always done:
“Within the disease itself lies the answer. Inflation is the antidote. Baumol says that, although costs will grow alarmingly high in the stagnant sector, they will decrease at similar rates in the progressive sector. The disease creates its own cure…ISM believes the evidence of Baumol’s cost disease is well-documented. Private-independent school leaders do not need to be concerned that our costs outpace inflation.”
The independent school budgeting process for decades has been based on filling gaps through donations, increasing tuition, and inflating the cost base. We asked Heads in this March 2022 survey how effective this process is today and we found that less than 50% found it very effective.
An approach to budgeting that relies on the thesis of Baumol’s cost “disease” is now facing some extraordinary factors that together, and even separately, make it look like a very shaky foundation.
- Very Low Unemployment Puts Teachers in the Driver’s Seat. In the US unemployment is at 3.6%, 1/10th of a percent below its 50-year low, along with over 11 million job openings and a labor participation rate (62%) at a 30-year low. The services sector as a whole (healthcare, technology services, financial services, media services, etc.) was approximately a 50/50 split with manufacturing when Baumol advanced his thesis in 1965 but now services are closer to 85% with manufacturing at 15% of the GDP pie. There are a lot more services today paying much more (thanks to the higher-margin knowledge sector and the internet) than there were 50 years ago. These services also have fewer barriers to switching skills through re-training than any such change to progressive manufacturing sectors had experienced over the past 50 years. With teachers burnt out from the pandemic and weighing teaching as a profession against more flexible service opportunities, this is not a good time for schools to be offering compensation or wage growth that is acutely below what other services sectors will pay for their talent. Can your school offer 5.6% salary increases?
- Teachers are doing a lot more. One of the real problems with the Baumol disease theory is that it assumes that teachers basically teach like musicians play and artists create. The demands on full-time exempt teachers, however, have exploded over the last 30 years, and independent school teachers face a customer base with expectations of service and student-parent support, unlike anything teachers faced 30 years ago. So in many ways, their “real” pay may have been declining on an hourly basis while taking home more work and additional responsibilities outside of school hours.
- More Work for Little Pay. The annual tuition increases of 2-4% over the last 30 years, therefore, do not account for all those extra invisible hourly responsibilities. While some schools offer stipends for additional tasks, the value of the additional compensation falls far short of the teacher’s personal time (these activities often occur on weekends and evenings). Other exempt service sectors may seem a lot more appealing in this context and other hourly paid services may appear to offer a fairer, more transparent deal.
- Tuition rises have been funneled to non-teaching costs. Perhaps the biggest problem for schools (and Baumol’s theory) is that their administrative costs have risen much faster than anything else. According to NAIS Stats at a Glance, Administration Salary Expenses PER STUDENT in 2003 was $1,674 and in 2021 was $4,140. That is 147% growth, way above the rate of inflation. Every dollar that is added to administrative costs reduces a school’s ability to offer salaries that are appealing to teachers, particularly the most sought-after ones in the recruitment process. A lower portion of the tuition increase can go to teachers as more of it has to support the extra administrator costs (whose salaries and benefits are higher). This is exactly what the 2012 study of higher education by Martin and Hill found, forcing a re-evaluation of Baumol’s theory: when organizations can tap other sources of income like donations, student loan funding, or state funding, they hire more non-teaching staff because they can, and that has nothing to do with any correlation between stagnant and progressive economic sectors. Martin & Hill report that only 16% of the rise in higher education costs had an impact consistent with Baumol’s theory.
- Extraordinary “coinciding” inflation, of course, is the biggest issue. Baumol’s theory had been tested with general consumables inflation 40+ years ago, but we now have two extraordinary inflation problems coinciding:
- Housing inflation. The inflation-adjusted median price of a home relative to the median income has been rising rapidly, particularly in the last 10 years. This did not happen during the previous inflation shock 40+ years ago. The prevailing rule of thumb is that you should not spend more than 25% of your take-home pay on housing. Here is a quote from a Head of School who emailed me recently: ”many of my faculty members’ housing costs are nearly 40% of their income after taxes. Meanwhile, the cost of real estate is going through the roof.” Why would millennials invest in a teaching career when it offers little opportunity for a house and a family? The housing market (like the stock and bond markets) has been inflated by the huge unending stimulus of the Fed since the 2008 recession, and now the pandemic has driven that even higher as suburban house prices explode. Teachers are some of the primary victims. As interest rates rise (and therefore mortgage rates) they are even further priced out of potential affordability.
