False Incentives
I am not alone, I guess, in not finding management accounting a wholly engrossing topic; it is thus a risk to ask you to pay attention to it. I beg your indulgence however, because I have come to realise that in order to understand higher education strategy it is essential to engage with how the money is distributed within universities. Despite the many pages recently devoted by the newspapers, and particularly our 'trade press', to the higher realms of university finances, almost no attention is paid to the mechanisms by which these finances are turned into education, research and knowledge transfer.
This is a shame because many of the characteristic behaviours of universities are rooted in the peculiarities of their financial management and the strange systems of false incentives that they give rise to.
For those who have never worked in a university, some introductory explanation is necessary. In a typical commercial setting financial control is largely exercised at senior levels in the organisation. Even relatively small amounts must be signed off by executive management. The ability to purchase goods and services externally is carefully restricted. There are a limited set of 'business units' whose interactions, mediated by products or services, with the external environment, are constrained. There is a, more or less, straightforward bottom line and the objective: to maximise shareholder value, is unambiguous. Universities are not like this.
In a university every individual researcher operates as a small business in their own right. They manage many separate accounts, some of which may be for research, others for services and work with industry, and yet others (variously titled, but at UCL called 'discretionary' accounts) that support investment, smooth the peaks and troughs in the 'operational' accounts, and pay for those essentials, such as continuing engagement with the scholarly community, that cannot be paid for directly on the operational accounts. From both sets of accounts they purchase goods and services that they specify.There is some oversight from management of this situation but it is limited by the complexity of the accounts (each of which has different rules of operation) poor information systems and a highly individualistic, entrepreneurial culture. The major control is through broad policy and accounting mechanisms.
Because a university serves a complex set of social purposes many of it's activities do not yield a financial surplus, or even wash their face. Some subjects are, by virtue of their costs or ability to attract external funding, more less permanently loss-making. Yet, the intellectual mission of a university means that they merit continuing support. Research, a defining purpose of a research-intensive global university, barely covers it's own costs even in the most favourable environment. It is thus essential that in addition to a system that provides for the large shared overheads of running a university, which are unequally incurred, there is a requirement for a system of extensive cross-subsidy.
As far as I am aware each university handles this in its own idiosyncratic fashion. No system is perfect, so the systems change with regularity. The systems can oscillate between either damaging strategically essential, but loss-making activities, or a confiscatory regime that strangles initiative. Often the friction point is the matter of 'carried over' losses and surpluses. Allow a large negative balance to be accumulated by a unit without sanctions being imposed, and this is unfair on those who live within their means; on the other hand permanently shackle a unit to a historic debt and you effectively prevent investment in order to address the underlying problem. The same applies to surpluses, confiscate surpluses and by this means remove future investment in success and discourage activities that generate a financial return; on the other hand allow large surpluses to be accumulated and tie up money that could deliver greater benefits elsewhere.
The worst systems (common in universities that use a formula resource allocation system) give rise to two 'currencies': money that can be saved and spent and credit ('scrip') that is traded centrally but cannot be used freely. The consequence is that the scrip becomes devalued and only activities that generate so-called 'real' money are valued.
An experienced academic manager will know how to play this game. The most common pattern is, in fact to hold back, principally educational, initiatives that will lead to additional work and a financial surplus that, chances are, they will never see the benefit of. Much better to invest the effort in research which confers a reliable 'status' return even though it might be marginally loss-making in financial terms.
Universities tend to organise around a dominant annual financial cycle. This is strange because our basic products and services have a 3 to 5 year horizon. It takes 5 years (at least) to introduce a course, recruit to it and see the first cohort graduate. It takes 5 years (at least) to identify a research area, build an activity and develop a funding pipeline. The external funding environment in the UK has however been so volatile and so blown by the winds of government policy that, when combined with a varying yearly settlement from the funding council, funding horizons have really closed in. No manager within a university can wholly rely upon any planning or strategic assumptions having currency beyond the immediate period, any strategy is thus an act of faith. The idea of budgeting for any period beyond the year end is simply fantasy. Academic managers are compelled to adopt a short-termist approach that maintains their immediate political position.
Most universities have an extensive system of internal trade. The main commodity in this trade is students. If you teach a student from another department you obtain a fractional return on that student. If you send a student on one of your courses to study in another department a portion of the fee they pay follows the student. Those departments under financial strain, will duplicate provision available elsewhere. Popular subjects will have little incentive to offer content that is accessible by students from elsewhere in the institution (particularly of they are paid in scrip). The consequences, a fragmentation of the curriculum and proliferation of modules bedevils many universities.
Universities have large shared overheads which must be met. In a commercial business there are a limited set of products and a well understood apportionment of costs to those products. While pricing is not easy in any setting there is at least a chance that some sort of pricing discipline can be imposed. Universities however engage with across an immense range of products and services with a large and diverse set of customers (for want of a better word). In order to guarantee that the overheads are met, and some degree of consistency across the institution, costing norms have arisen - for example the overhead chargeable on industrial research. This has over time morphed into a costing mentality rather than a pricing mentality. A business seeks to maximise it's return and generally recognises that much of its activity is marginal with respect to its fixed costs. Academic managers are constrained by their own costing straightjacket (I have worked a system in which I was fined the difference between the negotiated overhead and the nominal overhead) and are consequently unable to price to get the work.
UCL now operates an internal profit and loss account system. It is by far the best such scheme that I have had to work with and I commend it to others. It is not immune from some false incentives but at least has the merit of transparency. Habits however, ingrained by previous schemes (in UCL a formula driven resource allocation model), are very difficult to shift and some irrational behaviours come after a time to seem normal indeed the established thing to do. When an outside observer looks at the university system and sees these irrationalities they have good reason to throw their hands up.