- Consumables inflation. The impact of inflation on gas and grocery prices caused by the supply base shocks, the Ukraine war, and a rapid reconsideration of globalization has been unseen in the past several decades (currently at 8.5%). These are not effects likely to disappear rapidly. Once inflation expectations embed, they are painful to dismantle.
- Teachers aside, a rising tide has not lifted all the boats of our customers. From 1979 to 2020, productivity grew by 62% but wages by 17.5% (Source: Economic Policy Institute). Most of the profit benefits of that productivity went to corporations and the uber-rich: so the middle class is increasingly priced out and we see that with the huge necessary increase in our schools’ financial aid budgets. Can schools increase tuition at 8.5% or more in the years ahead?
One thing impacts another. All-day breakfast at McDonald’s was impacting higher value (margin) lunch item sales. All-day breakfast is the equivalent of independent schools piling on additional programs and the corresponding administrators. The financial model becomes more strained, the schools become top-heavy, and the value of the core educational program is eroded. Take a look at Chart 24 of two different schools’ Math sequences from our 2020 Covid Survey Report (page 46) – both independent schools with equal College track records in the same metro area. What might be the cost differential?
Baumol’s theory works for a world with a steady supply of teachers without the non-teaching job temptations of a very low unemployment rate: a market where teachers are not priced out from the housing or rental market by their low compensation, a teaching profession where the outsize demands of the workday are not impacting its nobility and the day-to-day pleasure of helping children, a profession not in a cycle of declining “real” wages failing to keep up with even the rising costs of basics like food and gas, and a market where schools can simply add content experts willy nilly.
Take a look at the responses from the recent OESIS Heads Survey of 84 Heads in March 2022 below. This is a supply base approaching a crisis point: 76% are “fairly or very concerned” about too many responsibilities on teachers, and 64% are “fairly or very concerned” about not being able to fill course gaps with stipends or overloads, and as we said earlier, 81% of Heads are “fairly or very concerned” about inflation.
We then asked Heads what would be their solution if recruitment becomes very difficult in the near future.
It is not surprising that most of the top responses, advertising, hiring teachers without Masters degrees, using more search firms, and giving more overload compensation prioritized the easiest alternatives. These are all quick-fix responses to longer-term challenges. The only real path to sustainability without compromising quality lies with the other options: reallocating teacher time to higher-value uses, reducing extras, and reducing the creep of the scope and sequence. It would be tempting to think that this would diminish the quality of the program but actually, it could dramatically improve the quality of the program, improve teacher job satisfaction, and enhance student wellness and agency. It could even provide greater school alignment with the mission. Most importantly it would contribute to financial sustainability.
However, to get to that promised land will require real capacity at the leadership level and visionaries at the Board level. It will require schools to think less about “brand management” from a marketing lens (enrollment strategies or financial aid or glossiness) and more about it from a “product management” holistic lens (think trade-offs and what the student really wants and needs, aligning with the mission). Brand management is more about the perceived value of what you are delivering (more content looks like more learning opportunities) whereas product management is more about the measurable value proposition where the rubber meets the road (how does the experience translate into enduring skills and competencies?). We made this point in that same Survey of 154 Schools in March 2020 at the dawn of the pandemic:
“McDonald’s decision reflects a strong product management perspective, an understanding of what is core to the survival of the business, a laser focus on conserving resources that are fundamental, and a capacity to act quickly (to pivot) and get ahead of other threats to survival. The choice that students need is not a large catalog of courses but the choice that comes with student agency, the choice that comes with project-based inquiry, the choice that comes with equitable starting points while each student develops a discrete set of valuable skills.”
Next time you want breakfast for dinner, think about the McDonald’s strategy and think about the future of your school.
You may also be interested in Part 1 of this series: OESIS 2022 Head of School Survey Report, Part 1 of 3: Governance | Sanje Ratnavale
If you are an independent school Head and want to continue this discussion please consider applying to join our OESIS Head of School Listserve (there is no cost to participate and comments are not to be shared without permission) moderated by Sanje Ratnavale, President of OESIS Network, Inc.